Diversifying the Chinese bond markets

China's debt capital markets are diversifying at a rapid pace. Chinese companies have long been active in the offshore dollar and euro markets, and international issuers have taken the opportunity of issuing into the offshore Renminbi (RMB) markets, part of the ongoing process of internationalizing the Chinese currency. But now, international issuers are increasingly also looking to issue bonds in China's domestic debt capital markets. 

This Panda bond market officially opened in 2005, with inaugural issues by the International Finance Corporation and the Asian Development Bank. After that initial burst of activity, the market paused until 2015, when the authorities in Beijing took steps to re-invigorate it. Since then, an increasing number of new issuers have seen the benefits of tapping the market. These include foreign companies with extensive onshore operations in China such as automotive company Daimler, sovereigns and sub-sovereigns including the Republic of Korea, the Republic of Hungary and the Province of British Columbia, and international banks, including HSBC and Maybank.

According to Sheng Wang, Co-head of the Financial Institutions Group at HSBC in Hong Kong, this is part of the wider plan to develop the Chinese economy. "The revitalization of the Panda bond market shows that the Chinese debt capital markets are seriously opening up for foreign issuers and investors. Issuers are attracted to the depth of the investor base, the opportunity to match funding to costs, and  the relationship benefits that  RMB bonds can generate in China."

The foreign investor base has its access to the onshore Chinese capital markets enhanced through a sequence of planned, strategic openings, such as the Qualified Foreign Institutional Investor (QFII) and RMB Qualified Foreign Institutional Investor (RQFII) quota schemes, the China Interbank Bond Market (CIBM) direct scheme, and most recently the Bond Connect scheme. 

The People's Bank of China (PBoC) and the Hong Kong Monetary Authority (HKMA) launched Bond Connect on July 3, 2017. The scheme is designed to allow investors from outside of China - including central banks, monetary authorities, sovereign wealth funds and large financial institutions - to invest in the onshore bond market. 

"The launch of Bond Connect last July has been a breakthrough for the Panda bond market," says Mr. Wang. "One of the reasons behind the new scheme was to increase foreign investor participation in the local market. At present, China has nearly USD 10 trillion of bonds outstanding, making it the third largest bond market in the world but foreign investors own only around 2%. But because of Bond Connect, recent international Panda bonds, including those by Maybank and the Republic of the Philippines had more than half of their individual issue placed with offshore accounts. International issuers can now issue in the onshore market and benefit from the name recognition they already have with offshore investors."

Panda bond issuers are now looking to tap into the high-quality investor base that has been systematically built up in the Chinese onshore market. In 2017, there was almost RMB 72 billion of issuance through 30 Panda deals, while in 2016 there was RMB 134 billion via 48 deals, according to data from Global RMB.^1. 

Timothy Yip, Head of Debt Capital Markets at HSBC Qianhai Securities in Shenzhen says that issuers can be flexible on the use of proceeds. "Proceeds can be used by companies to finance their onshore operations" he says. "The money raised can also be taken offshore, subject to prior approvals from the relevant regulators. This is especially true for sovereign issuers as we have seen with the deals for Poland, Hungary, and British Columbia, offerings in which at least a portion of the funds raised were expatriated offshore for usage."

Since the beginning of 2018, a wider array of issuers has come to the Panda bond market. These include a sovereign issue from the Emirate of Sharjah, and two Japanese banks, Mitsubishi UFJ Financial Group and Mizuho, which successfully issued their bonds after a bilateral recognition agreement on auditing was reached between the Chinese and Japanese regulators. 

By far the largest number of issuers into the Panda bond market are Chinese companies registered outside China, which count as offshore entities. These issuers are known as 'red chip' Panda bond issuers. 

