Investors demand tighter conditions on offshore bonds
Stricter covenants demanded from offshore yuan bond issuers after defaults
Offshore yuan investors are placing higher requirements on Chinese offshore bond issuers to avoid defaults, as higher funding costs and slowing growth weigh on existing debt commitments in China, Standard Chartered said.
"The offshore investors have been more cautious. One way investors show caution is asking for tighter documentation in terms of covenant in the bond doc[uments]," Henrik Raber, Standard Chartered's global head of debt capital markets, told the South China Morning Post. "In the dim sum market, an outcome you may see is that investors may ask for more covenants in high-yield companies."
A covenant is put in place in bond documentation by lenders to protect themselves from borrowers defaulting on their obligations. It refers to a promise that bond issuers will or will not conduct certain activities. For example, it usually states the limits on a borrower.
China's recent two defaults are touching the nerves of offshore yuan investors, making them more selective in buying offshore bonds by requiring more covenants to compensate for rising credit risks, Raber said.
This month, Shanghai Chaori Solar Energy failed to meet interest payments on its debt, making it the first-ever bond default in China, and was then followed by Haixin Steel which defaulted on bank loans. Raber said the defaults have unnerved offshore investors so they are inevitably becoming more selective.
"The issuers onshore and offshore are currently very different. The majority of issuers offshore are high-grade borrowers and in terms of rating spectrum," he said. "Although there may be credit pressure, I think it would be relatively limited compared to the onshore market.
"[Yet] there has been a view that the dim sum market is a market where the document is slightly lighter, or there is a perception the covenant versus the dollar market's are different," he added.
Such practices seem to have had a successful run for the past two or three years as the main buyers, particularly in the property sector, are mainly private banking clients who are very comfortable with the risks. Yet as the yuan appreciation theme goes away and investors start to see credit individually in much greater detail, investors would demand more covenants, he said.
Despite the credit concerns, Raber remains upbeat on the market potential given the bullish trade growth, and he expects the dim sum bond market to become one of the world's fastest growing bond markets in the coming five years.
The total dim sum bond market is likely to exceed 750 billion yuan by year-end, up from 572 billion yuan a year earlier, he said. Chinese banks and multinational companies are seen to dominate the pipeline thanks to higher capital needs, he said.