Treasury Today Country Profiles in association with Citi

Panda bonds come to life

Panda bear playing in tree

China is home to the world’s third largest bond market, but for international corporations, it has traditionally been underutilised as a source of financing, despite its great potential. This is beginning to change. Here we take a look at the history of the Panda bond market and its growing appeal to corporate borrowers.

It was hard to find many good news stories concerning China in 2016. The economy is, of course, undergoing a significant shift and growth has slowed somewhat as a result. A consequence of this has been Chinese policy makers clamping down on some of the regulatory progress made in recent years, most notably, the introduction of ‘window guidance’ to limit corporates’ cross-border cash flow.

However, at the same time, there have been significant developments in other parts of the economy. Most notably, the growing attractiveness of the Chinese onshore debt market to foreign companies. Indeed, in 2016 the Chinese Panda bond market exceeded the offshore RMB dim sum market for the first time, with US$8.39bn raised onshore in the first seven months of the year alone. It is good progress, but there remains some way to go for it to live up to its full potential.

Young shoots

The first Panda bonds were issued in October 2005 by the IFC and the Asian Development Bank to much fanfare. This followed years of discussions with Chinese government officials, who were worried about the potential impact of the bonds on its currency peg.

Yet the nascent market failed to live up to the initial hype with very few foreign corporates issuing bonds. “Before 2014, only international financial firms and a limited number of corporates were allowed to enter the Panda bond market,” explains Ying Gu, Emerging Markets Asia Rates & FX Strategist at J.P. Morgan. “But since last year, the regulators have loosened policies to allow overseas non-financial corporates and banks, as well as foreign governments to issue Panda bonds. This can go some way to explaining the recent boost in issuance.”

Typically, the companies who have issued since the market has opened up can be split into two buckets, says Keith Pogson, Senior Partner at EY Asia Pacific Financial Services. “First are those who want to prove it can be done to encourage others to do so. A lot of the banks who have issued, fit into this tranche as they want to advertise this to their clients.” The other group, he says, are those international non-financial corporates that have had a pressing need to raise large volumes of capital in the mainland – but these remain few and far between.

That doesn’t mean there isn’t a lot of corporate activity in the market. J.P. Morgan research has highlighted that 65% of issuances, weighted by market value, are made by corporates. “Many of these issuers are actually overseas incorporated Chinese companies, ‘real’ foreign borrowers are still yet to fully embrace the market,” says Gu.

German multinational automotive company, Daimler, is the most well-known ‘real’ foreign company to do so, issuing a one-year RMB500m bond at an interest rate of 5.2% in March 2014. The issuance was seen as a success and Daimler revisited the market in 2015 with a one-year RMB3bn bond to diversify its refinancing base and fund its expansion in China. The company has since also issued a private placement worth RMB4bn this year – the largest single Panda bond for a non-financial business.

An attractive proposition?

Given the markets historical lethargy, what then is driving the recent boost in issuance? In the view of J.P. Morgan’s Gu, cheap funding is the primary reason. “Issuing Panda bonds and then swapping CNY into USD using USD/CNH CSS provides more attractive funding costs compared with issuing USD bonds directly.” Panda bonds are also now cheaper than Hong Kong’s Dim-Sum bond and Taiwan’s Formosa bond – typically more favourable options for issuers wishing to raise funds in RMB.

China also offers bond issuers a new and extremely large investor base. “For those corporates looking to diversify their portfolio, Panda bonds could provide a useful tool,” says Gu. “China is, after all, the world’s third largest bond market and provides ample liquidity to issuers.”

Despite these benefits, and the recent surge in issuance the Panda bond market only accounts for a tiny fraction of China’s US$3bn onshore debt market, meaning that there is plenty of room for it to grow. However, there are a number of hurdles that need to be removed before the Panda bond becomes a truly attractive proposition to the international corporate community.

Do you need RMB?

“Although the Panda bond market has developed rapidly in the past two years, there are still some technical obstacles preventing foreign issuers from entering this market,” notes Gu.

Firstly, Panda bonds are reviewed on a case-by-case basis by the Chinese regulators, essentially meaning that there is a chance that the issuance will be rejected. For corporates wanting certainty, this is clearly a big issue. “What’s more there is very little transparency around this process and what makes a request successful,” says Gu. “Some corporates may be put off at the first hurdle because of this.”

If a corporate is successful in their issuance, there are further issues that can arise, chiefly because there is no official guidance on what can be done with the proceeds of a Panda bond issuance. “This is a particular issue for those companies who might want to raise cheap funding in the mainland and then move this cash offshore,” notes Gu. “If issuers cannot shift the proceeds offshore and they have little to no CNY investment plans onshore, then there really is no benefit for them to enter this market.”

Different standards

The documentary filing process is another area where corporates, especially those based in the US, find issue with the Panda bond. “Issuers must provide the past three years of financial statements under the Chinese Account Standards (CAS), Hong Kong Financial Reporting Standards (HKFRS), or International Financial Reporting Standards (IFRS),” says EY’s Pogson.

“For those corporates looking to diversify their portfolio, Panda bonds could provide a useful tool. China is, after all, the world’s third largest bond market and provides ample liquidity to issuers.”

Ying Gu, Emerging Markets Asia Rates & FX Strategist, J.P. Morgan

“This has been a problem because a lot of bond issuance is made in USD and filed under US GAAP,” he adds. “Issuing a Panda bond and changing your accounting standards to do so can, therefore, be too great a resource burden on many organisations, limiting the attractiveness of the market.”

