Panda bonds: the five hoops

Until recently, talk of panda bonds was exactly that: all talk and no action. The International Finance Corporation (IFC) and Asian Development Bank’s market-opening deals in 2005 sparked much hype about panda bonds becoming the next hot new asset class.

Back then, China’s government was relaxing restrictions on foreign institutional investors and its bond market was on track to becoming the third biggest in the world (after the US and Japan). A pipeline of panda bonds, being renminbi-denominated bonds sold by foreign entities to Chinese investors, seemed inevitable.

But the next decade saw just two deals, both issued by the same multi-laterals. The renminbi’s internationalisation and appreciation led to the creation of a thriving offshore market for so-called dim sum bonds, which was unimpeded by China’s capital controls and carried low coupons. This left little incentive for foreign issuers to try tapping the onshore market.

Growing market

All this changed in September 2015, when HSBC and Bank of China Hong Kong did exactly that. These deals signalled the willingness of Chinese regulators to approve issuance from non-multi-laterals.

More importantly, it coincided with the yuan’s devaluation and lower onshore interest rates, which meant dim sum bonds were no longer a cheaper source of funding than panda bonds. Some Hong Kong companies have even found it more cost effective to issue panda bonds and pay for a cross-currency swap, rather than selling bonds denominated in the currency they want.  

According to Dealogic, as of mid-November some 34 panda bonds had been issued in 2016, raising a total of $13.56bn across China’s two bond markets – the interbank market (CIBM), which is restricted to institutional investors, and the exchange-listed market, which is also open to retail.

Many others have been making inquiries. “Since around September last year we have had conversations with more than 200 potential issuers,” says Ariel Lei Yang, head of international business at local rating agency CCXI. “Of those, maybe about 40 to 50 have decided to do a deal, but only a few are in the formal rating process. Some of them may not have started the process of bringing the deal to market.”

Others, however, may have simply decided against issuing. Indeed, for corporates, financial institutions and sovereigns, one of the biggest deterrents to tapping the CIBM – the market favoured by international issuers as it accounts for 90% of China’s bond volumes and trading – is the lack of rules on how to sell a panda bond.

Awaiting rules

While China has published legislation for multi-laterals, the long-promised rules for other issuers have not been released. It means issuers must obtain deal-by-deal approval from the country's central bank, the People's Bank of China (PBOC), and, if they are a corporate or sovereign, also from the National Association of Financial Market Institutional Investors (Nafmii).

It can seem an opaque process, but there are consistencies between the deals that have been approved. “Each issuance is being vetted on a set of criteria that market participants are aware of, but aren’t set out in regulations or guidelines. So it’s not that there are no rules, it’s just that the rules and procedures aren’t public yet,” says Hwang Hwa Sim, a partner at law firm Linklaters.

For issuers that are used to granular guidelines and international market practice, this can create concerns. “For the uninitiated and those that haven’t been following the market for a while it sounds daunting, but it’s actually not. Once you start out, you find the roadmap is quite clear,” says Tee Choon Hong, Standard Chartered’s head of capital markets for Greater China and north Asia.

Based on their experience to date, bankers and advisers have identified five hoops that foreign issuers must jump through to tap the CIBM.

Hoop one: self-assessment

First, they must be a quality and high-profile issuer. There are no thresholds for turnover, assets and the like, but regulators clearly want the market to be built by premium names before opening it to second-tier credits. As such, issuers should assess whether the regulators are likely to be receptive to them.

“There is a self-selection process that I think issuers themselves should do,” says Timothy Yip, head of cross-border renminbi debt capital markets at HSBC. “They should pay attention to what is going on in the market and whether they fit into the type of issuers seen in the panda market so far.”

This means they must be in the same league as Daimler, Veolia Environnement, Standard Chartered and the governments of Poland and South Korea. For financial institutions it helps to have shown a long-term commitment to the Chinese market. For corporates, bankers believe that global names with established operations in China would go to the top of the approval list.

