The Chinese bond market must achieve greater diversity – of issuers and investors – if it is to facilitate the successful internationalisation of the renminbi, which requires the government to relax its rules on foreign participants, something it is already starting to do.

The Chinese bond market has grown rapidly in tandem with the double-digit growth experienced in the domestic economy since the mid-2000s. In 2005, the market was valued at just more than Rmb7500bn ($1224.89bn). Today, China’s bond market is the fourth largest in the world at about Rmb21730bn. But, while the market has grown significantly in absolute size, its development has been restricted by two key hurdles – the banks being the dominant investors and the government or quasi-government entities being the major issuer.

The past couple of years, however, have marked a watershed in its evolution, with the Chinese government ushering in various reforms and projects aimed at liberalising the market and broadening the range of issuers and investors.

Relaxing the rules

Arguably, the most important of these was the introduction of the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme, which has opened up a channel for foreign investors to invest offshore renminbi in China’s stock markets. Launched in December 2011, the RQFII scheme was set up with a Rmb20bn trial quota, which was subsequently increased to Rmb70bn in April 2012. This scheme was predated by the Qualified Foreign Institutional Investor (QFII) scheme, established in 2002, which allowed foreign-denominated capital to be converted into renminbi before it was invested in China’s stock markets.

According to industry insiders, both of these schemes have significantly improved foreign participation in the onshore market by allowing qualified foreign institutions to invest in listed equities, bonds, warrants and, more recently, interbank bonds in the Chinese markets.

“The onshore bond market has opened up through QFII and RQFII schemes in the sense that foreign investors are now able to more readily invest in domestic Chinese markets,” says David Russell, managing director and Asia region head for securities and funds services in the Hong Kong office of Citi. “An indicator of how the markets are opening up is that in the past five months alone, the total RQFII quota approved was Rmb57bn – this is equivalent to 45% of the total RQFII quota since the scheme launched in 2011 – although it is still a very small percentage of the domestic Chinese capital market.”

Indeed, foreign investors remain significantly under-represented in the market, accounting for an estimated 3% of aggregate onshore bond holdings, according to Manulife Asset Management. However, in a clear sign of the growing determination of the Chinese authorities to boost foreign investment, in July 2013, the China Securities Regulatory Commission announced that it was going to almost double the quota of the QFII scheme from $80bn to $150bn, as well as expand the RQFII programme to London, Singapore and Taiwan.

Appetite for dim-sum

Although often treated as a separate issue, the offshore – or dim-sum – market has also played an important role in raising the profile of the onshore renminbi bond market and building international trust in the renminbi as an investable currency.

While still a nascent market, having only had its first issuance in 2007, the dim-sum bond market has grown exponentially in value from less than Rmb50bn to more than Rmb500bn today. Data from Dealogic shows that appetite for dim-sum bonds continues to grow at a rapid pace, with total dim-sum-issuance volumes reaching Rmb49.2bn in the six months to the end of June 2013, up 22% from the same period in 2012, and the highest volume on record. 

China’s Ministry of Finance, commercial banks and domestic enterprises have increasingly been issuing dim-sum bonds in Hong Kong, with the total value reaching Rmb300bn by June 2013. As a result, Hong Kong has fast evolved into the most sophisticated dim-sum market – having launched various offshore renminbi-denominated products, including currency futures, real estate investment trusts, as well as an array of exchange-traded fund (ETF) products (a gold ETF, a share ETF as well as a bond ETF). 

However, it will increasingly have to stave off competition after London was granted a licence to issue dim-sum bonds in 2012, followed by Singapore and Taiwan in 2013. 

“As things stand today, appetite for the dim-sum market still mainly comes from regional investors, with Hong Kong and Singaporean investors still accounting for nearly 70% of the bond holdings,” says Crystal Zhao, a fixed-income analyst in Hong Kong at HSBC. “These types of investors like investing in Chinese companies.”

Indeed, of the total dim-sum bonds outstanding, Chinese corporates are by far the largest group of issuers, accounting for more than 40%, according to an Asian Economic Perspectives report published by UBS in August 2013.

“We have been seeing non-government-related entities taking up a material proportion of dim-sum bond issuance since 2012, owing to the improvement in liquidity of the offshore US dollar and remnimbi cross-currency swap market that enables issuers to seek funding in renminbi, even if actual funding demand is in other currencies,” says Becky Liu, senior rates strategist at Standard Chartered, who focuses on China and Hong Kong rates markets.

Steady progress

While significant headway is being made in corporate involvement in the dim-sum market, growth in corporate bond issuance in the onshore market has been hamstrung by stringent regulation.

“Currently, Chinese corporate bond issuance in the domestic market is tightly controlled and needs approval from government agencies such as the National Development and Reform Commission or the People’s Bank of China [the Chinese central bank] and, in reality, most of the quota was given to government companies,” says Vincent Chan, head of China research at Credit Suisse.

“The central government had indicated that it wants more onshore private companies to issue bonds, but somehow they usually don’t get the quota. The overseas renminbi bond market is currently much more favourable to private companies, with a lot of private mainland developers issuing bonds in Hong Kong.”

China’s corporate bond market remains noticeably underdeveloped relative to those of developed economies, with corporate bonds accounting for just 28% of China’s total issuance compared to about 60% in the US. While there are those who remain critical of this, some industry commentators are keen to stress the fact that onshore corporate bond market issuance is gathering momentum – albeit from a low base – and that its growth is being spurred by the government.

“The number of domestic corporate bonds has been growing very rapidly over the past couple of years. The policy from the central government over the past few years has been to promote bond issuance because its number one consideration is to relieve the burden on the banks’ balance sheets and it wants corporates to have some diversity in how they raise their funds,” says Ms Zhao. “Today, onshore corporate bonds represent roughly 30% of the overall bond market – a sizeable increase from less than 10% a few years ago.”

An increasing number of companies are emerging as first-time issuers. Between January 2012 and the end of May 2013, $138bn of debt was issued by 1054 debut corporate issuers, according to Bloomberg data. And this growth looks set to continue. International rating agency Standard & Poor’s forecasts that the debt needs of Chinese companies will hit $18000bn by the end of 2017.

Loosening the noose

Conscious of the vast long-term financing needs that lie ahead, the Chinese government is increasingly trying to shift the focus away from bank lending towards the bond market. In light of the rapid urbanisation taking place across China, the government is expected to spend an estimated $6400bn on the infrastructure required to settle about 400 million more citizens in cities.  

In recognition of the need to support future bond market development, the Chinese authorities have raised the prospect of relaxing control over future foreign issuance, with China’s State Council endorsing a plan to study the feasibility of allowing international companies to issue debt in the onshore bond market.

Furthermore, the Chinese authorities are aware of the need to develop a liquid bond market if they are serious about internationalising their currency. In addition to signing a recent spate of currency swap agreements, they are aware that if they are serious about increasing the global use of the renminbi, they need to give investors a platform for their investment.

While the renminbi’s internationalisation has been gathering pace over the past three years, renminbi-denominated bonds – issued both inside and outside China – represented just 0.4% of the global total in 2012.

To this end, the effective implementation of the reforms aimed at liberalising foreign exchange rates and the removal of capital account restrictions that were unveiled in May 2013 by the State Council are of crucial significance in helping to bring about greater foreign issuance in China. Meanwhile, the rapid growth of new offshore renminbi centres in London, Singapore and Taiwan is expected to significantly boost market liquidity over the next few years. 

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