What's behind the stellar growth of the dim sum bond market?

Michael Petit, Standard & Poor’s managing director and head of corporate and government ratings for Asia-Pacific, examines the driving forces behind the development of the dim sum market, its main agents, and likely evolution.

The market for offshore Chinese renminbi-denominated bonds is relatively small, but its growth has been spectacular.

The so-called “dim sum” market has raised Rmb150 billion (or close to $25 billion) since its inception in mid-2007. The market has even bucked the global trend by continuing to function in the past few months despite struggling at times. During the past 10 weeks, roughly Rmb40 billion worth of dim sum bonds were issued, a period during which G3 cross-border markets had essentially shut down.

What’s fuelling the development of the dim sum market?
The rapid accumulation of offshore renminbi deposits is likely to continue to propel the development of the dim sum market for the foreseeable future. The increasing amount of trade that is settled in renminbi is feeding the growth of these deposits. The usage of the Chinese currency will keep on rising as long as Chinese authorities support its internationalisation. In the second quarter of this year, for example, China settled about 10% of its trade in renminbi compared with only about 1% a year earlier. Offshore renminbi deposits in Hong Kong now amount to over Rmb600 billion from roughly Rmb100 billion a year earlier.

What other factors support the market?
The monetary and credit tightening that has prevailed over the past year in China has certainly led a good number of borrowers to the dim sum market. In that sense, the dim sum market has operated as a substitute for the domestic Chinese loan market. This is most likely a temporary phenomenon, and not necessarily a positive one, as it brought with it some of the opaqueness that is characteristic of the mainland bank loan market. More important are the series of measures that China’s vice-premier Li Keqiang announced last August to boost the role of Hong Kong in developing an offshore renminbi market. In effect, Chinese companies will now be allowed to directly issue bonds in the dim sum market, rather than through offshore subsidiaries. Li also indicated that China, through the Ministry of Finance, would be a regular issuer, which should prove critical in helping establish a reference curve in the dim sum market.

Are there any impediments to future growth?
The thorny issue of repatriating proceeds to the mainland remains a significant impediment to the offshore renminbi market developing into a truly major global offshore market — one that would be commensurate with the relative size of China in the global economy. While procedures can be put in place to facilitate that process, such as — those to be introduced for the repatriation of proceeds for foreign direct investment purposes — the challenges won’t be completely resolved until China fully liberalises its capital account and makes the renminbi freely convertible. Some mainland policymakers have recently hinted that this could occur within five years.

What is the typical credit risk profile of dim sum issuers?
Issuers in the dim sum market have covered the whole gamut from China sovereign (AA-/Stable/A-1+, cnAAA) to some property developers that we rate in the ‘cnBB’ category of the Greater China credit scale. An early characteristic of the market was that it was largely unrated and credit risk appeared to be a secondary consideration to currency appreciation. Global events, however, have very much promoted the importance of credit risk, and there is now clear evidence of pricing differentiation based on creditworthiness. Notwithstanding the market’s still relatively limited liquidity and lop-sided demand imbalance, spreads have significantly widened for speculative-grade-rated and non-rated issuers in the past few months. The prevalence of rated issuers is also likely to increase as the focus on currency appreciation diminishes and a stronger credit culture takes root.

How diversified is the market?
The dim sum market is increasingly attracting state-owned enterprises of various industries and international issuers, and both of these groups tend to be rated. The market is also well represented in terms of industry players, including property developers, high-tech companies, policy banks, commercial banks, and state-owned corporations that cover the natural resources, energy, telecom, transportation, public utilities and capital goods industries.

Mainland China issuers represent the bulk of issuance to date, but an increasingly broad range of global issuers have tapped the dim sum market with sometimes significantly more sizable issues. McDonald’s (A/Stable/A-1, cnAA+) became the first non-Chinese issuer to enter the market last August with a Rmb200 million issue. Others that followed include Caterpillar Financial Services (A/Stable/A-1, cnAA+), Orix (A-/Stable/--, cnA+), Mitsubishi UFJ Lease & Finance (not rated), Unilever (A+/Stable/A-1) and VTB Capital (BBB/Watch Neg/A-3, cnA). Notably, L'Air Liquide (A/Stable/A-1, cnAA+) became the first French issuer in the offshore renminbi market last month, with two issues aggregating Rmb2.6 billion.

Standard & Poor’s recently launched a Greater China credit rating scale. What is it for?
The rapid development of the offshore renminbi market was, of course, the impetus behind the development of the scale. The underlying rating criteria, methodology and processes that we use to assign Greater China credit ratings are identical to those associated with Standard & Poor’s global scale ratings. The mapping between Standard & Poor’s Greater China and global scales is publicly available.

In essence, the Greater China rating scale responds to the needs of investors and other credit risk management professionals who focus on Greater China as an asset class in and of itself. The scale provides a credible benchmark against which users can form their own independent opinion of relative credit strength within their investable universe of Greater China. For these users, the Greater China scale can provide more granularity of credit risks than is possible with Standard & Poor’s global scale. The rating distribution is also better aligned to their expectations of relative creditworthiness within a Greater China context, with China itself anchoring the scale at ‘cnAAA’.

We are assigning Greater China credit scale “issuer” ratings to all Greater China-domiciled obligors and “issue” credit ratings to their debt instruments. We are also assigning Greater China “issue” ratings to all Hong Kong dollar-denominated and offshore renminbi-denominated debt instruments regardless of the domicile of the obligor. Click here for more information.

What is the profile of investors in the offshore renminbi market?
That’s also very much a developing story. In terms of geography, investors are overwhelmingly Hong Kong-based, with most of the remainder based in Singapore. When UK-based retailer (A-/Stable/A-2, cnAA) launched a Rmb725 million issue earlier this month, Hong Kong-based investors accounted for less than 50% of the total allocation, Singapore about 30%, and European investors close to 20%. It was very much a global story.

Among investors, Chinese banks are particularly well represented. This partly explains the presence of a relatively large number of unrated issues (as the dim sum market essentially functions for them as an alternative to China’s bank loan market). An important development in the past year has been the emergence of an ever-increasing number of specialised funds investing in offshore renminbi paper. These funds have brought considerable professionalism to the market and acted as a vehicle for greater retail investor participation.

So is the dim sum market impervious to difficulties in other cross-border markets?
No, far from it. It’s certainly quite remarkable that the dim sum market remained open during the dry spell that prevailed since early August in the G3 markets. But it should be noted that investors in the offshore renminbi market have also been very selective during that period: While China’s ‘cnAAA’-rated bonds were oversubscribed, a number of speculative-grade-rated issuers, non-rated issuers, and at least one highly rated issuer had to delay their planned issues. These issuers operated in industries ranging from airlines and property development to aluminium extrusion and pharmaceuticals.

It is also important to realise that supply-demand conditions could shift — conceivably rapidly and dramatically so. Fast-growing offshore renminbi deposits and the ever-increasing number of specialised offshore renminbi funds (more than 17 to date) make the dim sum market very much a seller’s market for now, but this could change. For instance, mainland banks and insurance companies are reportedly planning to issue subordinated debt instruments in the dim sum market. Given these institutions’ immense capital needs, and depending upon whether these institutions seek to come to market at the same time or not, this could easily bring supply-demand conditions into balance or trigger overwhelming demand.

Another fundamental change is now taking place. The widely held assumption that the renminbi will always appreciate is being challenged. While this might be a hiccup in the development of the dim sum market by forcing a painful repricing of risk, it should prove healthy over time. It should eventually help the market shed its strong remaining speculative element around currency play to that of a more mature market where decisions are taken based on careful risk-reward considerations.

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