The Chinese currency is back on an appreciation path and yields are up. So what's not to like about it, asks Jasper Moiseiwitsch
The yuan appreciation story is back on the boil. After a steady drop in the volume of yuan deposits held in Hong Kong over the past year and declines registered by the currency (against the US dollar in the middle of the year) on concerns about a decelerating mainland economy, last week the yuan somewhat surprisingly hit a 19-year high. Investors believe the economy is turning a corner, and are coming back into the yuan.
For those looking to hold yuan there's good news: interest rates on the currency are rising in Hong Kong. Tellingly, the most popular yuan investment product of the day is bank certificates of deposit (CDs), for which yuan rates beat Hong Kong dollar rates by a wide margin.
HSBC pays 3.05 per cent for a 12-month yuan CD, versus 1.4 per cent for equal CD in Hong Kong dollars.
The yuan is maturing. It's become like any other global currency. It fluctuates in value. Notwithstanding last week's gains, investing in yuan is no longer a straight bet on currency appreciation - it's become a more subtle choice about the instrument, issuer and returns.
Lawrence Mak, BNP Paribas' head of corporate banking, says Hong Kong banks saw a huge boom in yuan deposits following key liberalisations in 2010, but initially did not know what to do with the money. Companies did not want yuan loans, so banks could not lend to them in the currency, and offshore banks were blocked from investing in the mainland. So banks paid poor interest on yuan deposits.
Much has changed over the past two years. For example, Hong Kong banks can now invest in the mainland interbank market - they can lend money to mainland banks, which gives the foreign banks an income-generating use for the yuan.
"Local banks have a lot more to do with yuan, such as lending, or reinvesting the yuan in China," says Benjamin Rudd, head of overseas investment of Ping An of China Asset Management. "Local banks have had to compete for yuan [and so have] increased the deposit rates."
Meanwhile, mainland regulators announced in December last year the renminbi qualified foreign institutional investor (RQFII) plan, which has opened up about 39 billion yuan (HK$48 billion) in investment opportunities on the mainland, at least some of which is used by local banks.
International companies are also getting more comfortable settling orders with mainland firms in yuan, typically through a Hong Kong institution. This has opened up another profitable use of yuan by local banks - trade finance.
Mak sees a merging of the mainland and Hong Kong markets, with yuan flowing back and forth.
Local yuan rates increasingly track those of the mainland, and they have risen to meet mainland rates. "The markets are getting closer and closer," says Mak.
This brings us to dim sum bonds, which are yuan bonds sold in Hong Kong, typically from mainland issuers. Rising interest rates for Hong Kong yuan deposits means issuers have had to raise the yield on their dim sum bonds.
"Dim sum bonds yield less than 4 per cent. Deposits pay 2.5 to 3 per cent. So the yield is only marginally higher," says Sermon Kwan, Bank of Singapore's head of China. "For retail it is wiser to stay in deposits."
Rising yields are a bonus for investors, but it has made the Hong Kong market less attractive for issuers, particularly as they can get the same cost of funding in the mainland for much less hassle.
This has prompted analysts to scale back expectations for dim sum issuance. Deutsche Bank on October 19 said there would be about one third fewer dim sum bonds priced in Hong Kong in 2012 than expected, attributing the shortfall to "elevated funding costs".
Partly thanks to competition from CDs, the dim sum market is picking up its act. In 2010-11 many high-yield unrated issuers punted out dim sum bonds on expectations that investors would inhale anything in yuan. Investors lost money on some of these issues.
These days, people focus more on yield and credit quality. The tone of the investment has changed. Dim sums have become a more serious investment with better pricing and better quality issuers.
"People realise the yuan is not a one-way street, so they look at the real underlying value of the bonds, not betting just on appreciation. We see some good quality names that are trading over par," says Kwan.
This year also saw the arrival in Hong Kong of 23 RQFII funds, which can invest in mainland stocks and bonds. The funds arrived with a lot of fanfare but investors' response so far has been moderate.
Nineteen of these are effectively bond funds with the ability to invest directly in mainland debt. This was attractive in 2010 when mainland bond yields were greatly above those paid in the Hong Kong market. But as interest rates in the two markets converge, the payoff for investing in mainland bonds has decreased.
"There was a lot of retail interest in RFQII funds when they launched, because historically there was a big difference in onshore and offshore interest rates. But the differential is not so big anymore," says Scott Wehl, head of banking products, APAC, UBS Wealth Management.
The other four RQFII funds that came in 2012 were exchange traded funds that invest directly in A shares. These funds involve less expense and more transparency than previous A-share ETFs listed in Hong Kong, which use derivatives.
Ironically, the yuan ETFs are much more popular when priced in Hong Kong dollars.
Harvest, an asset manager, launched an A-share ETF denominated in yuan earlier in the year, and interest was low. Then it launched a Hong Kong dollar tranche of the same instrument and trading volumes increased tenfold.
China Asset Management followed suit and, last Friday, launched a Hong Kong dollar version of its China AMC CSI 300 Index ETF. Hongkongers find it easier to trade the ETF in the local currency, says Henry Lee, a director at China Asset Management.
Which all speaks to the maturation of this market. Yuan investments are just another option for investors, and one that is often interchangeable with an equivalent class in Hong Kong or US dollars. And as the mainland marches towards full currency liberalisation (expected some time in 2015) this trend will only deepen.
"There is clear and concrete evidence of moves towards eventual capital account liberalisation. You can see a consistent sequence of events pointing in one direction," says Kuldeep Singh, head of markets Hong Kong for Citibank.