Political factors far outweigh financial gains in yuan bonds
Thanks to McDonald's yuan-denominated bond issue last month, the product, which was little known internationally, has finally shown up on the radar screen of many foreign corporations.
Who, how and why are questions many readers have been asking.
If you read the guidelines from the Hong Kong Monetary Authority, the answers look straightforward.
'The range of eligible issuers, issue arrangements and target investors can be determined in accordance with the applicable regulations and market conditions in Hong Kong,' they say. So, theoretically, any corporation can issue them as long as there is a market. But, as with most things on the mainland, it's never that straightforward.
First, you have to pay bondholders their interest in yuan. So you must have a stable source of yuan income. You don't need dollar income to issue dollar bonds, not just because the dollar is easily convertible but also because there are lots of foreign exchange forward contracts to cover the risk of exchange rate fluctuation. But there are few hedging instruments for the yuan, and those that exist come at a dear price.
Hopewell Holdings, the first non-financial foreign firm to issue a yuan bond, has no problem paying in yuan, because it operates several toll roads in southern China. And McDonald's sells tonnes of burgers in the country every day.
The second issue is you must have a need for the yuan, unless of course you want to tell shareholders that you are not a prudent manager and you are just punting for a yuan appreciation. Hopewell is building more toll roads in the country, while McDonald's is opening more restaurants there.
Then, you need special approval from the State Administration of Foreign Exchange.
Yes, it's true that the People's Bank of China has said institutions are free to do yuan business outside the mainland, and the issue of yuan bonds by foreigners is a matter for their home regulators.
But you have to send the money you've raised from the bond into China for your projects, and you need to send your yuan income out to pay the interest, right? Well, you need Beijing's stamp for that.
Remember, China's capital account remains closed, and you cannot freely move money in and out of the country. Besides, the law is clear only on the transfer of foreign currency into the country for investment purposes, but not on the repatriation of yuan.
So, the big question that follows is, what are the criteria for approval? As with most major policy breakthroughs in China, there are no guidelines yet. The two precedents are not very illuminating. In terms of credit rating, Hopewell and McDonald's are on opposite sides of the spectrum. The road operator, which has just recovered from a debt crisis, is not rated. The burger shop has an AA-minus rating, which is better than even that of the British government.
The only similarity is the guanxi. Both are well known - Hopewell at home and McDonald's internationally. Both are on good terms with Beijing. Both have hired bankers that are already in the loop. Hopewell's deal was done by Bank of China International and McDonald's had Standard Chartered, which spent months on the road with mainland central bankers to promote greater use of the yuan.
'The question is, with yuan income, a need for yuan and guanxi, why would one need a yuan bond?' said a financial controller who has been lobbied by bankers to follow Hopewell and McDonald's.
His mainland factory serves the domestic market and is sitting on piles of Hong Kong dollars from an early listing and some trading activities.
Yes, it is prudent to match a long-term yuan investment with long-term yuan funding. But Hopewell's and McDonald's bonds mature in two and three years, respectively. That's hardly long-term.
'Honestly, I never heard of a product with less than five years' maturity calling itself a bond,' said a veteran banker.
Yes, the yuan bond is cheaper than a yuan loan from banks, which are charging about 5 per cent interest. Hopewell and McDonald's are paying 2.98 per cent and 3 per cent, respectively, on their bonds.
'But I would have little problem borrowing Hong Kong dollars or issuing a Hong Kong dollar bond at 2 per cent,' said the financial controller.
The hassle of sending the money into the country and converting the funds into yuan for a legal investment project would be no more than getting a yuan bond approved. At least, there are clear rules and regulations on the former.
In fact, this option would be even more attractive if he counts in the expected appreciation of the yuan. As the yuan appreciates against the dollar, a dollar bond will cost less to repay for a company with yuan income.
But as anyone doing in business in China will tell you: 'Count not just the numbers but the political favours.'
Beijing is pushing for the internationalisation of its currency, and the issue of yuan bonds by foreign corporations is an important part of it. Mainland bureaucrats can certainly appreciate the value of a big name being part of the campaign.
With few commercial reasons for most companies to issue yuan bonds, and only political capital to gain, it's not surprising that more than six months after the HKMA announced its guidelines, only two issues totalling 1.5 billion yuan (HK$1.71 billion) have been done. Of these, McDonald's accounts for a negligible 200 million yuan.
It's also not surprising that the MTR Corp is the next name floating in the yuan bond pipeline.
The company is to build and operate a mass transit rail system in Hangzhou. MTR will have to pay 2.2 billion yuan in the coming 12 months and will need a stable source of yuan income in the next decade.
More importantly, let's not forget the MTR is largely owned by the Hong Kong government and is eagerly expanding its business on the mainland. Even if management might argue that it's financially better to raise Hong Kong dollars, the political reasons trump the financial.
A friend in need is a friend indeed.