Panda bonds alluring in China’s booming bond market
More reforms are needed in China’s domestic bond market to captivate foreign investors, and the yuan’s inclusion into the International Monetary Fund’s elite SDR basket was only an inch ahead in a mile-long journey.
With over 45 trillion yuan (HK$53 trillion), China’s bond market ranks the third largest in the world after the US and Japan. Riding on the tailwind of enormous deregulation and a credit easing cycle, new issuances have surged 73 per cent year-on-year to 17 trillion yuan between January and October. Yield curves are also inching down in a typical sign of a bond bull market.
Yet the party has been largely celebrated at home in China. Foreign ownership in the colossal market stands at a pitiful 2 per cent.
The IMF’s seal of approval last month to incorporate the yuan in the Special Drawing Rights basket, a notional currency rarely used in daily transactions, may spur foreign central banks to allocate more assets in yuan, but private investors would hardly budge on the pure basis of the IMF’s nod.
An SDR inclusion was ranked as the least important driver of investment decisions, according to a survey by BNP Paribas, which polled 44 institutional investors in both the private and public arena.
Other factors, including regulatory risks, information asymmetry vis-à-vis local players, and restrictions on investment quotas, were ranked far more important than the IMF’s symbolic move.
Ken Hu, chief investment officer at Invesco’s Asia Pacific fixed income department, said he would love to hold more Chinese treasury and sovereign bonds should the firm get more quota.
Atlanta-based Invesco, which manages some US$791billion, is applying for a quota in the Renminbi Qualified Foreign Institutional Investors programme, having obtained US$125 million in the Qualified Foreign Institutional Investors scheme.
“Yuan is probably the second strongest currency after the US dollar. It is also a high-yield currency, given the interest rates in China are still a lot higher than other major economies,” he said.
“When the yuan falls, other emerging market currencies will fall even further. So to some extent it is like a natural hedge. Plus it offers the benefit of diversification for foreign institutional investors,” Hu added.
A new breed of bonds is arising with a groundswell of promise to change the landscape in the domestic fixed income market – the so-called panda bonds issued by offshore entities.
“Foreign investors who wish to gain exposure to China’s fixed income market may find a panda bond a more comfortable alternative, as the issuers are typically credits familiar to international investors,” said Becky Liu, senior rates strategist at Standard Chartered Bank (HK).
Standard Chartered in early December issued 1 billion yuan of panda bonds, following the steps of HSBC, Bank of China (Hong Kong) and China Merchants Holdings (Hong Kong).
The Republic of Korea was among the first sovereign issuer to tap panda bond funding and the Canada’s Province of British Columbia is also in the pipeline of its issuance.
Still, pandas have a hard time attracting foreign corporate issuers, due to discrepancies in accounting rules and uncertainty in the regulatory regime.
Agnes Tsang, a consultant at law firm Allen & Overy, said authorities would roll out a new set of rules that simplifies the procedures after enough testing cases prove there is solid demand for panda bonds. “But the absence of legal clarity has dented companies’ enthusiasm to tap the new market.
“It has become a bit of a chicken-and-egg issue,” she said.
Evan Goldstein, global head of renminbi solutions at Deutsche Bank, said unfamiliarity with the onshore credit rating system and other fundraising alternatives have contributed to issuers looking elsewhere.
“Many European multinationals have their medium term note programmes in place. For the time being, they will be more inclined to issue notes on the back of those programmes based on accounting rules that they are accustomed to,” he said.