Europeans are well known for their love of travel. For centuries they colonised almost every country they ever set foot in. But where bond issuance is concerned they have never really needed to venture much outside of Europe before.
Before the euro was created in 1999 there were a multitude of European currencies to raise debt in, not to mention an extremely large eurodollar market based out of London thanks to a quirk in the US tax system, which allowed it to flourish from the 1960s onwards.
But now there is a new bond market in town and everyone knows it is far too big to ignore. At $7.2 trillion in total issuance, China’s domestic bond market already ranks as the third largest in the world. As a percentage of GDP it is still very small but growing fast and likely to supersede Japan’s within the next five years.
Historically, European borrowers have never really needed to access the Japanese market much beyond diversification purposes. When it comes to China, however, many already have a natural funding requirement.
This is partly a function of the renminbi’s growing internationalisation and its increasing use in global trade payments.
But it is also a function of Europe’s growing physical, manufacturing presence in China, in contrast to Japan where high costs have historically deterred much foreign direct investment from the European continent.
Volkswagen, for example, produced more than 3.5 million cars in China in 2014, employing some 450,000 people in its factories and dealerships.
“European borrowers are monitoring the Chinese bond market very closely,” Marc Mueller, Deutsche Bank’s Frankfurt-based head of DCM origination for Germany, Austria and Switzerland, told FinanceAsia. “German companies have a lot of assets in China they need to fund. The question boils down to issues of cost, liquidity, and ease of access compared to an inter-company loan.”
He added that clients have not been put off by the need for Chinese language documentation and accounts. “They’re already based in the country so they’re well versed in the language,” he said.
What has made life difficult is the current panda bond template, which is still based on the supranational deals of the mid-noughties. When Bank of China, HSBC, and Standard Chartered re-opened the market last autumn, they had to shoehorn their deals into documentation that did not quite fit.
Bankers are currently waiting for new guidelines from the People’s Bank of China. Their clients’ biggest bugbear appears to be the need to gain approval and to specify how the proceeds will be used.
Global borrowers with medium-term note programmes typically want access on their own terms or when they spot a market window, rather than having to wait for China’s regulatory authorities to grant permission on a case-by-case basis.
A number have consequently bypassed the system altogether, dipping their toes in the water with private placements. Others such as Rabobank have tapped offshore renminbi credit lines.
So far this year, the Aa2/A+/AA- rated Dutch bank has executed four private placements, raising a total of Rmb1.058 billion ($469 million), according to Dealogic and S&P Global Markets Intelligence data.
Manny Chohhan, Haitong’s London-based head of capital markets, said he is encouraging clients to get approval. “It makes sense for companies [that] will become regular borrowers and it gives them the optionality to build out a yield curve,” he said.
Chohhan also noted that recent panda deals have looked more like private placements anyway. Syndication was generally to a couple of dozen investors, which took the paper on a buy-and-hold basis.
Haitong has been building out its European investment banking presence since it purchased Portugal’s Banco Espirito Santo de Investimento last September.
Since the beginning of the year, the Chinese broker has also been bridging the educational divide through a weekly renminbi newsletter. This informs European clients on developments in China’s domestic bond market and provides updates on Chinese issuers accessing international markets.
LIMITED SWEET SPOTS
Chohhan also explains that while it is still very early days the onshore market has some sweet spots. In particular, he says BBB-rated European borrowers can raise renminbi-denominated funds inside their theoretical euro-denominated curve on a post-swap basis.
However, deals need to have tenors of no more than three years since the swap market is still very thin beyond this point.
“Chinese investors are still learning how to differentiate between the risk profiles of different companies so the credit curve is far less steep in China than Europe,” he said.
The curve also judders to a halt at the crossover point between investment grade and high yield, another function of a market where there is little domestic ratings differentiation between companies with very different risk profiles. This is the main reason why Ba1/BB+ rated Hungary recently raised Rmb1 billion from the dim sum bond market where there are far more international investors well versed in non-investment grade issuance. Hungary, along with Poland, is now looking to the panda market.
“Chinese investors prefer Chinese credit,” said Torsten Pfeifer, Citi’s head of G10 credit and rates sales in Asia Pacific and Japan. “European banks have been big issuers in other regional currencies such as the Hong Kong [dollar] and Singapore dollar where local investors have been starved of paper.”
Pfeifer added that appetite for European credit in these markets is still not as strong as it was before the global financial crisis. Investors have become a lot more selective and cautious in their analysis.
“They’ve really honed in on country risk and as result there is a lot more appetite for northern European borrowers,” he said.
But he is also a big believer in the potential for spread compression across the board thanks to the European Central Bank’s March 10 announcement that it will start purchasing eurozone corporate bonds as part of its quantitative easing programme.
“Very few international investors buy Japanese domestic bonds because spreads are so artificially low,” he said. “But if you look at European spread levels you can see they’ve some more years to go before they get to these levels.”
Indeed, research by Landesbank Baden-Wurttemberg suggests that spread tightening may only just be beginning. It cites the performance of Europe’s covered bond market, where the ECB has been purchasing up to one third of new deals since 2011.
When the programme started, spreads averaged 200 basis points. Now they are close to the 25bp mark, while the ECB has an €160 billion covered bond portfolio.
The note from Landesbank Baden-Wurttemberg suggests the prospective corporate bond pool will be smaller so competition for new deals could be intense.
Brewing giant Anheuser-Busch InBev, which is headquartered in Belgium, has already given some indication of what may yet be to come. Within a week of the ECB announcement, it was breaking records with an €13.25 billion bond issue, the largest ever euro-denominated corporate debt issue. Even more impressive was its €31 billion order book.