RMB Bond Issue in Hong Kong (a.k.a. A Delicious Dim Sum Offering!) – Some Structural Issues to Consider – Part 4

by Dorsey & Whitney LLP
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Introduction

Foreign and Chinese companies seeking to access the renminbi (“RMB”) bond market can now raise capital without time-consuming IPOs, rights issuances and secondary offerings. It also provides a cheaper form of RMB financing to an issuer than raising capital onshore1. An RMB bond provides investors (who otherwise have very few options to invest in offshore RMB) with RMB exposure. The Hong Kong RMB bond market, also known as the Dim Sum bond market, is the first offshore2 market for investments in the Chinese currency, but it has seen slow growth in the past few years. This eUpdate is part 4 in a series of eUpdates on this topic. Part 1 deals with laws and regulations applicable to, and features of, an RMB bond. Part 2 discusses points that an RMB bond issuer should consider. Part 3 deals with the documentation and issue process of an RMB bond. Part 4 considers some structural issues that the Dim Sum bond market continues to face after its liberalization in 2010.

Liberalization of the Dim Sum bond market

Since 20103, Mainland China4 began a series of deregulation which served to boost the use of its currency overseas and enabled more companies to access RMB in Hong Kong5; the Chinese government then extended the class of Dim Sum bond issuers to include multinational companies and international financial institutions6. In 2011, China’s 12th Five-Year Plan promulgated the policy of promoting wider use of RMB in cross-border transactions and supporting Hong Kong’s development as an offshore RMB business center7. A series of measures were introduced by various authorities in Mainland China subsequently, including further expansion of the RMB trade settlement scheme, the introduction of arrangements for inward and outward direct investments in RMB, as well as the RMB Qualified Foreign Institutional Investors (RQFII) scheme8.

Against the backdrop of all these measures taken by the authorities in Mainland China, however, the volumes of issuance have been slow: according to official data released by Hong Kong Monetary Authority, the volumes of issuance in Hong Kong were RMB 36 billion in 2010, RMB 108 billion in 2011 and RMB 112 billion in 20129. According to various sources, it also seems that investors have been “turning away” from Dim Sum bonds in 201310.

Flow and circulation of RMB funds between onshore and offshore markets

Repatriation of funds to China. Corporate issuers, in deciding where to invest their money, place emphasis on their ability to repatriate the funds back to Mainland China. Repatriating the proceeds onshore causes difficulties for those prospective Dim Sum bond issuers that have a need for RMB onshore11.

Procedures for repatriating RMB-denominated proceeds to Mainland China vary, depending on the type of bonds in question, and the approval process could be time-consuming. Bond prices, on the other hand, may vary on a daily basis. The inherent risk involved can deter many would-be investors. “Repatriation is based on timing. It’s a chicken and egg situation – you can have an onshore entity that does business in China and can do the registration with SAFE12 and then you also need the terms and conditions for the bond before you can apply. There’s a lot of uncertainty regarding the timing of this process – the markets can move.”13

In a private sector-led Hong Kong-London RMB Forum in September 2013, participants, including senior representatives of the Hong Kong and London offices of ten leading banks, recognized the importance of promoting and expanding channels for two-way flows with Mainland China14. Expanding channels for funds leaving Mainland China was expected to generate new liquidity for the offshore RMB market as investors in Mainland China enter international financial markets. To expand channels for funds entering Mainland China, it was said that more should be done to engage with potential market participants globally, to access the financial markets in Mainland China through RQFII and other arrangements15.

Other factors to consider

Liquidity. For investors, liquidity is the most important factor16. Liquidity in the Dim Sum bond market is far below that of the more sophisticated dollar-denominated Asian bond market: there are currently no benchmark bond issuances or hedging tools, which are standard in the more mature markets. There is a lack of RMB derivatives to hedge against risks17. A bondholder who has already bought Dim Sum bonds would often find it difficult to exit and, of course, even more difficult to sell in a hurry should the need arise18.

For corporate issuers, there is the risk of possible liquidity squeezes when they need to refinance maturing Dim Sum bond issues through a new bond issue. There is a reported RMB 300 billion of Dim Sum bonds maturing in 2014 so issuers will likely raise funds early to avoid any liquidity squeeze19.

