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Panda bonds: In it for the long haul

Onshore renminbi-denominated bonds issued by foreign entities are catching on but the market will take time to develop, writes Tee Choon Hong of Standard Chartered.
The panda bond market is still in its formative stages
The panda bond market is still in its formative stages

Issuing a bond is the start of a long-term project – as is building a new market.

Panda bonds – renminbi-denominated (RMB) securities issued on the domestic Chinese bond market by foreign entities – are attracting significant interest among issuers around the globe and across sectors. In January, the Canadian province of British Columbia followed the government of South Korea in issuing RMB3 billion of panda bonds, and many financial institutions and corporates are also looking east. From a geographic perspective, there has been active engagement by prospective European and North American issuers, as well as those from less developed markets.

While the panda bond market has already demonstrated its ability to attract diverse issuers (banks, including Standard Chartered, corporates and supranational entities, all issued before South Korea), more corporate candidates are expected to enter the fray, especially multinational firms looking to fund existing onshore Chinese operations or to repatriate funds raised in China for general purposes.

Some may switch from existing offshore RMB issuance. International issuers have been active in the ‘dim sum’ market since 2010. Notwithstanding the need to bring their issuance programmes under Chinese law and adapt to post-issue disclosure rules, international firms that have been using dim sum proceeds to fund onshore operations may well be attracted to the panda market, as could financial institutions that have issued dim sum to swap offshore RMB proceeds into USD.

Still in its formative stages, legal, regulatory and accounting issues must be ironed out before the panda market can really gain momentum. The process of creating the issuance framework takes time because it has many parts and players. Reciprocal recognition of accounting and auditing standards is the responsibility of the Ministry of Finance; for example, bond issuance licenses are granted by various regulators including People’s Bank of China, National Association of Financial Market Institutional Investors, or the China Securities Regulatory Commission, depending on which bond market the panda bond is to be issued. Just as importantly, a new market needs ongoing dialogue between regulators and issuers to support long-term working relationships.

Being an early mover is not without its challenges, but several factors are building a compelling case for action. The Chinese bond market is now the third largest globally (approximately USD7.5 trillion outstanding at end-2015), behind the US and Japan, and growing at double-digit rates. The RMB’s accession to the International Monetary Fund’s Special Drawing Rights (SDR) basket – spurring the development of a vast pool of easily accessible, long-term liquidity – adds to the panda market’s appeal, as do declining interest rates.

But the macro-economic conditions currently influencing China’s monetary policy should not be a major influence – positively or negatively – on potential issuers of RMB-denominated debt looking to diversify from funding sources in more familiar markets. Issuing debt is a long-term commitment. From the outset, both issuers and investors expect repeat issuance and deepening mutual understanding.

Similarly, the decision to create the pre-conditions for foreign entities to issue RMB-denominated bonds onshore is a long-term commitment by the Chinese government. Support for the panda market at the highest level – as part of the gradual policy objective of opening up China’s capital account – should give confidence to would-be issuers. China will not be rushed into liberalising cross-border capital flows, but the direction of travel has been clear, and unwavering, for several years. Recent developments only serve to underline this point that the regulatory environment will continue to evolve in support of long-term, government-mandated aims.

So much for supply. How strong is domestic Chinese demand for debt issued by foreign issuers? Inevitably, it takes time for foreign credits to develop a track record and a strong following among domestic investors, as does the generation of research and media interest, fuelling institutional and retail investors. But over-subscription of recent issues suggests strong latent interest. And even if the panda market were to grow from 3 to 20 issues in a year, current levels of demand would easily absorb supply.

Foreign investor demand will also play a role in the success of the panda bond market. The inclusion of the RMB in the SDR basket was a symbolic step toward greater onshore investment by public and private foreign investment institutions. But the relaxation of foreign investment quotas and the entry of foreign investment institutions into the domestic interbank bond market – both announced in Q1 2016 – may have at least as much impact on foreign participation in the panda market.

At the same time, greater alignment between financial market infrastructures is already delivering smoother access to Chinese assets by international investment institutions. A deal has recently been closed in the Shanghai Free Trade Zone to allow entities to settle debt security transactions via existing accounts at international central securities depository Euroclear, rather than at the Shanghai Clearing House. By enabling investors to use familiar facilities and processes to invest in panda bonds, China may have removed a major obstacle to foreign market participation. Much more remains to be done of course. But, as we all know, the bond market is all about the long term.

By Tee Choon Hong, Managing Director and Head, Capital Markets, Greater China and North Asia, Standard Chartered

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