Hong Kong’s development as an offshore renminbi (RMB) centre continues to gather pace, with the growing RMB Eurobond market (RMB bonds issued in Hong Kong) being a key element. Deutsche Bank became the first non-Asian bank to issue an RMB Eurobond last week, with a Rmb500 million ($73 million) deal for China Development Bank, and the first non-bank and corporate deals have also appeared in the past couple of months. Jerry Li, Deutsche Bank's head of global rates in China, and Patrick Tsang, head of fixed-income capital markets, talk about the emergence of this market and what it means for offshore borrowers looking to raise RMB funding.
What is driving the development of Hong Kong's RMB Eurobond market?
Patrick Tsang: It's best to take a step back and look at this as part of a broader push to turn Hong Kong into a functioning offshore RMB centre -- the roots of which can be found in 2003, when retail bank customers were first allowed to convert their Hong Kong dollars into RMB.
While the deposit base grew fairly slowly at first, it has jumped spectacularly to Rmb103.7 billion ($15.2 billion) today from a little more than Rmb20 billion in 2007. Alongside this growth, RMB convertibility was extended to the corporate sector, with a pilot scheme launched in June allowing trade between Hong Kong and China to be settled in RMB, rather than US dollars.
As the retail and corporate deposit bases have grown, demand for higher-yielding fixed-income products have increased alongside. While there has been speculation that holders of RMB may be able to use their cash to access China's domestic bond market, a quota is likely to cap supply, leaving a fair proportion of demand unfulfilled.
This is where Hong Kong's RMB Eurobond market comes in, serving as a means to provide RMB funding for borrowers and improved rates of return for deposit holders.
The HKMA's announcement in February that RMB business can be carried out in accordance with prevailing banking practices, so long as it does not entail any flow of RMB funds back to the mainland, effectively opened the market for offshore issuers looking to raise funds in RMB.
Activity to date has been encouraging. In the past quarter, we have seen: the first corporate bond, a Rmb200 million deal by McDonald’s; the first non-bank deal, a Rmb1.4 billion deal from Hopewell Highway Infrastructure; and the first certificate of deposit deal, a Rmb500 million transaction from Citic.
While these deals are fairly small, new issue sizes are steadily increasing, with our pipeline showing interest in several transactions above Rmb1 billion.
What are the benefits of issuing RMB Eurobonds in Hong Kong?
Tsang: There are currently four ways for foreign issuers to raise RMB funding: a locally-issued bond deal in China via a domestic entity; a ‘Panda’ bond issue, whereby a foreign borrower issues onshore in RMB; a retail-focused RMB bond issue in Hong Kong; and a RMB Eurobond issue, sold in Hong Kong and targeted at institutional investors.
By far the quickest and most efficient way is the RMB Eurobond issue, with an average execution timetable of four to six weeks, as opposed to anywhere between three to six months for the alternatives -- if they are possible at all.
The market is relevant to any borrower looking to raise funding in RMB or to broaden their investor base. For example, a local or foreign corporate in Hong Kong can use the proceeds of a RMB Eurobond issue to service their RMB liabilities in China, such as paying for the goods provided by a Chinese supplier.
Raising money in RMB can be beneficial in two key ways. First, it helps eliminate foreign exchange risk for companies with RMB liabilities. Second, while you can of course still settle trade in US dollars, the FX conversion rates employed onshore can sometimes be inefficient – settling in RMB can result in a more favourable cost of goods.
In terms of price, the absolute yields paid on the bonds issued so far have been competitive versus on-shore RMB bond funding.
For supranational borrowers, such as development banks and export banks, RMB Eurobonds offer a means to diversify their funding base and build profile. Meanwhile, Chinese state-owned enterprises are looking at this market as an alternative source of financing, provided they can bring proceeds on-shore cheaply.
Is the new RMB foreign exchange market in Hong Kong able to support the needs of bond issuers? How easy is it to move proceeds on-shore?
Jerry Li: There are currently three markets for RMB: the domestic on-shore market in China (referred to as the CNY market); the off-shore non-deliverable forward (NDF) market, which is priced in US dollars; and now the offshore deliverable Hong Kong RMB market, which we refer to as CNH (as opposed to the on-shore CNY).
Like the bond market, this is still at a nascent stage of development. However, after executing the first FX swap, cross-currency swap and money-market trades, Deutsche Bank's traders have seen liquidity jump from $3 million a day to upwards of $50 million to $100 million.
These volumes are of course still small -- the on-shore CNY market sees daily trading of $20 billion, while the NDF market is around $2 billion. However the growth of daily trading volumes for CNH to date is encouraging.
For bond issuers looking to convert RMB proceeds into US dollars, there is an interesting difference between the conversion rates of dollar/CNH and dollar/CNY. Because demand for RMB in Hong Kong is greater, dollar/CNH is currently trading at a slight premium to dollar/CNY, meaning borrowers get more US dollars for converting their RMB than what they would on-shore in China.
If issuers wish to send RMB proceeds to the mainland, an approval by the State Administration of Foreign Exchange (SAFE) is required, (which can be obtained) provided certain criteria are met.
What does this all mean for the Hong Kong dollar bond market?
Tsang: This does not spell the end for the Hong Kong dollar bond market anytime soon. As long as we have a Hong Kong dollar, there will always be a Hong Kong dollar bond market.
What the RMB Eurobond market does offer is the means to better match RMB assets and liabilities. For example, a Hong Kong corporate with suppliers in China can use its RMB proceeds to service its liabilities without the FX conversion risk arising from raising cash in a different currency.
How do you see the RMB Eurobond market developing from here?
Li: With the floodgates of trade settlement now open, there is significant potential for Hong Kong's RMB deposit base to grow -- and with it -- demand for RMB Eurobonds.
To get an idea of how significant trade flows are as a growth driver for Hong Kong’s RMB deposit base, we only have to look at the volume of global trade settled in RMB, which has grown from Rmb3.6 billion in the first half of 2009 to Rmb70.6 billion in the first half of 2010, according to the People's Bank of China. When you consider that only around 1% of Hong Kong/China trade is currently settled in RMB, the potential for growth to accelerate is clear.
The steady supply of government RMB Eurobond issuance to date suggests that officials are serious about developing this market and creating a benchmark yield curve. Ever-increasing deal sizes and tenors ensure the correct foundations are being laid to encourage participation by a broader range of issuers. We -- and indeed our peers -- are very focused on ensuring the RMB Eurobond market’s future is a successful one.