IFR Asia RMB Bond Markets Roundtable 2016: Part 1

IFR ASIA: Good morning, ladies and gentlemen. So, Tim, what’s happening in the renminbi bond markets? How do you see the funding landscape for potential issuers?

TIMOTHY YIP, HSBC: I’m delighted that the PBoC has continued the path of Rmb internationalisation in the way that it now offers global issuers additional avenues in terms of Rmb funding.

If we rewind back to 2007, when we had the first offshore Rmb bonds, people didn’t really know what Rmb was or were not very familiar with it. Then fast-forward to 2010, when the first multinational issuer arrived and for three or four years there were a lot of MNCs, sovereign entities, you name it, issuing offshore. The only problem was the size that people were able to achieve. About Rmb1bn–Rmb2bn (US$150m–$300m) would be the maximum size that an issuer can raise in the offshore market.

Currently, because the PBoC has reopened their interbank bond market for foreign issuers, people can now raise much larger sizes – as demonstrated by some of the private placements and publicly syndicated bonds that have been issued onshore by corporates and financial institutions, for example sovereign entities like Republic of Poland and Republic of Korea, and of course HSBC as well.

The second point is about the cross-border Rmb flow. Previously people would issue offshore and then try to repatriate the funds for use onshore. Now with the new avenue they can directly issue a Panda bond onshore and deploy the funds onshore as well. There have been lots of savvy and market-ready issuers constantly examining the onshore and offshore interest rate dynamics. If it’s cheaper to issue offshore then of course they would go offshore. If it’s most beneficial to issue onshore from an interest rate perspective and fund usage perspective then they would do it onshore.

IFR ASIA: At the moment it looks like it’s a lot cheaper onshore, no?

TIMOTHY YIP, HSBC: Yes, but at the same we have to also be pragmatic about time lag effect, because currently every single issuer wanting to access the interbank market or the exchange market needs to go through an approval process, either from PBoC, NAFMII, CSRC or the exchanges, depending on which market you want to go into.

So if you want to be opportunistic and you want some funding let’s say by next week then the offshore market would be a lot more flexible than the onshore market.

IFR ASIA: Okay. Where do we stand on the buyside? Is Dim Sum, the offshore CNH market, still attractive for you, Ben?

BEN YUEN, BOCHK: Yes. I think to answer this question you should look at the total return point of view. If you look at the Dim Sum bond market total return in the first eight months of 2016, if we measure by, let’s say, the FTSE-BOCHK Offshore Rmb bond indices, the total return annually is 7.7%. Onshore, one of the indices we can use is the CSI Aggregate Bond index, where the total return annually in the first eight months is only around 4.9%. So you can see from the total return point of view the Dim Sum bond market looks more attractive.

On the other hand if we compare the yields in the two bond markets, the onshore market is a bit cheaper for the issuer than offshore. The offshore Dim Sum bond index yield is around 3.35% and for the onshore indices at the moment is 3.2%.

From the investor’s point of view I still think the offshore Dim Sum bond market looks more attractive at the moment. But when we invest we also need to consider the size of the portfolio. If the portfolio size is, let’s say, US$100m–$200m, the Dim Sum bond market I think is perfect, given the returns and liquidity for trading.

For a US$2bn–$3bn portfolio, I think those investors should definitely be looking at the onshore market. It’s not just the size and liquidity, but the number of issuers is definitely more than the offshore Dim Sum bond market.

So two points: from a total return point of view the offshore Dim Sum bond market is still attractive, but if you’re looking for size then the onshore bond market is the first choice.

IFR ASIA: Freddy, do you share a similar view?

FREDDY WONG, FIDELITY: At the end of the day we have two fairly open markets, with a different investor base. To an extent if you are an issuer and you need your funding sitting onshore for domestic usage or in an offshore market for global usage, you may prefer to come into a different market from that perspective. If you’re purely looking for domestic funding the onshore route is the preferred one for you to raise money easily.