Size and tenor. Over 90% of the Dim Sum bonds in the past three years had an issue tenor of five years or less20, and a standard Dim Sum bond issue is sized around RMB500 million to RMB1 billion21. This is unattractive to many potential international issuers, because the proceeds are bite-sized, and the fact that they must be refinanced after a few years could expose issuers to currency risks22.

Meanwhile, the proceeds for anything longer-dated come with higher risks, because cross-currency swaps become less liquid beyond five years23. Ananda Development Pcl, a Thai real estate developer, planned to sell the first-ever Dim Sum bonds with no fixed maturity – but subsequently “pulled” the offer as proposed yields failed to meet the company’s expectations24. The weaker demand for longer-tenor bond also reflects increased sensitivity to interest rate fluctuations, as investors are wary of China’s surging interest rates and tight liquidity onshore25.

Diminishing cost advantage. China’s borrowing costs have been increasing at a fast pace since late 2010, as the authorities looked to liberalize interest and exchange rates. “The benchmark 10-year yield jumped 49 basis points last quarter and 48 basis points in the three months through September, the biggest increases since a 57 basis point gain in the final three months of 2010, a ChinaBond gauge shows”26. Indeed, where there is inadequate cost benefit to justify offshore financing, Chinese companies would prefer tapping the domestic market, given its much wider investor base27. Another key factor has been the low interest rate environment in 2013 for PRC issuers issuing US$ denominated bonds: it will be interesting to see if the possible tapering of US quantitative easing from 2014 onwards will encourage RMB issuance.

New year’s resolutions

For greater use of RMB in cross-border transactions and the internationalization of the currency, effective channels must be in place for the flow and circulation of RMB in onshore and offshore markets28, and a more “hands-off” approach ought to be adopted by the authorities in Mainland China. This would also be in line with the November pledge of the Communist Party to give markets a more decisive role in the economy29. As part of the reforms, the People’s Bank of China (“PBOC”) outlined plans to end daily currency intervention and move towards RMB convertibility, including allowing special accounts for trials in Shanghai’s free-trade zone30. This means that the PBOC will basically end normal intervention in foreign-exchange, enhance RMB’s inflow and outflow flexibility and increase RMB’s daily trading limit31. Also, Mainland China may launch an internationally compatible China International Payment System (CIPS) and a RMB Qualified Domestic Institutional Investor (RQDII) programme is also in the pipeline32. If the RQDII scheme is launched, residents in Mainland China will have more opportunities to invest offshore33. Further, more quotas for the RQFII scheme mentioned above were granted as Mainland China increased its efforts to ease its cross-border transactions34.

It is widely hoped that the latest or proposed plans of various authorities of Mainland China will help to solve some of the structural issues that the Dim Sum bond market faces and increase appetite for Dim Sum bonds. Most recently on January 9, 2014, the London branch of Bank of China raised RMB 2.5 billion35. The bond has a tenor of three years36, and is the first issue from the London branch of a Chinese bank to the Dim Sum bond market37. Bank of China’s recent issue is among “positive signs of the continued development of London’s RMB market"38, and it follows the granting of a license to a U.K. fund manager to invest directly in China’s markets under the RQFII scheme39. Speculators are optimistic about the Dim Sum bond market in 2014 and expect more international participation from issuers and investors40

