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.
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.”
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.