At the same time if you’re coming into the offshore market you may actually need US dollar funding. The Dim Sum market to an extent can provide you some value by issuing in Rmb and converting into US dollars so that on a cross-currency swap basis you may actually benefit from a lower cost of funding.

I agree with Ben that the size of the onshore market offers much more liquidity. If you look at the onshore market it’s US$9trn equivalent, while the offshore market is about US$300bn equivalent at this point of time.

The total return perspective is interesting, because to an extent the offshore market has priced in a certain liquidity premium because it’s still a relatively new market. It’s only got a five-year history. A series of issues have come to the market across quite a spectrum, but at the same time you do have some credit events. Investors need to differentiate the good and bad credit quality, and to an extent the US dollar credit market can help you to benchmark some of those offshore Dim Sum bonds. Especially, for example, where companies have issued Dim Sum and US dollars, you can look at converting the Dim Sum to dollars to compare the returns. Dollar credit has been running big time this year, so you might benefit from higher returns on some high-yield credits by investing in their offshore Dim Sum bonds.

For onshore credit there has been an easing bias in government policy and interest rate cuts. The onshore 10-year CGB government bond has traded from 3.3% to now about 2.7% for seven-year duration, which is quite a powerful return.

You really have to think right now of two different markets, but with a roadmap for how these two markets will trade going forward, whether it’s becoming one single market or it will remain separate until the point that everyone has free access.

IFR ASIA: As the borders come down these yields should converge, shouldn’t they?

KEN HU, INVESCO: Yes and no. In the longer run, yes, they should converge. Maybe before we go into this area let me introduce the view of Invesco on China’s debt market. We actually see China’s bond markets from a very top-down global context, from global asset allocations to content. China is the second-largest economy in the world and the bond markets rank number three in the world in terms of size, but when you think about how much the global portfolios have allocated to China’s bonds, basically it’s almost zero.

Now foreigners only account for about 2% of this big market. If you look at the other markets like Malaysia, Indonesia or some other smaller markets like Canada, foreign investors usually account for like one third or almost half of the total market size.

Back in China, foreigners only account for 2%. That does not make sense. We see China as a very strategic market to us from a global asset allocations point of view. I’m not talking about how much the Rmb has appreciated or depreciated just this month or this year. I think this is too short term.

In the longer term we should look for diversification. We have done a lot of macro studies on China, and we find that the Chinese economic cycles and the interest rate cycles have very different features from the others, which means that it’s not very important whether we should include offshore or onshore Rmb bonds. What’s more important is the diversification benefits that China is able to give to international bond investors.

If you look at the current global environment, if you look at some indices like the Barclays Global Aggregate Index, the global one has about one fourth of the index yielding at negative nominal yields. So for global funds it makes a lot of sense to put Rmb bonds, no matter onshore or offshore, into global bond portfolios. One point is to increase the diversification benefits because of the different interest cycles in China and so on. Another point is to increase the yields – when you compare to JGBs or German Bunds, they give you negative yields. In China, the Chinese government gives you almost 3% at 10 years. So from the US perspective it makes a lot of sense.

A lot of the people are now complaining about the depreciation of the Rmb but my colleagues sitting in London have a very different view. They say: “Hey, the renminbi is great. It’s been appreciating against the British pound!”

Maybe Hong Kong investors are too oriented towards the US dollar, but in a global context if you talk to European investors they will see that the renminbi is a very strong currency.

We have done a study that says if China is going to be included into some major global bond indices – I’m not going to name which vendor – we estimate that there will be around US$400bn–$600bn inflows into China just due to benchmarking activity. That means a lot of investment opportunities and also business opportunities.

TONY TANG, DAGONG: Let me just add one point on the Barclays index. It’s a good measure when you come to investing onshore, especially when you’re looking to the correlations between Rmb onshore versus the global market. There’s a low correlation by all measures, and it generates quite a high Sharpe ratio for you to actually diversify your portfolio as Ken mentioned. The importance of diversification is not just for asset-class diversification but also investor-base diversification for China, you can attract a lot of foreign investors to come in your debt market.

