Unloved dim sum bond market offers ‘top’ value as yuan seen stabilising, analysts say

Yuan-denominated bonds issued in Hong Kong, also known as dim sum bonds, are attractive on the basis of yields and the outlook for China’s currency, analysts say

PUBLISHED : Tuesday, 25 April, 2017, 5:37pm
UPDATED : Tuesday, 25 April, 2017, 10:12pm

Hong Kong’s unloved dim sum bond market may find foreign investors returning in the coming months as improving sentiment towards the outlook for the yuan throw a new light on an asset class that appears to be offering good value.

Total issuance in dim sum bonds, or yuan-denominated bonds issued in Hong Kong, dropped to 3 billion yuan (US$435 million) in the first quarter, compared to 22.1 billion yuan a year earlier and 69.9 billion yuan in the same period in 2015, according to Thomson Reuters data.

The drop has been linked to concerns over investors’ reluctance to hold yuan-denominated assets amid strong depreciation expectations for the currency.

Meanwhile, Hong Kong yuan deposits dropped to 511 billion yuan in February, from 522 billion yuan in January, reflecting the lowest level since April 2011, according to monetary authority data.

But China’s decision to begin easing capital controls last week amid a stabilising yuan may suggest a revival for the offshore yuan bond market.

“Dim sum bonds have been forgotten by investors but this actually means there is value in the market, especially compared to the US dollar and onshore Chinese bond markets which have already rallied a lot,” Bryan Collins, fixed income portfolio manager at Fidelity International said. “Dim sum bonds are on the top of my Asia bond investment list now.”

China has been gradually opening its US$7 trillion domestic bond market, the third largest in the world, to international investors. The market is now accessible through several programmes such as the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor programmes, and the new China Interbank Market (CIBM) scheme. The Mainland China-Hong Kong Bond Market Connect may also be launched later this year.

As the domestic and offshore markets become increasingly interlinked, they are expected to eventually integrate into a single yuan bond market over time.

The decline in offshore yuan bond issuance last year came amid rapid growth of Panda bond issuance on the mainland as both Chinese and international issuers turned to the domestic market to lock in cheap funding. The two markets have become more interrelated as Panda bonds become a viable option for international issuers to raise yuan funds, offering Chinese companies the flexibility to choose between the two markets.

As fears of a further depreciation in the year recede, the high funding costs to issuers in the dim sum market are expected to drop. High yields will not be needed to compensate for a declining currency, and may thus help dim sum bond issuance and offshore yuan deposits to recover, analysts said.

Still, operational, custody, and administrative issues in the domestic market need to be ironed out before foreigner investors become comfortable investing on the mainland, analysts say.

Foreign central banks and supranational institutions now hold about 15 per cent of China’s onshore government bonds while general foreign investors own about 2 per cent, according to Chinabond data.

Dim sum bonds, which can bypass onshore regulations and tax implications, will probably still be the first stop for US and Hong Kong-based investors, at least for the next three to five years, Collins said.

Standard Chartered Bank chief China economist Ding Shuang says any further loosening of capital controls by Chinese policy makers will depend on whether the nation’s foreign exchange reserve can stay above the US$3 trillion level.

The Hong Kong Monetary Authority’s recent decision to launch a 5-year ministry of finance treasury bond futures, the offshore markets’ first futures on domestic Chinese government bonds and an important risk management tool to manage Chinese exposure, may also attract international investors to Hong Kong, Collins said.

Signs of renewed demand for Dim Sum bonds are emerging. A three-year 1.5 billion yuan bond issued by the Bank of China’s Johannesburg branch was heavily oversubscribed, according to Lorna Greene, director, Asia debt syndicate and origination, at National Australia Bank.

Matthews Asia, a privately-owned investment management firm, estimates the proportion of outstanding Asian bonds issued by Chinese corporates will rise to 83 per cent in 2020 from 63 per cent in 2014.