China chalks up symbolic victory by persuading World Bank to issue low-yield SDR bonds

Commercial investors unlikely to show much interest due to the low yield

PUBLISHED : Wednesday, 24 August, 2016, 9:23pm
UPDATED : Wednesday, 24 August, 2016, 11:00pm

The World Bank will next week launch a bond in China which is denominated in the International Monetary Fund’s special drawing rights (SDR) and can be repaid in Chinese renminbi.

The first of its kind, the bond comes ahead of the Chinese central government hosting a gathering of the leaders of the world’s 20 largest economies.

“The bond issuance comes at a time when China is about to host the G20 and when the yuan is about to become part of the SDR,” said David Yim, head of debt capital markets, Greater China for Standard Chartered.

However, the bond, which will be issued in China’s onshore interbank bond market, may initially only attract official buyers such as central banks as the low yield, its small size and the depreciating value of yuan seems likely to limit interest from other investors.

The bond, which Bloomberg reports is to be issued on August 31, will be the first SDR denominated bond for 30 years. The first batch will have a three-year maturity with a face value of 500 million SDR units – one unit approximately equals US$1.40 – and will be repaid in yuan. The SDR bonds will carry a coupon rate of between 0.3 per cent and 0.6 per cent, Reuters reported.

The yuan will be officially included in the SDR basket of the International Monetary Fund on October 1 this year. SDRs are monetary units issued by the IMF and are held by its member states as part of their currency reserves. Their value is determined by a weighted currency basket composed of, at present, the US dollar, the euro, the yen and the British pound.

William Chung, senior vice president at CIFM Asset Management (Hong Kong), said the major buyers are likely to be official investors, rather than yield-seekers as the coupon rate of the SDR bond is quite low.

“Central banks need to add some yuan reserves after it is included in the SDR basket. The SDR bond becomes an option. They don’t buy it for yields,” Chung said.

China’s fixed-income fund managers endeavour to deliver 7 to 8 per cent return on their funds, so they may have limited interest in allocating SDR bonds, he added.

Standard Chartered’s Yim said although the issue is small, the rarity of it would see it eagerly taken up by some central banks or mainland banks to show their support for the landmark issue.

“It will barely appear on a balance sheet. However, it may not be considered attractive to other institutions given its low coupon and small size,” he said.

Stephen Innes, senior trader at Oanda, agreed that the very low yield would make it impossible to attract institutional or retail investors. Further, as central banks are likely to hold the bond to maturity, there will be little secondary market liquidity for the bond.

The falling value of the yuan also makes the SDR bond less appealing, Innes added.

“While some investors are undaunted by low or negative returns, they tend to purchase these with expectations for capital appreciation as the underlying currency strengthens,” Innes said, taking the soaring Japanese yen as an example.

Although an addition to China’s bond products pool will benefit the market, the SDR bond may face an uphill battle for universal acceptance given the broader economic and policy uncertainty in the mainland, Innes added. “I view the product as more or less a political win for Beijing. So in that regard, definitely a symbolic victory.”

In a statement on its website the People’s Bank of China said; “The approved issuance of SDR bonds... will help broaden the use of the SDR as a way to enhance the stability and resilience of the international monetary system.”

Andy Seaman, chief investment officer at UK based Stratton Street Capital, said there should be a lot of interest in SDR bonds. “The global financial system would function much better with a basket currency like the SDR being the world’s reserve currency rather than the US dollar,” he said. “However, the fact that the bonds are being issued via the interbank bond market will mean that Chinese investors will have to compare the yield of the SDR bonds with that of similar maturity renminbi bonds.”

In a recent research report, CICC said that complexities such as low liquidity and potential revisions to the SDR basket every five years would weigh on the development of the SDR market.

But it could increase yuan’s use for financial settlements, CICC said.

The Post contacted the World Bank for a comment but no response was received at the time of going to press.