IFR ASIA: There are still a lot of hurdles preventing people from getting free access. What’s changed on that side, and what needs to happen to move it on even further?

MUSHTAQ KAPASI, ICMA: I can speak from a more global perspective. I think there is still a sense, even after all these years of internationalisation of the renminbi, that China is very foreign. The legal system is still uncertain, the regulatory policy making is opaque and unfamiliar, and there are language and cultural barriers.

We’re seeing some major steps, especially in the last couple of years with the PBoC’s announcement to open up the market to foreign investors, for example, and now the opening up of Panda bonds that is getting a lot of issuers interested in the Chinese market as well.

There’s still a sense that it’s difficult to enter the market. One example is the PBoC’s move to open up the market to foreign investors. They made a huge announcement in a public forum earlier this year, which was welcome to everybody globally. Over the last few months there have been some guidelines but there’s still some work to be done in terms of the actual implementation.

If you ask an average small fund manager in Europe “Would you like to buy bonds in China? It’s legal, you can do it.” They’ll say “How do you do it?” as they don’t really understand it. They have to get their heads around the credits, around the legal system, around the market dynamics and the operational requirements.

There’s still a fair bit of investor education to be done. I think including renminbi in the major benchmark indices would be an enormous signal to the market that it’s OK to invest in Chinese bonds. Once you get a critical mass of global investors coming into the onshore markets then it will open the floodgates.

I think we’re already seeing this with the Rmb’s inclusion in the SDR, at least from sovereign wealth investors. Again that’s more of a high-level development, but when you get the bond indices involved then it’s going to start happening.

JINI LEE, ASHURST: I think it’s actually a very exciting time to be in the markets. As Mushtaq said earlier, we’ve seen China really opening up and the emergence of Panda bonds has been causing a lot of excitement in the last two years. The flow has slowed down a little bit recently, and a lot of that I think is due to regulation and timing and various hurdles which the panellists have mentioned about issuing onshore including getting approvals from the regulators.

From a legal perspective the onshore process for issuing is still markedly different from offshore. Timing-wise there is no way you’d be able to do an onshore bond issuance in one week as Tim mentioned earlier. If speed is of utmost importance then offshore markets are still a lot more attractive.

In the last couple of years we’ve seen a lot of PRC issuers coming offshore to issue when the markets were favourable and then think about how to bring the money back onshore. It’s interesting how that’s flipped and how issuers are actually finding it cheaper to issue onshore. The market dynamics will continue to evolve and really it’s still a question of how the proceeds are going to be utilised. If there are overseas projects, where money has to come out of China, it might make sense to issue offshore because the money is already there.

The different legal systems are another big driver for people choosing to issue onshore versus offshore, and from the investors’ perspective the trust in the system that they will get their money back.

TIMOTHY YIP, HSBC: That’s a very important point for foreigners wanting to access the Chinese market. If you look at a lot of the western economies they practice common law and that has been the basis for a lot of the jurisdictions. China has used civil law for almost 5,000 years and civil law is just the way it is. A lot of issuers or investors are perplexed about why this method has worked only one week ago for another client but this time around only a week later it doesn’t work for them. It’s because of the civil legal system, where we actually respond to the changing dynamics.

It’s a very important point for anybody wanting access to the Chinese market to really understand this fundamental difference.

MUSHTAQ KAPASI, ICMA: We’ve spoken with a large number of potential Panda bond issuers around the world to get their thoughts on the current process and how it might be improved. A couple of points came up. First of all there is a huge amount of interest in issuing into the Panda bond market. Surprisingly it’s not just for the obvious reasons you might think. There’s a huge amount of variation among issuers, whether they be sovereigns, multilaterals, corporates, financial institutions, small issuers, large issuers, international issuers, or local issuers. They see a number of different attractions to the market. Some of it is purely economic: they can just get better funding than in their home currency. Some of it is more operational – they have a lot to do in China and they can use the funds onshore for their ongoing operations. Some of it is more political – improving relationships within China. Some of it is investor diversification. There are a number of different reasons why they might be interested in accessing the market.

