IFR Asia RMB Bonds Roundtable 2017: Part 1

IFR ASIA: I think the place to start is probably a recap of what’s changed since we sat down last year. Tim, you were here when we did a similar event 12 months ago. What’s been the most significant developments in your mind in RMB bond markets?

TIMOTHY YIP, HSBC: I think there’s two major areas. One is the ongoing development of the Panda bond markets. Back when HSBC was the first issuer to reopen the market in 2015 after a period of hiatus, there was a lot of noise about whether it was sustainable or whether it was just a flash in the pan. Since then, however, the PBoC has steadily opened the markets to include further high-quality issuers, especially from the sovereign and supranational sector.

So we have seen the World Bank issuing SDR bonds, the Republic of Hungary issuing a Belt and Road sovereign Panda bond and Maybank becoming the first Asian financial institution to issue a Belt and Road Panda bond. That’s the first key area.

The second major development is the PBoC allowing more foreign investors into China by way of the Bond Connect scheme. Previously there was RQFII, QFII and the CIBM route. Now, with the implementation of Bond Connect from July, offshore investors have another weapon in their arsenal to invest onshore.

IFR ASIA: Two excellent themes to delve into there. Let’s talk about the investor make-up first. Freddy, you were here 12 months ago as well and since then you’ve moved to Shanghai! How have these changes affected your business?

FREDDY WONG, FIDELITY: Tim’s mentioned the major developments in the China capital markets. From an asset manager’s perspective, there’s a couple of things, too. China has allowed foreign asset managers to run a domestic business through a whole new entity and at this stage, clearly, we are one of the first ones to enter the market and set up our business in this way. It’s part of the opening up that you can see, as China is becoming more international, not just allowing domestic managers to do business globally but also encouraging global money to come onshore.

Bond Connect is one of the key things for bringing foreign capital into the domestic market, but we have to also keep in mind that onshore investing was already happening, through quotas or direct access to the interbank market. Now, domestic investors are also growing and investing offshore at the same time. So it’s really the pace of RMB internationalisation that is changing. It’s growing much faster.

IFR ASIA: I’m interested in your experience setting up in Shanghai. Is it very complicated? I’m wondering why other people haven’t done it yet.

FREDDY WONG, FIDELITY: I think to set up a domestic business clearly you need to understand what your business need is, your ultimate goal. Where do you want to run the business in the future? The way that we have set up the business right now is as a private fund manager, which sits within the private fund entity

This is quite different to what a lot of asset managers are running globally, and there are certainly different hurdles that you have to overcome. One of the most obvious obstacles is to be able to launch a product on the day that you get a licence from the Asset Management Association. They set a time of six months, and within six months you need to raise money locally and manage that money for local clients. I believe a lot of global managers are at that point. Once they get a licence they need to be able to launch a product within six months to fulfil those requirements.

IFR ASIA: So, if you don’t use it in six months, you lose the licence?

FREDDY WONG, FIDELITY: Exactly.

IFR ASIA: Ricco, you spend a lot of time talking to investors and regulators on these changes. What’s top of mind for ICMA at the moment?

RICCO ZHANG, ICMA: Well, just as our colleagues mentioned, generally speaking the keyword is “opening”. I see a golden opportunity: if any international players want to enter the onshore market, now is the right time! We’re talking about Panda bonds and Bond Connect, and the message from the regulators is very clear – they welcome the capital, they welcome the participation of the international community in the Chinese market.

We first saw Panda bond issuers in 2015 when the market was relaunched, then gradually we have seen more and more issuance. Now, under the Belt and Road initiative, regulators welcome countries to tap the onshore market to support any related projects. Panda bonds would be a very useful financing tool for sovereign issuers, for financial institutions, for corporates when they want to finance infrastructure projects.

From the investors’ side, Bond Connect now makes onshore securities available to the international community. The RMB getting into the SDR basket also brought in a lot of big investors, and the onshore market actually provides a lot of product for them.

China’s regulators do want to understand better what the international side expects. We did a comparison between international market practice and domestic market practice in China. What we found is very interesting: in principle, you can argue that the two approaches are very different, but basically you just want to make the market more efficient. So there’s a gap between the two markets. The regulators now want to understand what they need to do to narrow the gap to attract more investors and issuers into the market.

We also noticed recently that the regulators have given licences to more international banks. HSBC actually had been the only international bank with an underwriting licence for quite a long time, but in the last couple of years, more and more international banks are getting licensed to underwrite deals in the interbank bond market. All those reforms are very encouraging and, again, I want to emphasise, this is really good timing if international participants want to enter the market.

IFR ASIA: Let’s stick with Bond Connect at the moment because this does show the world that regulators are very keen on opening up the local markets. Kelly, you’ve worked very closely with regulators on both sides of the border. Do you get the sense that this is just the beginning?

KELLY MCKENNEY, TRADEWEB: I think it’s just the beginning in terms of market activity. The scheme only started in July of this year and it is an entirely new way to access the onshore bond market. Just based on the take-up that we’ve seen so far, my impression is that international investors are viewing this as a very efficient way of accessing that market and ultimately, I think they’re finding that it’s quicker and easier to get in through this new scheme. One thing that people are saying is “OK, we had our QFII, we just had CIBM and now we’ve got something new. When is this going to stop?”