Aside from wanting to boost the CIBM’s credibility, regulators are being selective to ensure its stability. “The authorities are very keen to protect Chinese domestic investors in a market that only started to see defaults recently, [and] local investors may lack experience with foreign credits. So they will be cautious about bringing offshore issuers into China,” says CG Lai, BNP Paribas’s head of global markets for Greater China. For Nafmii in particular, investor protection is a top priority.

Before making a formal application, it is advisable to speak with the regulators to determine if they are likely to approve the deal, and if so what the parameters would be.

“I’ve heard that if the PBOC or Nafmii thinks it is not appropriate for you to issue panda bonds, they will give you an indication. So it’s best to start with some informal discussions, as if you are rejected, you save some face,” says Tiecheng Yang of global law firm Clifford Chance.

After this initial step, it is generally recommended that the issuer meets face-to-face with the relevant regulators.

“They can make contact via e-mail, but most people make the trip to Beijing,” says Mr Tee. “For the big household names you probably don’t always need to do that, but if you do, it conveys a stronger message. It shows you are serious about going ahead with the deal.”

Hoop two: local law

All documents – including an application letter, offering circular, underwriting agreement, financial accounts and other supporting documents – must be in simplified Mandarin and governed by Chinese law. While this may not be a problem for Hong Kong issuers, for those from elsewhere it can be a big ask.

"For US, Australian and European clients, the idea of having liability on a Chinese offering document is a big leap for a lot of these boards. When we raised the option to regional clients about two years ago, we were sometimes met with laughter, but things have quickly changed,” says Linklaters partner Jonathan Horan. “Corporates across Asia are interested in the market, but the Chinese offering document and Chinese law remain real considerations.”

For companies without a senior ranking Mandarin speaker, lawyers typically prepare the offering documents in the issuer’s native language for internal approval before it is translated and filed.  

On the plus side, as the CIBM is limited to institutional investors the disclosures, risk factors, liability and terms and conditions are very similar to those seen in offshore bonds. “Bar the language and governing law, the documentation requirements for the interbank market are not that far off international standards,” says David Tsai of Clifford Chance.

The ongoing requirements, however, can be different. The concept of a bond trustee does not exist in China, so post-issuance the issuer must engage with bond holders directly. It must disclose its quarterly reports, but sometimes its home country accounting periods are different to China’s, which can create problems. 

Hoop three: accounting and auditing

Financial accounts present one of the biggest stumbling blocks. As a starting point, the PBOC and Nafmii only accept accounts that are reported under Chinese Generally Accepted Accounting Principles (GAAP) and have been audited by a Chinese-registered firm. However, last year they signed a reciprocity agreement with Hong Kong that recognises the equivalence of their respective versions of GAAP and auditors. This is why a number of the banks have issued panda bonds via their Hong Kong units.

For non-Hong Kong issuers, the situation is more complicated. The EU’s International Financial Reporting Standards are being recognised as equivalent but EU auditing is not. Bankers have not seen anyone push for the recognition of US GAAP or US auditors, but the consensus is that a US issuer is likely to have more complex discussions with the regulator than a European.

It is possible to apply to the Ministry of Finance for a waiver regarding accounting or auditing standards. However the outcome depends on the individual issuer – the ministry is likely to be more receptive to sovereigns, for instance – and the outcome can be a requirement for summary translations to highlight major accounting differences.

For those unwilling to commit the time and money to try appeasing the Ministry of Finance, there is an easier way to sell a panda bond. Instead of a fully fledge syndicated deal, it is possible to do a private offering. This limits the pool of investors to about 200 blue-chip investors but, in aggregate, they provide almost as much liquidity as the CIBM’s full buy-side universe.

Starting last year, the PBOC and Nafmii have had much more flexibility in granting accounting and auditing waivers for deals that are privately placed. This has proved a sea change for the panda bond market, as it drastically expands the pool of potential issuers. For issuers that are not sovereigns or based in Hong Kong, this is the preferred route to market. Of the dozen or so panda bonds issued in the CIBM this year, it is understood that about half have been private placements.

