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Time to sample dim sum bonds?

Photo of Dim Sum

A key moment in the internationalisation of the renminbi came in February 2010 when the offshore RMB bond market was opened to non-financial corporations. Since then several well-known companies have tried out the ‘dim sum’ bond market – and some have already come back for more. This article looks at the benefits of issuing CNH bonds, the obstacles companies may face when doing so and the future prospects of this new market.

As outlined in ‘The birth of a new currency’, a key milestone in the internationalisation of the renminbi came in August 2010 when the offshore bond market was first opened to non-bank issuers. For corporations with operations in China, this has come as a welcome development at a time when domestic bank lending continues to face pressure in the form of increased bank reserve requirements.

The market for CNH bonds (nicknamed ‘dim sum’ bonds after the Hong Kong delicacy) has grown rapidly – see chart 1 – and offers companies looking to fund their operations in China a low-cost alternative to raising funds onshore.

Chart 1: CNH bonds outstanding
Chart 1: CNH bonds outstanding

Source: DBS Group Research 2011

The benefits of the CNH bond market are open to European and US based companies with operations in China, as well as to domestic companies: a number of well-known names including McDonald’s, Unilever and Caterpillar have tried out the new offshore bond market in the past year. Nevertheless, the market is new and it is important for companies to be aware of the regulatory requirements associated with China’s offshore bond market. The key obstacle companies must face when issuing CNH bonds is that the proceeds of the bonds cannot be repatriated back to China without approval from the regulators.

Birth of the CNH bond market

The beginnings of the CNH market can be traced back to 2004, when the People’s Bank of China (PBoC) first permitted RMB business to take place outside mainland China, in Hong Kong. At this stage, this was limited to the provision of RMB deposit, remittance and currency exchange services to retail customers. Chinese financial institutions were first permitted to issue RMB bonds in Hong Kong in 2007 (under the PBoC’s ‘Interim Measures for the Administration of the Issuance of RMB Bonds in Hong Kong Special Administrative Region by Domestic Financial Institutions’.)

It was not until 2010 that non-financial corporations were permitted to access the CNH bond market. In February of that year the Hong Kong Monetary Authority (HKMA) issued a circular (‘Elucidation of Supervisory Principles and Operational Arrangements Regarding Renminbi Business in Hong Kong’), removing prior restrictions on the types of issuer which could access the market.

The first corporate issues followed a couple of months later. In July 2010, Chinese highway infrastructure company, Hopewell Highway Infrastructure, issued the first corporate CNH bond. Two months later, McDonald’s became the first foreign company to follow suit and since then, the market has grown at a healthy rate. Issuance of CNH bonds in 2010 stood at RMB 35.68 billion. In comparison, by August, issuance in 2011 had already reached RMB 94.98 billion. “We should continue to see this market grow,” says Terence Chia, Director, Asia Debt Syndicate, Citi. “If we do a straight line projection, we should see around RMB 130 billion being done by the end of this year.”

It is worth remembering that the issuance volume of the CNH bond market remains small in comparison to China’s domestic bond market: in 2010, total onshore RMB bond issuance was RMB 5.1 trillion.

Nevertheless, the market is expanding rapidly. In mid-August 2011, the market was given a significant boost in the form of a RMB 20 billion issuance by China’s Ministry of Finance, which previously issued RMB 8 billion of debt in November 2010 and RMB 6 billion in September 2009.

Chart 2: CNH bond issuance landscape by tenor
Chart 2: CNH bond issuance landscape by tenor

Source: Moody’s

So why invest in CNH bonds? Foreign companies were first permitted to hold offshore RMB deposits in Hong Kong in 2004. However, initially there was little for companies to do with these deposits, which have grown rapidly from around RMB 54 billion in January 2009 to over RMB 553 billion by the end of June 2011, according to figures published by the HKMA.

Chart 3: Weak correlation between onshore and offshore bond yields
Chart 3: Weak correlation between onshore and offshore bond yields

Source: DBS Group Research 2011

Consequently, demand for CNH bonds has been far greater than the supply: when New Zealand dairy exporter, Fonterra issued RMB 300m in June 2011, the bond was six times oversubscribed. And the institutional tranche of a RMB 5 billion bond issued by Export-Import Bank of China in December 2010 was 53 times oversubscribed. The expected appreciation of the RMB against the US dollar is another important consideration for investors considering buying CNH bonds.

The secondary market for CNH bonds has so far been limited, which has largely been attributed to the relatively small number of bonds being issued: investors have been more interested in holding onto CNH bonds than selling them on. However, there are some signs that the secondary market is also beginning to pick up. Dim sum bond funds have been launched around the globe, including in Europe, Singapore and the US.

Benefits for corporates

For many companies, the CNH market offers an attractive alternative to raising funds in the onshore market. For one thing, the cost of funding is significantly lower: the highest rated companies can get onshore RMB bank funding at a rate of 90% of the one year benchmark loan rate set by the People’s Bank of China, which was raised to 6.56% on 7th July 2011.

The cost of the CNH bonds issued by corporations in the past year has tended to be significantly cheaper: McDonald’s CNH bonds were issued with a coupon of 3% in August 2010, and in July this year, Caterpillar achieved a rate of 1.35% with its second issuance. In June, Fonterra issued RMB 300m at a coupon of 1.1%.

