Across The Border

Dim sum bonds under pressure as yuan continues to gain global recognition

Sales of domestic panda bonds overtake their Hong Kong-issued equivalents for the first time in first nine months

PUBLISHED : Monday, 10 October, 2016, 4:32pm
UPDATED : Monday, 10 October, 2016, 9:57pm

The increasing volatility of funding costs this year in the offshore yuan market has weighed heavily on the price of dim sum bonds.

And analysts say the bonds – denominated in yuan and issued in Hong Kong – are expected to feel more pain as the offshore market continues to be used as a policy tool by the Chinese government to stabilise the national currency as it strives to internationalise its standing.

After several months of calm, dim sum investors have started experiencing intense periods of squeezed liquidity.

In mid-September, short-term funding of yuan in Hong Kong suddenly dried up, with the overnight yuan Hibor, the Hong Kong Interbank Offered Rate for the yuan, peaking at 23.68 per cent.

As the main funding method for many banks and dealers, the extraordinarily high overnight Hibor reduced their ability to bid for bonds, which resulted in a swift drop in their price and a surge in yield. Bond yields rise when their price falls.

As funding rates in the offshore yuan market rose, government bonds and high-grade bonds were the worst performers, as they are more closely correlated to rates, according to a research note from HSBC.

The rising dim sum bond yields have also scared off new bond issuers to the market.

The pool of offshore yuan, which has been shrinking for 12 months, is still too shallow to withstand a surge in demand
Zhi Ming Zhang, head of China research at HSBC in Hong Kong

According to data provider Dealogic, dim sum bond issuance totaled US$7.2 billion in the first nine months of this year, but that was surpassed by panda bond issuance (US$11.8bn) – yuan denominated debt sold by foreign companies in the domestic market – for the first time ever.

And Carmen Ling, global head of RMB solutions at Standard Chartered Bank, said short term panda bond issuance will continue to outpace dim sum issuance, as onshore funding costs are about 1 percentage point lower than in the offshore market.

Analysts say the recent underperformance of dim sum bonds was largely funding driven, not for the first time, or the last.

The squeezed funding environment is similar to the start of the year, which led to government intervention, when the yuan was faced with intensified depreciation pressure.

The government succeeded in fighting off short selling against offshore yuan by controlling offshore liquidity to stabilise the currency’s exchange rate.

It’s widely believed the recent turbulence was also the result of Chinese government intervention.

“We believe the offshore yuan market is being used as a policy tool, so CNH bonds (dim sum bonds) may continue to suffer during the RMB internationalisation process,” said Zhi Ming Zhang, the head of China research at HSBC in Hong Kong, in a latest research note.

The bank expects further government measures to make the yuan more freely traded, in line with its new special drawing right status, however, adding the offshore market may face more pain during the process with the volatility of the offshore funding rate not expected to ease soon.

“The pool of offshore yuan, which has been shrinking for 12 months, is still too shallow to withstand a surge in demand,” said Zhang.

Total offshore yuan deposits shrank 31 per cent in July compared with the same month a year earlier, according to statistics from RBC Capital Markets, and yuan deposits in Hong Kong were down 33 per cent in July year on year, according to separate data from Hong Kong Monetary Authority.

A lack of a monetary policy anchors also increased volatility.

There are no central banks conducting regular money market operations to smooth liquidity conditions offshore, said Wang Ju, a senior FX strategist at HSBC in Hong Kong, in a separate report.

Whenever there is conflict between a policy preference for exchange rate stability and the market’s view on exchange rates, said Wang, we tend to see more volatile movements by the FX forward points in the offshore yuan market.