The offshore renminbi, or dim sum, bond market has risen dramatically in the past 18 months. The first such deals appeared in 2007, but until mid-2010 volumes were small, with issuance totalling just Rmb16bn ($2.52bn) in 2009.
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The past two years have seen exponential growth, thanks to the Chinese authorities lifting restrictions and making it possible for many more borrowers to tap the market. There were Rmb41bn-worth of deals printed in 2010 and almost Rmb150bn in the first 11 months of 2011, taking the total value of outstanding dim sum bonds to about Rmb220bn.
Bankers say that while the market is still small in comparison to the world’s biggest bond markets, such as the dollar and euro ones, its expansion has been impressive. “We have seen phenomenal growth in the dim sum market,” says James Fielder, HSBC’s head of local currency syndicate for Asia. “I doubt anyone would have expected to see the level of issuance that we did in 2011.”
Part of the plan
The dim sum market is a major part of China’s gradual internationalisation of the renminbi, which is likely to see it eventually become a fully convertible currency. Analysts say that after officials allowed the renminbi to be used to settle trade transactions – a process which began in 2009 – the development of a renminbi bond market was a logical next step.
Having a large bond market is seen as a prerequisite for creating a reserve currency, which many believe is Beijing’s ultimate aim for the renminbi. “They are committed to the internationalisation process,” says Philip Poole, global head of macro and investment strategy at HSBC Global Asset Management. “An important part of that is creating deep and liquid bond markets.”
China could have opted to open its onshore bond markets, which are difficult for foreigners to access. But it was wary about the effects a surge of inflows to the mainland would have on its currency. Instead, it opted for what some bankers call a ‘dry run’ to gauge international investors’ appetite for renminbi bonds by developing an offshore market in Hong Kong.
The rapid increase in dim sum issuance is testament to the success of this policy so far. Issuers have embraced the market. For Chinese companies, it has given them access to a new investor base and allows them to raise debt far more cheaply than they can in the onshore capital markets.
Non-Chinese companies have also taken to the market. Dim sum bonds have provided a way for those with mainland operations to fund these operations with renminbi debt, especially since China’s central bank eased rules about issuers moving the proceeds onshore.
First movers
One of the first non-financial corporate borrowers to tap the market was fast-food giant McDonald’s, which in mid-2010 printed Rmb200m of three-year paper to pay for its expansion in China. Last year UK supermarket group Tesco and Air Liquide, a French gas producer, both of which want to grow in China, were among the borrowers to follow suit.
Increasingly, issuers without major Chinese operations are printing dim sums, particularly European companies whose funding costs at home have risen substantially in the past six months because of the eurozone crisis. They have been able to do this thanks to the deepening of the market for currency swaps involving the renminbi, a phenomenon caused by investors becoming less bullish – amid a slowdown of Chinese exports – about the prospect of the currency continuing to appreciate quickly over the next two years.
As such, in some cases it has become cheaper for European companies to issue short-dated renminbi bonds – usually with a maturity of no more than a year – and swap the proceeds into dollars or euros, instead of issuing directly in the latter two currencies.
“The swap market is more developed because there is now a two-way view for shorter duration,” says Augusto King, co-head of debt capital markets for Asia at Royal Bank of Scotland. “Not everyone thinks the renminbi will appreciate. In fact, given the macro situation in China, quite a lot of investors actually think the renminbi will depreciate. Many international issuers are comparing what they can do on an after-swap basis in renminbi with what they can do on a straight basis in dollars or euros.”
Supply and demand
Demand for dim sum bonds has so far easily matched supply. The market has presented non-Chinese investors with a way of gaining exposure to the currency, which, despite sentiment weakening in the past few months, most think will appreciate by an average of about 3% to 5% annually over the medium term. “For the most part, the market is about getting exposure to the currency,” says Mr Poole.
