China's international sovereign debt issue last week - the first in more than two years - is unlikely to unleash a flood of international corporate bond issues from mainland companies. As long as domestic interest rates remain low in China, bank borrowing will remain a cheaper funding alternative. But mainland-backed companies have been more active issuers of international convertible bonds this year, lured by rising share prices, investor appetite for risk and narrowing credit spreads. Overseas convertible bond issuance by mainland companies has already reached a four-year peak, surpassing the US$690 million recorded in 2000. According to data provided by Thomson Financial, Dealogic and JP Morgan, 10 mainland companies have issued foreign currency convertible bonds this year, raising more than US$1 billion. The recovery of the convertible bond market arrived on the back of rebounding equity prices, as the equity option component of convertibles subsidises the servicing cost of the fixed-income component. The Hang Seng H-share index, which tracks mainland-incorporated companies, has risen 92 per cent this year. The Hang Seng red-chip index - comprised of mainland-backed firms incorporated in Hong Kong - has gained 34 per cent. The equity market recovery, together with improving global economic fundamentals and an even rosier outlook for Asia, has whetted investors' appetite for risk. That has made convertible bonds' equity element more attractive, hence reducing issuers' funding costs. 'As investors' risk appetite improves, we are definitely finding that investors are paying more for the embedded equity option than they were earlier in the year,' said Alex Large, head of Asian equity-linked origination at JP Morgan. JP Morgan has arranged convertible bond sales by three Hong Kong-listed companies this year. When Panva Gas led the way with a US$50 million international convertible bond issue in April, the embedded equity option accounted for just 4.5 per cent of the convertible's face value. As the year wore on and optimism prevailed in Asia, the bond component's contribution rose to about 9 per cent for independent power producer Beijing Datang Power Generation's US$153.8 million issue last month and almost 10 per cent for Citic International Financial Holdings' (CIFH) $180 million offering last week. 'The servicing costs of convertible bonds have got much cheaper this year as a result of this phenomenon,' Mr Large said. CIFH's convertible bond yield of 0.25 per cent marked a low among Hong Kong issues and came in at 255 basis points below the three-year swap rate of 2.8 per cent. Also contributing to issuers' enthusiasm for convertible bonds are low interest rates, especially in the United States. As a result, corporate credit spreads have tightened considerably this year alongside sovereign debt spreads, more so since March. Improved economic fundamentals are again driving the narrowing credit spread. This has been reinforced by international ratings agencies' recent upgrades of Asian sovereign debt, including China's. Most Chinese issuers have issued international convertible bonds this year to bankroll capital expenditure and expansion, rather than refinance old debts. Curiously, Beijing Datang has been the only H-share company to tap the international convertible bond market despite H shares' phenomenal gains this year and hunger for China-themed investment. Instead red chips and the so-called Chinese private chips have dominated the ranks of issuers. Some analysts blame the incongruity on the lengthy approval procedures state-controlled H-share companies endure before they can issue debt. Despite last week's market correction, Mr Large said the convertible bond recovery looked set to continue. 'Most people think Asian equities are relatively undervalued compared to the rest of the world and also have high growth prospects,' he said. 'We have a very optimistic outlook for the Asian equities markets. We think that's going to continue to be reflected in relatively high risk appetite within convertible bond markets and attractive pricing for issues.' Yet even with the apparently tight yield of China's latest sovereign bond issue setting an encouraging benchmark for corporate issuers, appearances by Chinese companies in the straight foreign currency bond market are expected to remain relatively rare. Five international non-convertible debt issues by Chinese companies this year fetched US$1.1 billion, after last year's $762.8 million, according to Dealogic. However, the US$1 billion and 400 million euro (HK$3.62 billion) Chinese sovereign debt issue concluded last week inflated this year's figure. 'I don't really see a wave of issuance because from a pure funding perspective, it's still more attractive for most issuers to raise money domestically,' said Jon Pratt, Credit Suisse First Boston's head of debt equity markets for Asia ex-Japan. 'Most borrowers in China have been able to source adequate funding at very low cost [at home],' he added. 'This should continue as we expect liquidity in the Chinese banking system to remain high and the domestic savings rate to grow as personal income increases.' Ben Yuen, head of fixed income at First State Investments, notes that for those able to raise funds through domestic bond issues, a tranche of Chinese treasury bonds maturing in April 2012 has a 3.9 per cent yield, compared with the 10-year US treasury yield of 4.3 per cent. The interest rate gap has begun to narrow of late. Moves by the People's Bank of China to stave-off economic overheating last month lifted interbank lending rates from 2.1 per cent to 2.96 per cent. However, with the People's Bank of China and rival government agencies seemingly divided on the need to take more action to curb over-investment, economists see only moderate monetary tightening in the near future. Hence it would be a while before domestic and international interest rate movements swung in favour of international corporate bond issues, analysts said. 'I believe that most debt issuance over the next few years from China will come from companies raising funds for international expansion, recapitalisation of the banking sector or institutions that have been to the market in the past and are simply looking to maintain a presence in the international debt markets,' Mr Pratt said. One example is China's offshore oil giant CNOOC, which has issued international debt with 10- to 30-year maturities. Aside from CNOOC's need for foreign currency to finance its offshore operations, its repeat appearances on the international bond market are seen as an attempt to set strategic benchmarks and maintain - according to Mr Pratt - 'a ready and willing investor base should they need to tap into that market quickly and raise long-term financing that might not be available elsewhere at the same cost or in the same maturities'. A larger number of Chinese companies in other sectors may join their oil and gas peers as they too explore international acquisitions and expansion. According to Mr Yuen, periodic offerings would raise Chinese issuers' debt market profile. He said another reason for Chinese companies to go overseas for long-term debt was that domestic bank loans tended to have shorter maturities, while longer-maturity issues in China's under-developed corporate bond markets might not be sufficiently liquid.