Hoop four: use of proceeds 
The application letter must clearly state the reason for issuing a panda bond and where the proceeds will be used. Nafmii and the PBOC have taken a tough stance on the latter. “If you raise a domestic bond, there would of course be a preference from the regulators for you to use proceeds onshore. The last thing regulators want is issuers coming onshore and arbitraging domestic investors,” says HSBC’s Mr Yip.

The policy is consistent with China’s broader efforts to stem capital outflows and develop its capital markets, and is proving an important part of regulators’ decision making. BNP Paribas’s Mr Lai has recently detected that if an issuer states from the outset it wants to keep the funds onshore, the chances of the deal being ultimately approved appear to be higher.

As with accounting and auditing, sovereigns receive more flexibility. It is understood all three governments that have issued panda bonds – South Korea, Poland and the Canadian province of British Columbia – were allowed to take their proceeds offshore.

“Improving bilateral relationships is a factor here, so in many cases they will be receiving one-off waivers to issue. But it’s different if you are a corporate,” says Mr Lai.

Some corporates and banks have, however, received waivers from the PBOC after showing the proceeds will go towards a China-related cause. Bank of China Hong Kong, for example, is using part of its funds to support Beijing’s flagship One Belt One Road project. Other uses thought to be acceptable include refinancing dim sum bonds that are due to mature, or trade payments that must be settled in renminbi.

Issuers that have shown a strong commitment to the Chinese market may also get more leeway. But it is not always clear on what grounds waivers are and are not granted. “For corporate issuers, how lenient they are could very much be tied to the movement of the currency, at least for the time being,” says Mr Lai. “That’s not unreasonable to presume.”

Hoop five: local market norms

On top of satisfying the PBOC and Nafmii, issuers must also follow local market idiosyncrasies. That means three- to five-year tenors, as opposed to the seven- to 10-year maturities typically seen internationally. It also means less control over price formation and the allocation process.

While in the international market the syndicate and issuer can agree to tighten price guidance or amend issue size based on investor demand, China’s bookbuilding system is more mechanical. It is often described as akin to a Dutch auction. After the syndicate announces the price range, investors place orders for different volumes based on the different available prices. The books are filled starting with the lowest bids, and the coupon that everyone receives is set at the clearing price.

This lack of flexibility places a premium on assessing investor appetite. While the likes of Standard Chartered, HSBC and Bank of China Hong Kong’s deals have been heavily oversubscribed, corporates that are lesser known in China may be met with some scepticism. “China has been a fairly China-centric country, so investors are much more comfortable with local credit. It will take some time for us to persuade local investors to buy foreign names,” says Mr Lai.

“That’s another reason why the corporates we’ve seen, other than those headquartered in China but listed in Hong Kong, are all top-notch names.” 

Irrespective of the issuer’s rating by Fitch, Standard & Poor's or Moody’s, the buy side will expect the bond to be rated by a local rating agency. “We have done roadshows for panda issues and domestic issues and the feedback is quite unanimous that onshore investors prefer issuers to have a local rating. Otherwise some investors have said they will regard it as unrated,” says Mr Yip.

Local rating agency CCXI requires onsite inspection of the issuer’s overseas operations and face-to-face interviews with senior management.

The mental leap

Conservative treasurers who are accustomed to rulebooks and well-established execution processes have had reservations about panda bonds. But bankers stress that it is a standardised product, people know how to buy and trade it, and secondary liquidity is strong. The time being taken to create a rulebook is commensurate with the task at hand; once released, panda bonds are expected to become one of the world’s biggest bond markets.

It is no surprise, then, that China’s regulators are taking the characteristically prudent approach that has served the market well. “I can’t think of any market that has made more progress over the past five to 10 years in terms of developing itself, putting together a framework, implementing regulations, and attracting foreign issuers and investors,” says Philippe Ahoua, head of treasury client solutions for Asia-Pacific at the IFC. “They’ve done a terrific job, and it’s a big job to do. You can’t create a fixed-income market overnight.”

But there is no need to wait. As Standard Chartered’s Mr Tee says, it may sound daunting but the roadmap is actually quite clear. It just involves jumping through a few hoops.

NAFMII and PBOC did not respond to a request for comment.