However, the consistent negative feedback about the market, if I could put it that way, is simply the lack of certainty. A lot of issuers are more than happy to jump through a number of different regulatory hoops. They don’t mind the extra rating requirements, they don’t mind extra work on the documentation or the accounting side, they don’t mind extra time to get the approvals through. All of this can be priced in; all of this can be planned for; all of this can be managed. The problem is the uncertainty.

I think until that is solved you’re still going to see a relatively limited world of foreign issuers coming in. Once you can get a bit more concrete substance around the timelines and the requirements for issuance then that’s going to open the door for a lot of issuers that are still not quite comfortable with the onshore market.

IFR ASIA: Probably a year ago now we were writing about Panda bond rules that were about to be released. NAFMII was doing a lot of work on what an issuer would need to do to get access. What happened to that, where are we now?

JINI LEE, ASHURST: That’s an ongoing process. We’ve all asked the same question ourselves in terms of when the rules are going to be published. I think there are various reasons, politically and regulatory, why they haven’t appeared yet. At this stage we can only wait for them to come out.

IFR ASIA: Do you think something will still happen there?

JINI LEE, ASHURST: I think so, yes, it’s just a matter of timing.

BEN YUEN, BOCHK: The point about the Panda bond market is interesting. I prepared some numbers: if you look at Dim Sum bond issues year to date we’re talking about Rmb76.4bn. For the Panda bond market including corporate deals and private placement deals you’re looking at Rmb61.8bn. It’s not that big yet, but compared with the Dim Sum bond market it’s quite similar. That’s the first part.

The second thing I want to mention about the Panda bond market is the focus on development. Why is that? Because for foreign investors considering the onshore bond market, one of the big questions is the credit quality of the onshore issuers. That’s a big question mark. This year to date we have had 23 defaults in the onshore bond market, and that’s beyond the expectations of foreign investors. So foreign issuers that are global, international names can help develop the onshore renminbi bond market.

We touched on the legal area but haven’t started to talk about accounting. The accounting standard is also one of the barriers for bond issuers to print in the onshore bond market. At the moment the Chinese regulators only recognise Hong Kong accounting standards or IFRS accounting, as it is similar to the Chinese type of accounting, but exclude other international standards.

I think the Panda bond market can develop a bit faster if this can cover more of the world.

IFR ASIA: Any view on when that’s going to happen?

MUSHTAQ KAPASI, ICMA: The accounting issue is very much front and centre for the Panda bond market. It’s a complex problem, and not something that can be solved overnight. There are a number of policymakers and regulators involved in the determination of which accounting rules can be accepted in the Chinese markets. There’s also a geopolitical element. You have to look at how other countries treat Chinese issuers in their own jurisdictions. I think that’s something that certainly the Chinese are very aware of.

In some of my discussions with Chinese policymakers the point is made – validly I think – that ultimately this is the domestic Chinese market. If you are issuing in a domestic market which presumably consists of domestic investors, then they are used to a certain accounting standard. If any issuer wants to enter that market then perhaps it’s not unreasonable to ask that they use the same standards that the onshore investors are accustomed to.

Now of course the counter argument is that if you want to open up the market and globalise it then you should be more flexible. To be fair, there is precedent in other jurisdictions for accepting foreign, non-domestic accounting principles for the markets. I think the answer is somewhere in between.

If you step back a bit it’s clear that China wants to attract foreign issuers. It’s clear they want to open up their markets. I think that there will be a compromise that’s hashed out over time, but I don’t think it’s going to happen right away.