1   “Onshore” in this article refers to the jurisdiction of the PRC.
2   “Offshore” in this article refers to the other jurisdiction areas of the PRC, in particular, Hong Kong.
3   For more information on PRC Regulations (especially those prior to 2010), see RMB Bond Issue in Hong Kong (a.k.a. A Delicious Dim Sum Offering!) - Part 1 (http://www.dorsey.com/eu_hk_rmb_bond_issue_pt1), May 9, 2013.
4   “Mainland China” in this article refers to the geopolitical area under the jurisdiction of the PRC, excluding Hong Kong, Macau and Taiwan.
“PRC” in this article refers to the People’s Republic of China, excluding Hong Kong, Macau and Taiwan.
5   “Easing of rules on dim sum bonds urged”, Bloomberg, December 13, 2013.
6   See RMB Bond Issue in Hong Kong (a.k.a. A Delicious Dim Sum Offering!) - Part 1, ibid.
7   http://www.hkma.gov.hk/eng/key-information/insight/20130221.shtml
8   Ibid.
9   Ibid.
10  “Investors Retreat from Dim-Sum Bonds” by Vipal Monga, The Wall Street Journal, October 15, 2013. See also “CNH Tracker – Dim sum market set for a booster shot” by Michelle Chen, Reuters, October 23, 2013; “Slowest summer sales in three years for dim sum bonds”, Bloomberg, September 13, 2013; “China Spurs Rebound in Issuance of Dim-Sum Bonds” by Fiona Law, The Wall Street Journal, November 28, 2013.
11  Richard Anund, Senior Director and Asia Representative at Svensk Exportkredit. See “Size, policy continue to constrain dim sum bond growth” by Anita Davis, Asiamoney PLUS, September 27, 2013.
12  The State Administration of Foreign Exchange of the PRC.
13  See supra note 11.
14  http://www.hkma.gov.hk/eng/key-information/press-releases/2013/20130926-3.shtml
15  Ibid.
16  Ronald Lee, the chief trader for fixed income at the Hong Kong branch of Bank of Communications. See “Slowest summer sales in three years for dim sum bonds”, Bloomberg, September 13, 2013.
17  “China Spurs Rebound in Issuance of Dim-Sum Bonds” by Fiona Law, The Wall Street Journal, November 28, 2013.
18  “Market for “Dim Sum” Diminishes” by Fiona Law, The Wall Street Journal, May 31, 2012.
19  “CNH Tracker – Heavy Dim Sum supply seen next year on refinancing pressure” by Michelle Chen, Reuters, December 12, 2013.
20  See presentation by Frances Cheung of Crédit Agricole Corporate & Investment Bank on Offshore RMB.
21  “Size, policy continue to constrain dim sum bond growth” by Anita Davis, Asiamoney PLUS, September 27, 2013.
22  Ibid.
23  Ibid.
24  “Thailand’s Ananda Said to Cancel First Perpetual Dim Sum Bonds” by Rachel Evans and Boris Korby, Bloomberg, November 6, 2013.
25  “China’s Sovereign Bond Auction Reflects Cloudy Yuan Story” by Fiona Law, The Wall Street Journal, November 21, 2013.
26  “Dim Sum Busiest in 17 Months as BlackRock Bullish: China Credit” by Fion Li, Bloomberg, December 3, 2013.
27  Frank Huang, the head of trading at SinoPac Securities Asia. See “Slowest summer sales in three years for dim sum bonds”, Bloomberg, September 13, 2013.
28  http://www.hkma.gov.hk/eng/key-information/insight/20130221.shtml
29  “Failing dim sum yields reflect yuan hopes”, Bloomberg, December 11, 2013.
30  See supra note 26.
31  Governor Zhou Xiaochuan wrote in a guidebook explaining decisions taken at the November 9-12, 2013 Communist Party meeting. See supra note 26.
32  “Fresh offshore RMB products to launch in 2014: ANZ” by Clare Hammond, Asiamoney PLUS, December 16, 2013.
33  Ibid.
34  Ibid.
35  “Dim Sum market makes healthy start to 2014” by Jing Song, FinanceAsia, January 10, 2014.
36  “Bank of China Said to Sell 3-Year Dim Sum Notes in London” by Maria Levitov, Bloomberg, January 10, 2014.
37  See supra note 35.
38  Mark Boleat, policy chairman for the City of London Corporation. See supra note 36.
39  Ibid.
40  “Pimco Sees Dim Sum Refinancing Boom on Cash Crunch” by Tanya Angerer and Rachel Evans, Bloomberg, January 3, 2014. See also supra note 26; supra note 32; “Dim Sum Sales Rebound Tipped as Yuan Strengthens: China Credit”, by Tanya Angerer, Bloomberg, October 15, 2013.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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