On the flipside of that, I do think international asset managers, institutional investors, insurance companies and so on are looking at this initiative closely and are seeing that actually it is an improvement on previous access schemes. So I don’t foresee anything else coming along in the near future, at least not for the asset classes that you’re getting in Bond Connect – which is basically something like 30,000 fixed income assets available in China.

IFR ASIA: Have you been surprised at the take-up rates? Is it used as much as people expected it to be?

KELLY MCKENNEY, TRADEWEB: From our perspective, as a trading platform, when we launch a new product we would expect to have an initial period of what we’d call a soft launch. I don’t think China really does soft launch, so it was a really speedy and efficient introduction, and there was enormous take-up from the beginning.

I guess there was a little bit of concern that this was going to be a one-day wonder and that it is going to drop-off. But, interestingly, the number of participants has more than doubled in the last three months. So that’s been a positive.

The only official statistics that are available about turnover on Bond Connect are from the PBoC on day one: more than Rmb7bn was traded through 140-odd transactions, which was obviously a big push for the first day. I think a lot of people who know the market well, saw that as a lot for that particular market, for the international investors accessing that market. But surprisingly – although we obviously are not getting those same levels since, because there really was a big push on day one – we are still seeing quite substantial turnover on a daily basis. Excluding day one, the trend is very favourable in terms of growing the number of transactions, actual trading volumes and obviously investors signing up.

IFR ASIA: A lot of the names that we saw on day one were offshore Chinese asset managers. Has it moved beyond that now, are we getting real international money?

KELLY MCKENNEY, TRADEWEB: That’s a very relevant question. The way I look at it is this: when you’re signing up for any new scheme, on day one there are a lot of unanswered questions. So the most likely market participants that were going to sign up from day one were always going to have some sort of a connection to China, because they would be more encouraged than, let’s say, a big international asset manager. I think that’s a very normal trend on day one. But certainly since then, there’s been a continued programme of international roadshows, both within the Asia Pacific region – Tokyo, Korea, Taiwan, etc – as well as in the US and Europe.

The participation rates have been very strong, and we certainly are seeing the international asset management community getting more involved now.

FREDDY WONG, FIDELITY: Just to add to that point, the Bond Connect programme doesn’t mean that only Hong Kong subsidiaries of Chinese entities have been going onshore. Traditional or global asset managers still invest onshore, but they may not be using the Bond Connect programme.They’re still going for the traditional route of QFII or RQFII quotas. The reasons for them not using Bond Connect on day one are more because of operational issues, as a lot of firms may not have that set-up internally to get it working on day one, but doesn’t mean they don’t want to.

IFR ASIA: In the early stages there were questions around settlement, custody and things like taxation. So has that all been resolved now?

RICCO ZHANG, ICMA: Well, not really. There are still a lot of details to work on but I must echo my colleague’s comment on that. When we talk with our members on the buyside, they are very diversified. Some of them are already very active through Bond Connect, and I know a couple of asset managers with a presence in Shanghai, just like Fidelity. That’s very encouraging, because they all want to be involved in the onshore market.

Some other big names may be waiting to see how it will go, but it’s definitely on their internal agenda. Just like Freddy mentioned, they’re still using QFII or RQFII for the time being but, again, that doesn’t mean they won’t use Bond Connect in the future.

Actually, just last year we hosted an event on Free Trade Zone bonds in London with the Shanghai Clearing House. The idea is to provide a single link between the international side and the onshore market through the Shanghai Free Trade Zone, which is the only national Free Trade Zone. It’s about connecting Euroclear and the Shanghai Clearing House, so international investors looking to tap the onshore market don’t have to do any registration or make any filing with the onshore regulators.

This was a very good initiative before Bond Connect, but now the market is evolving so fast. The Chinese authorities only announced Bond Connect at the beginning of this year, and that’s a similar idea of just making life easier for investors when they want to go into the onshore market.

IFR ASIA: Does Bond Connect take away from some of the other initiatives?

RICCO ZHANG, ICMA: You might say so, but some other investors, for example, like central banks, have onshore assets directly available to them. So they will use that access to the onshore market. When we ask what’s in their portfolio, and whether they have offshore RMB products or onshore RMB product exposure, surprisingly most of them actually hold their RMB assets in the onshore market.

It’s the same for issuers. Just like it used to be all about Dim Sum bonds, we now see that if issuers want to raise RMB, basically a Panda bond is the first choice.

IFR ASIA: Does Bond Connect mean that the idea of a Free Trade Zone bond is now consigned to history? There’s only been one issuance from the Shanghai Municipal Government.

RICCO ZHANG, ICMA: There are a couple of other initiatives out there, but you’re probably right. It was a useful pilot programme. Nobody knew that Bond Connect would happen so soon, and so fast. All these programmes just make life easier for the international community, and are still very welcome.

IFR ASIA: What about primary markets? Tim, have you worked on new issues through Bond Connect?