Another burden for international corporates seeking issuance can come from the fact that a local credit rating is needed, alongside one from an international agency. Again the process here is slightly different to what international corporates would be used to when issuing in other markets and, of course, creates further work for the organisation.

Creating a mature market

Combined, these factors show the hallmarks of an immature market and one not aligned with international standards. “At present, corporates don’t have to push their domestic markets too hard to raise cash. This means that unless there is a genuine business need to take on RMB liabilities it doesn’t make sense for international corporates to issue Panda bonds,” states Pogson.

But he is philosophical in his outlook. “The market is setup this way deliberately, the Chinese regulators did not want to take a risk and loosely regulate the market, only to add further regulation later. This would dent the image of the market and also be quite difficult to do,” he says. “This is why they evaluate issuance on a case-by-case basis at present, because it gives them a chance to bend the rules, without issuing formal regulation, to see what works and what doesn’t – this will have big advantages in the long run.

And Pogson is already hearing positive noises coming from the Chinese regulators, who plan to make the Panda bond more attractive to international corporates, aligning it with international standards both in terms of how they access the market and the filing requirements.

But there is still more work to be done. In the near future, the issuance of Panda bonds will increase rapidly due to a low base,” says J.P. Morgan’s Gu. “But to ensure the sustainable development of the Panda bond, reforms are critical to resolve the discrepancies in accounting rules, as well as provide clear guidance on fund repatriation to offshore and simplify the approval process. In the long term, a fully liberalised capital account, free floating currencies and well-developed rates and FX hedging instruments are necessary to the success of this market.

I fully believe, however, that with the internationalisation of RMB and the openness of the onshore bond market, Panda bonds will become an important market for global issuers and investors and the market will reach its full potential,” he concludes.

Case study

Veolia enters the Panda bond market

The French multinational joins a small number of foreign corporates that have tapped the nascent Chinese onshore bond market.

In early September 2016, French multinational, Veolia, issued its first Panda Bond. Worth RMB1bn (€135m) the deal was the first foray into the market by any French company. Issued via a private placement, the paper bears an interest rate of 3.5% for a three-year maturity and was issued to both Chinese and international investors. Despite the relative low-value of the deal, it presents another significant milestone in the development of the nascent market and highlights that it is increasingly becoming a viable option for companies looking to raise RMB debt.

It is also a significant transaction for Veolia. The company has been looking at numerous ways to raise RMB funds for some time as it looks to satisfy its policy of matching its borrowing currencies to that of its assets.

Claire Bechaux, Director of Treasury at Veolia explains how the company’s traditional approach has been to issue Eurobonds and swap the proceeds into RMB. But the company has always had sights on the onshore market and towards the end of last year, the stars began to align. “A lot of our partner banks were talking to us about the Panda bond market and how this was beginning to open up,” she says. “At the same time, there were increasing levels of volatility in the offshore RMB market. It, therefore, seemed logical to explore the possibility of issuing a Panda bond further.

“We knew that it wouldn’t be an easy process, however, and we made this clear to the CFO when pitching the idea,” adds Bechaux. “Yet the benefits of doing this issuance far outweighed the negatives.”

Open discussions

To begin the process, Veolia entered into discussions with the Chinese regulator alongside the Bank of China, who had been selected as the Global Coordinator and Lead Underwriter. “It was a very open and transparent discussion and we found the Chinese regulators very willing to hear our concerns and then see how they could help solve these by flexing the rules,” says Bechaux.

Most notably, Veolia had questions around certain legal clauses and documentation, as well as the use of proceeds. “We spent quite a lot of time working on this area because the regulators are very keen for the proceeds of any Panda bond transaction to be used to support the real economy,” she explains. “If you are looking to take the proceeds offshore then you have to present a strong case as to how this helps the real economy – they want to avoid companies taking advantage of currency arbitrage.” In Veolia’s case, the proceeds were used to refinance offshore debt that had been used to finance the Group’s investments in mainland China.

Bechaux also notes how the fact Veolia issued a private placement simplified the process somewhat and removed some of the hurdles that have put other companies off issuing thus far. “We could use our European IFRS accounts if we issued this way, for instance, and thus removing the need to translate these into Chinese GaaP,” she says. “This saved time and reduced the complexity of the transaction and given that this was our first foray into the market we wanted to be successful so it made sense to take this approach and I would recommend it to other companies as well.”

The need to obtain a credit rating from a local rating agency can also prove a stumbling block for corporates. However, Veolia found this to be a relatively straightforward process. “We obtained a rating in four weeks and the process was very similar to obtaining a rating from an international agency – albeit with a greater focus on activity in China,” notes Bechaux. “And just like the regulators we found them to be extremely professional and very keen to make life as simple as possible.”

A worthwhile project

Having issued the bond, Bechaux says that Veolia is very happy with the outcome. “It has been a worthwhile project and we are now in a position to issue in the mainland again by simply drawing down on our existing programme,” she says. “This provides us with a lot of flexibility. What is more, the pricing was very good.”

Indeed, Bechaux admits that whilst not the most important factor, the pricing certainly gave the treasury extra incentive to issue a Panda bond. “We have options to raise RMB, so we didn’t need to go through this intensive process to issue onshore and if the pricing wasn’t as favourable we probably wouldn’t have at this moment in time. It was the last push.”

For Scott Barton, Head of Corporate & Institutional Banking, Europe, Standard Chartered – a key financial advisor on the transaction – this deal will “open up the window to access the Panda market for all corporates around the world”. He does note, however, that “Panda bond issuance is in its nascent stage so the process naturally comes in shades of grey and involves elements of careful negotiations. At the end of the day, the cost savings it brings is well worth the efforts to get a programme set up.”

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