One more thing from the issuers’ perspective is that, as Ben mentioned, China has taken some steps to allow a certain level of equivalence for some standards such as IFRS. Of course Hong Kong GAAP is accepted. So actually it’s not the same across the board for issuers. There are quite a few issuers who are not so concerned about the accounting difficulties. I think it’s mainly those based in the Americas that are the most affected by this.

IFR ASIA: Tony, we mentioned credit quality in the onshore market. If you have international names coming into the onshore market, that’s good for domestic investors as well, isn’t it?

TONY TANG, DAGONG: Yes, a very interesting discussion so far. There are a few points I think we are not talking about. Firstly on international issuers going to the onshore market, now we call it the Panda bond market but so far we haven’t really seen many real Panda bonds from international issuers. A lot of them are fake Panda issuers.

Before I go any further, I will mention one thing. What we’re talking about are segregated markets, whether it’s offshore Dim Sum, US dollars or a Panda bond. They are segregated, but they are fundamentally all driven by the domestic supply-demand situation in China. If in the last few years we’ve seen if, say, the regulator tightens up funding for one sector, say property, all the property issuers they will fly into the offshore markets to issue bonds – whether it’s in dollars, whether it’s Dim Sum, whatever. It all depends on the funding access they have in the domestic markets. All of these markets, Dim Sum or Panda, are correlated. That’s one point.

The second is the credit rating system. We all talk all about the foreign investor’s perspective, but we actually are forgetting about domestic investors. There is a huge pool – I already mentioned it’s a US$7trn bond market. So a lot of domestic investors have already established a huge portfolio. So they’re very used to domestic rating systems, even though foreign investors have different opinions about whether the notching system is wide enough to differentiate the risks. However, that’s the reality.

When international issuers come to China or other global investors go to China, they need to have a benchmark. If I’m a China Life, I might have a Rmb1trn bond portfolio in China spread out over four notches. When they want to invest in an offshore deal, with its S&P or Moody’s ratings, they have 16, 17 notches difference on that scale, so they can’t benchmark. They don’t know what their AAA or AA means on a global scale.

I think that for me the major hurdle for investors is actually the rating system. People can’t price the risk properly. They don’t know how to price the risk properly.

So even though the PBoC opens up the interbank bond markets for investors, we see very little inflows so far, because for a big fund like Invesco, you might want long-term diversification into the Chinese bond market but it’s hard to choose how you’re going to invest. How do you compare it existing portfolios. That’s my take.

There’s huge diversification needs for domestic investors, too, like Ping An, Fosun, China Life, those type of investors. They want to invest to overseas but they can’t diversify because they barely have an overseas presence. For Dagong, we are trying to create a mapping system because we have a huge portfolio of ratings in the Chinese market, so a lot of investors use our ratings as a benchmark there. We’re creating a bridge for the global scale ratings and the domestic ratings. Hopefully we can connect the two rating systems and then to provide a true risk feature for both global investors and domestic investors.

IFR ASIA: That sounds challenging. It’s well known that so many domestic Chinese bonds are Triple A rated on the domestic scale, so how do you break that Triple A into three or four different notches, maybe eight different notches?

TONY TANG, DAGONG: For Dagong we are considering Triple A domestic ratings as investment-grade on the global scale, which means everything from BBB– and above on the global scale will map to a domestic AAA. If it is AA+ in the domestic rating system it will be in the Double B category globally. Then we will have a mapping table, but of course there will be some crossover issuers. I see at some other Chinese agencies, the fashion is to start AAA+, AAA–.

IFR ASIA: You can get AAA+ plus now? I didn’t know that!

TONY TANG, DAGONG: There are agencies doing that in domestic market. I also heard some agencies do AAA-1, -2, -3, -4 now. For us, that’s not a good solution because you just dilute the Triple A name. The proper path is still to create mapping for the global scale and national scale.