This demand has risen roughly in tandem with the amount of renminbi deposits held in Hong Kong. From 2004, when banks there were first able to offer renminbi services to individuals, to mid-2010, the deposit base grew steadily to about Rmb100bn, according to Moody’s. Since then, following a loosening of restrictions by Hong Kong and Chinese authorities, renminbi deposits have risen rapidly. Hong Kong now has about Rmb620bn of them.
Given the low rates of interest on these deposits and a lack of alternative renminbi assets available for investors to buy, many of them are being put to work in the offshore bond market. HSBC estimates that outstanding dim sum bonds as a proportion of deposits in Hong Kong rose from 15% in November 2010 to 32% in September 2011.
Changing function
The dim sum market has not been immune to the fallout from the eurozone crisis. For three weeks from late September 2011, issuance all but ceased, as was the case in many other big bond markets around the globe. And average yields widened in the secondary market by about 100 to 150 basis points.
But the market quickly reopened with deals for borrowers such as China National Petroleum Corp, France’s Lafarge Cement, and Industrial and Commercial Bank of China’s Asia unit.
Nonetheless, bankers say that while demand is still strong, investors have become more disciplined and are no longer accepting low yields simply on the basis that the renminbi will strengthen swiftly. “The dim sum market is becoming more of a credit market rather than mostly a play on the appreciation of the renminbi,” says Mr Fielder. “That is good, a sign that it is developing.”
Investors have also demanded tighter covenant packages, particularly from speculative grade issuers. Many insist on gearing ratios, which limit a borrower’s ability to take on additional debt. “If an issuer is deemed to be non-investment grade – whether or not they are rated – investors want a decent covenant package or to be paid a higher coupon to compensate for the credit risk,” says Mr King. “Otherwise, they will not buy the deal.”
The renminbi market has suffered from an illiquid secondary market throughout its short existence. While bankers say liquidity has deepened in the past year, investors still struggle to buy bonds in the secondary market amid a lack of sellers. As such, they are often forced to wait for more issuance in the primary market before being able to place any new money coming into their funds.
Still, the future of the dim sum market seems bright. HSBC believes that gross issuance in 2012 will be between Rmb260bn and Rmb310bn, and between Rmb300bn and Rmb500bn in 2013. If the most optimistic forecasts prove correct, the amount of outstanding dim sum bonds will be just under Rmb1000bn by the end of 2013.
Tenors will probably lengthen in the next two years. Until recently, non-financial corporate issuers were largely restricted to issuing bonds with maturities of three years or less. But as the market matures the demand for longer-dated debt rises, as was shown in the second half of 2011 by Air Liquide selling some seven-year paper and ICBC Asia printing a 10-year deal. The latter was particularly popular with insurance companies, more of which in Hong Kong are taking on long-term renminbi liabilities, which they need to match with long-term renminbi assets.
Moving mainland
Another big development could be the emergence of more mainland Chinese borrowers. Until a change of regulations in August, they could only issue dim sum bonds through offshore subsidiaries. Baosteel, the state-owned steelmaker, became the first Chinese company to issue offshore directly when it printed Rmb3.6bn of bonds in late November 2011.
More companies are expected to do the same in 2012. “If Chinese companies can get approval to send the proceeds back onshore, why wouldn’t they look at the offshore renminbi market?” says Mr Fielder.
Investors hope this will create more diverse supply in the market. “At the moment it is largely dominated by real estate firms and banks,” says Hayden Briscoe, a renminbi bond fund manager at US asset management firm AllianceBernstein. “We would welcome oil and gas companies, utilities and borrowers from the consumer sector.”
The dim sum market’s long-term future will depend on what the Chinese authorities decide to do with the onshore bond market. Some investors feel that within a few years they will have opened up the latter to the extent that yields there and in the offshore market will have converged fully. “Within five years there will be no difference between the dim sum and onshore markets,” says Mr Briscoe.
Others say such a scenario will take longer to emerge, given that it will require Beijing to remove capital controls. For now, they say, China is focused on developing its offshore bond market rather than opening its onshore one to foreigners. Until that changes, the dim market is likely to flourish.
