China's dim sum banquet lacking variety

China is showing further commitment to developing the offshore renminbi bond market in Hong Kong by introducing more mainland issuers, but there is a danger that this will reduce credit spreads and cause investors to tire of the influx of Chinese borrowers.

China’s top planner, the National Development and Reform Commission (NDRC), has announced six requirements for non-financial companies to issue dim sum bonds in Hong Kong. It remains to be seen exactly how many borrowers will hit the market and with what size of deals, but clearly many mainland companies will join a market previously reserved only for Chinese banks.

The NDRC said in a statement on Tuesday that eligible issuers must have good corporate management, good cashflow and strong profitability, and must use the proceeds for fixed asset investments that are in line with the nation’s macroeconomic blueprint. The companies must also have a three-year track record of good creditworthiness with no serious violations or infringements.

The requirement for the use of proceeds suggests investors will need to get comfortable with China’s vast infrastructure and public utilities projects, which are the country’s single biggest source of growth.

Three government-backed power plant operators and one mining company, including Huaneng Power International, China Guangdong Nuclear Power, China Datang Corp and China Minmetals Corp, won approvals from the NDRC late last month to raise a combined Rmb18.5 billion in Hong Kong.

More supply is not necessarily what the market wants. “Investors need credit spreads,” said Chia Woon Khien, managing director of local markets strategy at Royal Bank of Scotland. “They want more diversity and are very hungry for foreign names. At this moment we haven’t seen many foreign names yet.”

The lack of variety also narrows the investor base, despite the strong demand. Although there has been some liberalisation, such as letting Taiwanese investors enter the market, participation has mostly been in Hong Kong and Singapore.

Moreover, poor disclosure and weak covenants among Chinese borrowers are constraining demand for offshore renminbi bonds. The growth in new issuance is expected to slow to less than 100% this year, compared to an explosive growth of 259% in 2011, according Fitch.

Overeating
The announcement comes at a time when demand for credit in China has fallen substantially. New loans issued by Chinese banks are expected to total around Rmb800 billion in April, much lower than the more than Rmb1 trillion lent in March.

After two years of monetary tightening, China is returning to the situation in late 2008 when banks hastily promoted loans to corporate clients in a lending spree. China’s domestic bond market continues to languish despite years of financial reforms and remains dominated by banks raising money to meet the capital needs of the fast-growing economy.

Most of that money ends up being lent at low rates to government-backed enterprises, yet these are likely to be the first companies to issue dim sum bonds because smaller private companies will struggle to meet all of the NDRC’s requirements.

This means the influx of new issuance will offer little in the way of diversity for investors already holding bonds sold by the banks — and that could dampen appetite for the coming banquet. Perhaps Chinese authorities should consider that dim sum always tastes better on an empty stomach.