FREDDY WONG, FIDELITY: From what I’ve heard so far from people here it sounds like there is quite a lot of uncertainty within the market that slows things down or stops people from investing. You can talk about the legal framework that’s been developing, accounting standards, adaptation to Chinese law. From an issuer’s perspective, they may raise the money onshore but they cannot repatriate the money offshore for their usage. Also for onshore investors looking at issuers from overseas or MNCs in the Panda bond market, they are uncertain about what the quality of these companies looks like. It’s similar for offshore investors when they are not too certain about onshore credit ratings and so on. So that creates this kind of uncertainty between the two markets and the Panda bond market in particular.

This kind of uncertainty to me is actually a good thing, because uncertainty in the long term will be resolved and we will end up with a better market. It’s good to highlight all the uncertainty now, so that people can work towards a better result in opening the market in the future.

IFR ASIA: Good point. Just coming back to the idea of risk pricing, Ken, you mentioned you look at CNY as well as CNH, so how do work out if the risk is priced appropriately?

KEN HU, INVESCO: It’s a very complicated question – we can talk for another two hours about that! To keep it short, obviously we have to appreciate that there are different investor bases, so it’s not only about the fundamental analysis but also a lot of other technical analysis around supply and demand. Also we have to appreciate the difference in rating systems between the local and international ones. I’m not saying which one is better than the other because ratings in my eyes are more like an art – it’s hard to prove which is right or which one is wrong. I think it’s more important to appreciate the art in the context of both the international perspective and also the local culture. I would say at Invesco we do look at both the international and the local ratings for two reasons: one is for the information; the other reason is to really appreciate the local practices and the local culture.

Like Freddy said, the market inefficiencies, due to cultural differences or different market practices, are very good for us because there is an investment opportunity which means a very good source of alpha.

IFR ASIA: As long as you have access, as long as you can trade in and out…

KEN HU, INVESCO: Yes, which means that you need to have both global and local people, so that we can exchange ideas in a very open format. We have a team of 11 sitting in Shenzhen, and they all report to me. We also have a global system for communications between global and local analysts, and I think this is very important. I would like to say that somehow I think the Chinese authorities would definitely like to help international investors invest in the onshore market.

I like the point raised by Mushtaq about the opaqueness in the market. For example, if we look at the websites of some authorities in China, if you click on the Chinese one and the English one you’ll find different content. I’m not saying that is bad, but it will cause some international investors to have second thoughts. They will say: “Hey, how come the English one and the Chinese one are not the same?”

I think Hong Kong has done a very good job. We are bilingual; we always have the same contents – they look the same. Even Japan is fine. It’s in just one language, but international investors know they need to hire some employees who speak Japanese if they would like to invest in JGBs or Japanese bonds. I would say dealing with this kind of inconsistency, for example with some of the websites, would help.

JINI LEE, ASHURST: That’s a good point. The quality of disclosure I think is an important differentiator for investors when they’re thinking about the international markets versus the onshore markets. I mean if you’re dealing with an offshore company that’s listed on the main board of the Singapore stock exchange or Hong Kong stock exchange, you get very good, regular disclosure. Investors are very comfortable with that, and then you have access to rating reports and so on.

I do think it’s just a matter of time. We have to give the onshore markets a break. It’s only been a couple of years when the market has begun to open up, compared to the international legal systems where the Eurobond markets have been around for a very long time. It’s taken time to get us there and to have the common markets in Europe. That’s been the result of continued efforts from a lot of governments getting together and putting together rules, guidelines and having a two-way conversation with investors in terms of what they want and with issuers in terms of what they’re willing to offer.

IFR ASIA: Tim, looking at the deals that you’ve brought into the onshore Panda market, is the mix of issuers we’ve seen because of demand – because local investors actually want high-quality diversification? Or is there something else driving it, perhaps politics opening up opportunities?

TIMOTHY YIP, HSBC: I think it’s a mixture of everything you just said. Domestic investors are also aware of the increasing number of credit events happening onshore. They realise that in order to have a sustainable and diversified portfolio they need to get their hands on paper issued by foreign credits. So that’s why when Daimler was the first case in the interbank bond market in 2014 that was very well received. I think the PBoC and the CSRC want to introduce more foreign credits into the domestic system. Of course this will be a very gradual process, as some of the panellists have mentioned, and I think the key words will be gradual, steady and sustainable.

