Offshore renminbi bond market still at experimental stage

Speakers at AsianInvestor/FinanceAsia's "RMB Rising" conference dampen expectations about the growth of the offshore market for renminbi-denominated bonds.

Few issues in international trade and finance are more topical than the subject of AsianInvestor/FinanceAsia’s “RMB Rising” conference, held yesterday at the Renaissance Harbour View hotel in Hong Kong.

More than 125 delegates from 60 entities and 10 media organisations attended the conference, keen to share their views about the future role of China’s currency, the renminbi.

The morning got off to a vigorous start with a down-to-earth discussion about the prospects for the offshore renminbi-denominated bond market. Banks keen to attract mandates have made this a hot topic in recent months, and the financial press has been eager to discuss its implications, not least because high-profile bond launches, christened “dim sum” bonds by FinanceAsia readers in a poll last week, are tangible and even sexy. They are easier to examine and draw conclusions from than the myriad trade settlement arrangements in renminbi which, arguably, represent the more significant aspects of the currency’s “internationalisation”.

Veronique Lafon-Vinais, adjunct associate professor of finance, Hong Kong University of Science and Technology and widely experienced as a professional in banking and capital markets moderated the discussion between two other highly respected professionals: Marshall Mays, director of the Asian Bond Market Forum, and Francis Ho, director of group treasury at CLP Holdings.

Mays started by putting the subject into context. In Asian countries in general, there has been a deliberate move towards developing domestic bond markets and reducing companies’ reliance on debt finance from bank loans. China has been pursuing the same path, he said.

He traced that (careful) process back to a decade ago, when the Chinese authorities began forging relationships, installing the necessary regulatory infrastructure and, around five years ago, focusing on institution building.

Crucially, the decisions have been made in Beijing in order to fit conscious, cross-border plans for the creation of viable offshore and onshore bond markets.

Although bond issuance by the government and state-owned entities has developed rapidly, the corporate bond market on the mainland is still small. Nevertheless, there is a clear trend underway, as the Chinese authorities persuade banks to base their lending policies on commercial risk assessment.

A key educating tool is the bond market, where already credit spreads and adjustments for tenors on the yield curve have appeared. The involvement of more foreign participants, able to trade bonds in the over-the-counter market, has helped that process, despite the market being still dominated by buy-and-hold investors.

The growth, especially rapid during the past year, of new trade centres throughout the world for renminbi clearing has led to a substantial build up of offshore deposits. This has been particularly evident in Hong Kong, where, as Ho pointed out, renminbi deposits in the banking system have risen from Rmb80 billion ($12 billion) to Rmb130 billion in the past three months.

And as Mays succinctly observed: “The [renminbi] financial markets are being driven by the requirements of the real world.”

But, the problem is a dearth of attractive assets for that deluge of offshore renminbi liquidity. The reason is obvious. As several other panellists noted throughout the morning’s session, the Chinese currency is a one-way, appreciating bet, so why would borrowers want to raise debt that would cost them more to pay back in the future? A shortage of cost-effective hedging instruments also acts as a disincentive.

Only Enoch Fung, Asia economist in Goldman Sachs’s Asia economic research team, in a later discussion about the effect of “RMB Rising” on Hong Kong, chose to emphasise a positive voice about the prospect of new bond issues being launched to meet that renminbi supply – although he, too, conceded that there would be short-term difficulties. Simply, there are few companies, without a political agenda, which might sell renminbi.

Nevertheless, there have already been landmark deals. This month the Asian Development Bank (ADB) raised Rmb1.2 billion with a 10-year issue in Hong Kong. It was the first denominated in renminbi offshore by a triple-A rated entity and the first by a supranational. It followed a small launch by McDonald’s in August and was a further milestone in the rapidly developing renminbi debt market in Hong Kong. Asian investors bought more than 60% of the Regulation-S deal, which pays a 2.85% coupon, and some bankers expected the deal to act as a benchmark to price further issues.

However, “the offshore market is at an experimental stage”, concluded Mays. The necessary institutions are being quickly put in place, but it is hindered by “internal conflicts” between the desire for high yielding assets by investors holding residual renminbi deposits once trade transactions have cleared, and the equally strong desire by borrowers to lock in low-costing debt.

A free, or at least freer, floating Chinese currency seems to be the prerequisite for the nascent onshore renminbi bond market to make more than toddler steps forward.

Ho provided a borrower’s perspective. CLP is a Hong Kong-based power company with investments throughout the world, including about 60 current projects in mainland China. Typically, the company uses its project cashflows to service debt raised from domestic banks in local currencies, without parent guarantees.

Perhaps diplomatically, Ho said he liked developments in the offshore renminbi bond market, but he also didn’t shy away from pointing out its constraints and weaknesses – and also its potential. He summarised them in three categories: the “quantum” of the market; tenor; and cost-effectiveness.

Currently, despite the rapid growth in deposits, renminbi liquidity is too small, and needs to rise to at least Rmb400 billion. Most bond issues have tenors of two to three years, but CLP would need to find demand for bonds issued with maturities of 10 to 20 years to match its project cashflows.

Finally, and here Ho was most optimistic, it should be possible for borrowers such as CLP to launch bonds with lower interest rates because in Hong Kong rates are be determined by market forces rather than defined by the People’s Bank of China (PBoC).

“It will take time, but eventually an offshore market will allow us to diversify [our funding sources],” he said.

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