TIMOTHY YIP, HSBC: Going back to Bond Connect for a second, I think it really demonstrates the agility of the PBoC in the way that China just cannot have a one-size-fits-all approach, and that’s why we’ve got different schemes.

If you look at QFII, RQFII, CIBM and Bond Connect, they all have their pros and cons. If you are looking to invest across both equities and fixed income, then perhaps QFII is the way to go. If you’re central bank, of course CIBM will work for you, and thirdly, if you’re a foreign investor and prefer not to appoint a local custodian, then of course Bond Connect would be a very attractive proposition.

The idea of having different bespoke products for different types of investors can continue for the foreseeable future. This is why in the primary transactions, going back to your question Steve, we are seeing more foreign investors being enticed by the opportunities.

Previously they were using CIBM only to buy into what we call rates products in China, basically China MOF bonds and policy bank bonds. But now they’re actually setting up through Bond Connect to invest in credit products. So in the new issues that we’ve seen for Maybank, also for Hungary and for HSBC China, which is a domestic financial bond, we were able to leverage on Bond Connect and encourage foreign investors to participate.

It was quite interesting to see their views on pricing and market sentiment to be materially different to that of onshore investors. I think that explains partially the attraction of including foreign investors in the Chinese market, because they would support foreign names, such as Panda bonds. Then the secondary effect would be for foreign capital to start supporting local, domestic credits, and help finance the real economy.

IFR ASIA: Philip, you’ve actually rated some of these Panda bonds. What difference does it make having that Bond Connect mechanism in place?

PHILIP LI, CHENGXIN: The Panda bond is one further step in China’s internationalisation of its capital markets. Starting from the fourth quarter 2015 to last month, there were 19 Panda bonds issued, 13 are rated by China Chengxin. As Tim mentioned, foreign investors would like to buy Panda bonds because they are familiar with their international ratings. So in this context, Bond Connect helps a lot for foreign investors who want to buy Panda bonds. We also find a lot of domestic investors would like to buy Panda bonds.

According to the latest statistics, international investors hold less than 2% of the total outstanding amount of debts issued in the Chinese debt market. Almost 100% of the debts foreign investors hold are issued by policy banks and very big government enterprises. So this raises the question whether foreign investors trust the domestic credit ratings. There have been quite a lot of criticisms on the domestic debts being “over-rated” by the Chinese rating agencies. I want to respond to the criticisms.

Domestic and international credit ratings are measured by two different scales. The international scale is tighter, whereas the domestic scale is looser.

Lots of people overlook one very important point. In the domestic debt market of a country – no matter if it’s China , Japan, Thailand, Malaysia, Indonesia or any other country – the ceiling of the domestic rating is set at AAA for its government. It’s always like that. Take Japan for example. Japan is rated A+, same as China, by S&P and Fitch or A1 by Moody’s. If we apply the international scale to the Japanese corporate debts, then almost all of them would be rated below A+. For a country with a lower international rating, for example, Indonesia, then most of the domestic Indonesia debts are rated below investment grade. If so, it hurts the reputation of the country and won’t help the its domestic debt market development.

In China, the financial authorities set a minimum investment grade for the investors to follow. These investors are government-related funds, state-owned insurance companies and banks. They are restricted or advised to buy debts rated AA or above. So that, issuers rated below AA almost have no chance to issue debt because they find it very difficult to find underwriters to sell their debts. This explains why almost all domestic ratings of the debts in China are AA or AAA.

Having said that, there is room for the Chinese domestic credit rating system to improve. One very important area is to avoid rating shopping by issuers. There are seven Chinese credit rating agencies, and the top three capture more than 80% of the total market share. Due to competition, some of the rating agencies compromise on the requests made by issuers to give a higher rating. Tighter regulation and a code of conduct for credit rating agencies to observe and follow can help improve the trustworthiness of the domestic ratings.

IFR ASIA: China is now allowing foreign rating agencies to come into the onshore market. Does that mean that S&P and Moody’s are going to start rating onshore bonds? You could end up with one security with two very different grades.

PHILIP LI, CHENGXIN: Well, starting from July 16 this year, international credit rating agencies are allowed to set up wholly-owned companies in China to provide credit rating services to issuers and issues in the Chinese debt market. I would say only the big three US-based rating agencies would attempt to take the first step. At the moment two of them have joint ventures in China. One is Moody’s, which holds 30% of China Chengxin. Fitch holds 49% of China Lianhe. China closed the door to foreign credit rating agencies to joint venture with Chinese credit rating agencies in 2007, and S&P was too late to find a partner to form a join venture before the door was closed.

IFR ASIA: But any of those could now come in and take 100%.

PHILIP LI, CHENGXIN: Yes, legally. But, in the cases of Moody’s and Fitch, that depends on whether or not their joint venture contracts with the domestic credit rating agencies allow them to work independently in China. Most likely they have to change the contract terms or sell out their share stakes, whereas for S&P, it does not have such issue.

The other issue is that they have to consider how much business they will get. If you look at Japan, there are five credit rating agencies – three from outside and two domestic Japanese. More than 70% of the Japanese debts are rated by the two Japanese credit rating agencies.