What the Chinese authorities do not want is for domestic investors to suffer losses in the hands of so-called questionable foreign credits. That would bring instability and undesirable dynamics into the onshore financial system. That is why they have been very careful in terms of approving the credits they want. So it started off with Panda bonds in the interbank bond market from highly rated financial institutions such as HSBC followed by the sovereign issuers, Republic of Korea, Province of British Columbia, Republic of Poland, and of course the last one was the World Bank issuing an SDR bond onshore. Of course you get the corporates as well, and there will be a few coming in the pipeline.

I think it’s a mixture of offshore issuers wanting to raise cheaper Rmb and ultimately use the Rmb onshore – as Freddy has said, that’s very efficient. At the same time it also benefits domestic investors because they want to diversify away from domestic credits. Sometimes domestic investors will harbour ambitions that the issuer will be paying up to issue Panda bonds for the very first time so they get a pick up over the CDB curve.

MUSHTAQ KAPASI, ICMA: This is a very good point raised by Tim. It makes me think of the difference between the western approach to rule making for bond issuance and the Chinese approach. What I’ve seen – and this has been going on for several years in terms of Rmb internationalisation – is that the Chinese authorities don’t want to set rules that anyone can go in and arbitrage and structure a way around.

When they look at a transaction they look at the entire transaction and all the implications. They look at the credit rating of the issuer. They look at the risk to onshore investors. They look at the macro-economic impact. They look at the use of proceeds, where are the funds going to be invested. It’s a consideration of all of those aspects of the transaction. It’s a different approach, and that’s perhaps why you’re seeing successful issuances from Daimler and some of the sovereigns, and maybe a little less success from some of the lower-rated sovereigns and some of the lesser-known corporates that hope to enter the market.

I think foreign issuers are getting more used to this approach and I think the efforts of HSBC and other underwriters and law firms are very helpful in this regard.

TONY TANG, DAGONG: There’s also a two-way educational process for international investors to understand China and also more importantly for the Chinese investor to understand the global practice and the foreign credits.

For domestic investors the actual internal controls, the policies and the expertise are still not there yet for them to diversify into offshore markets. They need to build their internal teams to bring in enough expertise to understand the global markets, and that would take a fair number of years.

We have seen in the last few years Chinese investors coming to Hong Kong to grab a lot of, let’s say, low-quality credit. They just come in to buy it and actually push down the yields. The reason is that the most of those deals are local government entities in China, so they understand the Chinese political system, the local government system, and they have no problem grabbing those deals. If they want to participate more actively in some international issuers and which they’re not familiar with, then it puts a question mark in their head.

IFR ASIA: I want to drill down a little bit into some of the more recent developments. The first one is the idea of investor protection in the onshore market. We’ve started to see a move to introduce things like covenants, perhaps due to foreign issuers coming in. Is that what people are looking for onshore?

TONY TANG, DAGONG: At this moment we haven’t seen a lot of covenants. It’s because of the domestic loans. Before the bond market boom, China was heavily reliant on bank funding and in China the laws don’t require covenants. It’s a new concept for both issuers and investors.

Remember a lot of borrowers are actually SOEs, so the banks or even the bond investors relax their requirements for these SOEs. So if you put a lot of strict covenants on these issuers, it will be difficult for the issuer to accept. They want flexibility. If an important, local SOE had a problem or was coming close to breaching their covenants, what are you going to do? Are you going to penalise them or force the local government to intervene? I think the market hasn’t really found the balance on how they’re going to perceive this covenant – whether the breach of covenant really means something I think that will take some time.

Covenant itself is just a technical term to impose on the issuers but, in terms of implementation and execution, the acceptance for both issuers and investors will be quite difficult for now.