Chart 4: 2007-2010 Issuance breakdown: mainland Chinese, Hong Kong and foreign
Chart 4: 2007-2010 Issuance breakdown: mainland Chinese, Hong Kong and foreign

Source: Moody’s

While in theory, foreign corporations are permitted to issue onshore RMB bonds – ‘Panda bonds’ – in practice, the approval process is not straightforward and companies choosing to raise funds in this way – including ADB, IFC and MUFJ – have tended to be financial institutions. Other foreign corporations are instead looking to the new CNH market to raise funds. In addition to low yields, the CNH market offers greater maturities than can be achieved in the RMB market. Whereas RMB bonds can only offer maturity of one or two years, CNH bonds can typically achieve a maturity of up to three years. Meanwhile, companies issuing dim sum bonds have indicated that reducing FX risk is also playing a part in attracting them to the market.

“Another advantage of the CNH market is that you are diversifying your funding, and distributing those bonds into new pockets of liquidity,” observes Chia. “In the onshore market, tenors tend to be shorter, and you may eat up some bank lines if the banks are the ones investing in those bonds. In the offshore market, you are able to reach out to a wider pool of investors outside the domestic market.”

Meanwhile the limited availability of bank lending may have played a role in encouraging corporations to dip a toe in the CNH bond market. “The regulators have been tightening up the onshore loans market quite significantly,” says Chia. “Recently, they raised the reserve ratio for banks by another 50 basis points and hiked onshore loans and deposit rates by 25 basis points in a bid to tighten liquidity and reduce loans growth. The driver is really China wanting to cool down the economy from growing too quickly.

“In terms of the loan market, corporates are increasingly finding it more difficult and expensive to get loans onshore – I am talking here about the privately owned corporations, which tend not to be investment grade, rather than the state owned enterprises which still have liquidity in the loans market.”

So which companies have been accessing the market? Domestic Chinese companies, Asian issuers and issuers from the US and Europe have all issued bonds in the past year. “Raising funds in CNH is beneficial for issuers who are looking to bring the CNH proceeds back to China, because compared to onshore financing, it is a lot cheaper for issuers to raise CNH bonds in Hong Kong,” says Chia. “Offshore issuers can also raise CNH and swap them back into US dollars or euros, but doing it via this route is expensive and funding levels are also wider than issuers can achieve in their home markets.”

McDonald’s was the first foreign corporation to issue a bond in the CNH market at a relatively modest RMB 200m. Since then other multinationals have followed suit, including Caterpillar with a RMB 1 billion bond in November 2010 and Unilever with its RMB 300m issue in March 2011. Caterpillar returned to the market in July 2011 with a RMB 2.3 billion issue and McDonald’s is reportedly planning a second issue.

Dim sum bonds issued by foreign corporations
August 2010

McDonald’s issue three bonds worth a total of RMB 200m with a coupon rate of 3% – the first CNH bond issuance by a foreign non-financial company.

November 2010

Caterpillar pays 2% to issue a two year RMB 1 billion bond.

March 2011

Unilever raises RMB 300m, due in March 2014 and priced at 1.15%.

May 2011

Volkswagen raises RMB 1.5 billion in five year notes at a rate of 2.15%.

June 2011

Fonterra sells RMB 300m three year bonds paying interest of 1.1%. The bonds were six times oversubscribed.

July 2011

Caterpillar becomes first foreign corporation to pay a second visit to the CNH market with a RMB 2.3 billion bond at a rate of 1.35%.

“What we have seen is that issuers who have come to this market are largely corporations who have China operations – who are basically raising CNH bonds in order to fund operations in China,” adds Chia.

Overcoming the obstacles

For companies looking to access the CNH bond market, the first and most important consideration is obtaining approval from the authorities to bring the funds onshore. The process can be lengthy, and issuers can either obtain regulatory approval themselves, if they have a good relationship with the regulators, or they can seek assistance from the banks they have mandated.

The speed at which approval is granted can vary depending on the nature of the company applying, as Chia explains: “Approval can take a few months to secure. To a certain extent it depends on the sector the company is in and what the issuer is looking to do with the proceeds. For a business focused on clean energy, which the government is looking to promote, approval tends to be more straightforward and quicker than if the company is in the real estate sector, for example.”

Another consideration is the fact that the documentation required for CNH bond issuance is significantly more rigorous than for domestic RMB bonds. As the documentation is designed to meet international standards, the level of disclosure required is higher and the costs associated with consulting international lawyers also tend to be higher.

Chia adds: “The main challenge is the markets themselves. Right now we are seeing unprecedented volatility. The CNH market, while it has been less volatile than the dollar market, has not been completely insulated from broader market weakness. So the levels which issuers can achieve in the CNH market today are wider than they were only six months ago, or even three months ago. CNH funding is becoming more expensive.”

Future prospects

Growth in the CNH bond market is widely expected to continue at its current rate, at least in the coming months. “There is a very healthy pipeline of deals waiting to tap the market,” says Chia. “There is also a very long queue of issuers waiting for regulatory approval. Issuers do recognise the cost benefit – not just Chinese companies, but also companies with operations in China which are looking to tap this market to achieve lower cost of funding.”

One question is whether Chinese regulators could step in to dampen down that growth if it was deemed to be too rapid. “I don’t think the regulatory landscape will change drastically where the CNH bond market is concerned,” comments Chia. “Regulators may sense that there’s too much arbitrage going on with issuers able to raise funds in Hong Kong more cheaply than onshore and may look to cool the market down by giving out fewer approvals – but compared to the onshore market, the CNH issuance volumes are minute.

So I don’t see regulators coming down hard to control this market – but of course this is a new market and if things were felt to be moving out of control the regulators could decide to enforce stringent rules or even stop activity altogether. But I don’t think that is on the cards.”