The Panda bond market is increasingly becoming a natural place to finance investments as part of the Belt and Road Initiative (BRI), since costs and funding for these projects can often be paid for using RMB. In early January 2018, Global Logistics Properties became the first issuer approved to be a BRI issuer. It is using the proceeds to build a distribution network in Western Europe. Meanwhile the investment in Sri Lanka's Hambantota port by China Merchants Port will be financed through the issuance of similarly designated Panda bonds. 

According to Mr Yip, the typical size of a Panda bond is between RMB 1 billion and RMB 3 billion with tenors up to five years being the sweet spot for investors. But longer tenors and larger-sized deals are in the works. 

A key consideration for foreign issuers looking at the Panda bond market is that it encompasses two segments - the interbank market and the exchange market. The investor base for the interbank market largely comprises banks and other official institutions, while that of the exchange market consists of traditional asset or fund managers, wealth managers, securities houses and participation from insurance. In terms of overall issuance volumes, the interbank market accounts for almost 90% -95% with the exchange market accounting for the rest.

While the two markets aggregate to make up the China domestic bond markets, they do have different characteristics that should be taken into account by prospective issuers. For instance, the investor base for Interbank is essentially institutional only, whilst retail investors have the option to participate in publicly syndicated bonds which are issued into the Exchange Market. 

Separately from the onshore markets, the offshore RMB bond market - sometimes known as the dim sum market for those transactions executed in Hong Kong - offers yet another option for companies to raise funding in China's currency.

"The dim sum market tends to be more opportunistic, so having the flexibility to move between the offshore and onshore RMB markets is important," says Mr. Yip. "The onshore investor base is purely focused on RMB and typically have not met many international issuers before, and so there is an investor education process that needs to occur. Starting to access the Panda bond market now is a good idea because as the market progresses you want everyone to know your name."

The three markets - interbank Panda, exchange Panda and dim sum - do have different dynamics. According to Mr Yip, the three factors that issuers should consider when looking at the three markets are the level of accessibility, the projected lead time it takes to access each market and pricing differentials. 

"Global issuers need to follow the three markets," says Gina Tang, Head of Debt Capital Markets, Hong Kong and China, at HSBC in Hong Kong. "HSBC can provide advice on how to navigate between the three." 

Establishing an overall RMB issuance programme and then staying nimble across all three options will give the optimum outcome. According to Mr Yip, this is how many large domestic Chinese companies such as SOEs operate. For example, it is relatively common for Chinese SOEs to have secured approvals to issue in both the interbank and exchange segments whilst applying to the National Development and Reform Commission (NDRC) for an offshore issuance quota (which will include offshore RMB). Then they can issue in any of the three markets when the pricing and timing are most favourable to them.

"It is an exciting time for issuers as they have three different options," says Mr Yip. "The dim sum offshore market has reopened after a few years where there was virtually no issuance apart from a few private placements. But the onshore markets in my opinion offer greater depth. The liquidity onshore is much greater than the liquidity offshore. The size you can achieve, and the volume of investors onshore obviously far exceeds what is offshore. If you are an issuer with long-term goals in China and you have RMB needs it is very important to look at the Panda bond market and start setting up your programme."

With the appointment of a new governor at the PBoC, market participants are anticipating a new set of guidelines to promote the market even further and to attract international issuers. Recent reforms to the regulatory agenda show that the authorities are keen to make the market as accessible as possible. 

The direction of travel is clear and is a key policy goal for the Chinese authorities. "This opening up is very much part of the maturing process in internationalizing the RMB," says Mr Yip. "And that is using the RMB as a direct funding tool."

RMB bond issuance has developed significantly over the past two to three years. HSBC is a global leader in the offshore RMB bond market. HSBC Bank China has been active in bringing a range of issuers to China's interbank bond market. HSBC Qianhai Securities is licensed to operate in the exchange market, having commenced operations in late 2017. 

For more information, please visit www.gbm.hsbc.com. For professional customers and eligible counterparties only.

^{1. Global Capital GlobalRMB Database (https://www.globalcapital.com/rmb/data/panda-bond-database)}