Offshore RMB bonds face hurdles, but offer huge promise

Speakers at the AsianInvestor/FinanceAsia “RMB Rising” conference outline the challenges facing the offshore renminbi bond market and its future prospects.

The AsianInvestor/FinanceAsia “RMB Rising” 2011 conference, which was held at the Grand Hyatt in Singapore on Tuesday this week, reflected the sway that China's "internationalisation" story – particularly pertaining to its bond market and its currency – holds over investors, companies and banks.

The well-attended, half-day event drew more than 100 delegates and speakers, including representatives from multinational companies such as Walt Disney and Dow Chemical. Notably, most of them stuck around throughout the event, instead of disappearing after the coffee break.

This was no doubt testament to the widespread interest that China generates. For the past few months, the offshore renminbi bond market, or the “dim sum” market as it is commonly referred to, has certainly captured the attention of global investors. Its growth trajectory has been swift, with a widening array of issuers opting to tap the market.

Throughout the conference, the words bandied around to describe the offshore bond market were “nascent,” and in its “infancy”, underscoring just how embryonic the market is.

Since the market kicked off in 2007 -- when the mainland authorities first allowed banks incorporated in China to issue renminbi-denominated bonds in Hong Kong -- such bonds have gained traction.

The market’s growth has been driven by the rising amount of renminbi deposits in Hong Kong and investors’ seemingly insatiable demand for any asset that allows exposure to the appreciating Chinese currency.

However, the offshore renminbi bond market continues to face a myriad challenges, including a lack of liquidity and the lack of a sufficiently developed swap market.

According to panellist Alexander Jaeschke, head of fixed income for Greater China at BNP Paribas, the offshore renminbi bond market also lacks a proper benchmark rate as a reference point for pricing floating-rate bonds.
 
On the mainland, the Shanghai Interbank Offered Rate (Shibor) is frequently used as a reference rate for floating-rate bonds, whereas the Hong Kong Interbank Offered Rate (Hibor) is used as a benchmark for Hong Kong dollar-denominated floating-rate bonds. “We don’t have an equivalent of Hibor for the CNH,” Jaeschke said at the conference. The “CNH” is the moniker used to describe the pool of offshore renminbi in Hong Kong.

And, while rapidly growing, the daily interbank trading volume in USD/CNH spot stands at about $300 million, or a mere 10% of the daily USD/CNY non-deliverable forward volume. “CNY” refers to the onshore renminbi, also known as Chinese yuan.

Corporate issuance is just a small slice of total dim sum bond issuance as companies face difficulties repatriating funds. As of December 2010, out of the Rmb55 billion ($8.3 billion) of outstanding dim sum bonds, Jaeschke estimates that only Rmb6 billion to Rmb8 billion are corporate bonds, which is roughly 11% to 14.5% of the total market.

From an investor standpoint, the volatility of the CNH also poses challenges when investing in offshore renminbi bonds. Rajeev De Mello, head of investments and operations at Western Asset Management in Singapore, pointed out that the CNH traded at a 2.8% premium to the onshore value (the CNY), ahead of the G20 meeting in October amid widespread speculation that China would revalue the yuan. It subsequently traded at a slight discount to the onshore value in December.

“If an investor buys [the CNH] at a substantial premium, he is exposed to the risk of the currency moving at a slightly different pace from the onshore currency. This is especially true when sentiment tips,” De Mello said during the conference.

Developing alongside the dim sum bond market is the synthetic offshore renminbi market, which has also attracted much attention as issuers are able to raise large amounts in this format – as reflected by Evergrande Real Estate's recent Rmb9.25 billion ($1.4 billion) bond.

This market, which refers to renminbi-denominated but US dollar-settled bonds, has given rise to opportunistic issuance from Chinese real estate developers that are hoping to raise funds more cheaply than in the US dollar market. 

While the synthetic format allows a wider pool of investors to buy the bonds, Western Asset Management’s De Mello has reservations about such bonds. He described them as being “a bit gimmicky” and prone to being sold off as soon as markets turn bearish.

“I’m always concerned that those bonds are the first ones that investors will sell because perhaps they bought them for only one reason, which might be the appreciation of the currency,” he said at the conference.

From an issuer perspective, synthetic bonds allow them to remit funds back to the mainland with greater ease. This is particularly helpful for Chinese real estate companies, which face restrictions on borrowing onshore. However, the process of getting approval to remit funds is not easy for any company --- a theme that surfaced several times during the conference.

Pius Chong, managing director and head of transaction management, Asia-Pacific global markets at HSBC, noted that companies that require funds would welcome a more simplified process and framework for how to remit renminbi proceeds onshore.

As the market evolves, Chong expects renminbi-denominated product offerings to expand beyond the realm of the bond market. “There should, within the course of this year, be a variety of product offerings. The next will probably be RMB-denominated shares in Hong Kong and hopefully through the Singapore Exchange as well,” Chong said at the conference.

Away from the bond market, other points that were discussed included the challenges posed by renminbi liberalisation for the Hong Kong dollar, the expected appreciation of the renminbi and its use as a reserve currency.

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