China's domestic bond market is growing as a means to provide an alternative source of funding for the country's companies, which have relied too heavily on easy access to bank loans. The expansion has also encouraged its regulators to open up access to foreign firms and allow greater innovation within the market.
"The regulators have gradually opened up the onshore corporate bond market, allowing for diversification of issuer, investor and structure. This has been followed by a slow increase in the number of underwriters with international links. One reason that more counterparties can engage in the market is that there is now a higher absolute level of liquidity," said Fergus Edwards, Asia head of syndicate, at UBS.
Two features that have characterised this steady market progression are increased volumes and greater retail participation. Issuance of corporate and financial bonds targeted to the domestic markets has totalled the equivalent of almost $160 billion so far this year from 307 deals, according to data provider Dealogic. That's up from $65 billion in 2008 and just $9 billion in 2004.
"The Chinese authorities are encouraging the growth of all sectors of the domestic market, partly to shift corporate and municipal government borrowing away from their dependence on banks, but also because they see it as a healthy and necessary step towards more efficient local capital markets," said Patrick Tsang, Asia head of cross-border debt capital markets, at Deutsche Bank.
Market structure
The issuance process, although unconventional by international bond market standards, has become structured. "Typically, the institutional book-build happens rapidly following announced tenor and price guidance; then once terms have been fixed and announced on the Chinabond website, retail orders are invited," said Edwards. Almost all corporate bond issuance takes place in the interbank market.
In many cases, Shibor (the interbank offer rate) is used as the benchmark for agreeing the spread with the regulator, but the terms are then quoted as an absolute, fixed yield when a bond issue is offered to investors. The Shibor curve is now well developed and has reasonable liquidity out to five years.
But, according to market participants, most Chinese enterprise and corporate bonds are held to maturity by long-term investors and there is little secondary market trading.
Meanwhile, some overseas investors can participate through the qualified foreign institutional investor (QFII) scheme, which was launched in 2002 to open up the Chinese capital market to a limited range of foreign institutional investors. It allows them to exchange foreign currency for renminbi, which can then be invested in securities, including government and corporate bonds -- although they have mostly been used for share purchases.
So far, the State Administration of Foreign Exchange, has granted investment quotas totalling $15.72 billion to 78 institutions.
A number of Chinese regulatory bodies, such as the CSRC, actively monitor the development of the on-shore renminbi bond market, and strict guidelines define eligibility for issuance. Several multinational corporations have asked about access to the onshore market. "We hope to see such issuance in the not too distant future, just as we have witnessed recent developments in the offshore renminbi market in Hong Kong," said Tsang.
The International Finance Corporation and the Asian Development Bank sold 10-year renminbi-denominated bonds (so-called panda bonds) onshore in October 2005. The money raised had to stay in China and there have been no subsequent issues. "The government prefers that the country's fledgling nongovernment bond market remains a source for liquidity for its own companies and state-owned enterprises, and an alternative to bank lending," argued a Hong Kong-based banker.
Besides, she added, "it will take time for mainland investors to become comfortable and familiar with overseas names".
Fledgling offshore market
For the first time, on September 28, China launched two tranches of renminbi-denominated fixed rate bonds for sale to retail investors in Hong Kong. The Rmb6 billion ($879 million) offering was also the first sovereign renminbi bond issue outside the mainland.
According to Linklaters, which advised the underwriters, "the retail offering [broke] new regulatory ground in that it [was] made on the basis not of a prospectus or Securities and Futures Commission authorised offering document, but under the so-called 'dealer exemption', and signalled a re-assessment and softening of guidelines on selling procedures which have been applied to recent non-sovereign retail bond issues".
But more important, it represented a significant step towards making the renminbi a global currency. China's finance ministry described it as an attempt to "improve the international status of the currency", and followed other recent initiatives. The hope is that an offshore market in government bonds would help set a benchmark "risk-free" interest rate for renminbi debt, preparing the ground for issuance by mainland companies; and eventually it should offer an appealing way for foreign institutions to hold renminbi.
In July, China started a pilot programme that expanded renminbi settlement arrangements between Hong Kong and five major trading cities on the mainland, and, partly in response to turbulence in capital and foreign exchange markets a year ago, it has signed agreements with Argentina, Belarus, Indonesia, Malaysia and South Korea, which allow it to receive renminbi instead of dollars for its exports to those countries.
Five state-owned Chinese banks, including Bank of China and China Construction Bank, have issued renminbi bonds in Hong Kong since 2007, when the government started to allow the deals. Only financial entities incorporated in the mainland can issue renminbi-denominated bonds offshore, and so far that just means HSBC and Bank of East Asia among offshore lenders. Earlier this year, HSBC became the first foreign bank to issue renminbi bonds in the SAR.
"It seems reasonable to suppose that, eventually, onshore and offshore renminbi bond markets will become fungible. This will, however, take time," said Fergus Edwards, Asia head of syndicate, at UBS.
Overseas banks present and correct
Foreign investment banks are not allowed to hold more than 33.3% of a securities joint-venture (JV) with a local partner and the regulations prohibit a JV from offering secondary market services such as broking and research and, under a rule introduced in 2007, JVs won't be able to expand their services for five years.
Goldman Sachs set up the first JV, called Goldman Sachs Gao Hua, in 2004, but although other overseas banks have also forged JVs with Chinese firms, UBS is the only foreign bank to have management control of its entity, UBS-Securities. The business was established in 2007 and was granted its underwriting licence the same year. As of October 27, UBS has been bookrunner on 11 transactions, and is the only Sino-foreign JV to feature in the top 10.
Deutsche formed an alliance with Shanxi Securities to create Zhong De Securities in January 2009, which received a business licence on July 8 from the China Securities Regulatory Commission. The licence will allow Zhong De Securities to underwrite financial, enterprise and corporate bonds, as well as A-shares and foreign investment shares.
Credit Suisse formed a JV last year called Credit Suisse Founder Securities, which underwrites renminbi issuance as well as equity offerings. Notably it acted as joint-lead underwriter on a Rmb40 billion ($5.86 billion) subordinated bond issue for ICBC in July 2009.
This story first appeared in the FinanceAsia Bond Market Guide, which was published together with the November issue of FinanceAsia magazine.
