Boom time for the offshore RMB bond market

Transcription

1 Boom time for the offshore RMB bond market More centres of issuance, easier access for international investors and the step-by-step relaxation of capital controls - all spell surging growth for China s offshore RMB bond market. China s banks look to be prime beneficiaries.

2 Boom time for the offshore RMB bond market A lot of offshore bond issuance is driven by the fact that lending is available offshore at more favourable interest rates than onshore Andrew Malcolm Partner with Linklaters in Hong Kong The offshore renminbi (RMB) bond market looks set to hit a new record for issuance this year. That may be little surprise after records were smashed in the first half of the year, with RMB370bn (USD60bn) of bonds being issued. However, that included an element of pre-funding by Chinese banks and corporates in the first quarter when mainland liquidity was tightened and most commentators expect something of a slowdown in the second half. An estimated total of RMB 550bn-plus (USD90bn) of issuance will still compare favourably with 2013 s then record RMB385bn (USD63bn). The development of the offshore RMB bond market is seen as a corner stone in Beijing s policy of progressively internationalising its currency. It is China s ambition to internationalise the RMB, says Qiong Wu, Executive Director, Fixed income Research, Bank of China International (BOCI) in Hong Kong. For that to succeed, the RMB has to become an investment currency. However, the fast-growing bond market is also proving a boon to China s banks and corporates. The offshore bond market is now a useful means of raising capital for the banks, says Andrew Malcolm, a Partner with Linklaters in Hong Kong. A lot of offshore bond issuance is driven by the fact that lending is available offshore at more favourable interest rates than onshore. Capital controls are being loosened bit by bit, making it easier for onshore banks and corporates to access the international liquidity pool. A lot of issues are designed to raise capital for deployment in China. Future optimism has been coupled with savvy policy and the formation of solid, long-term partnerships to facilitate international investor access to the offshore RMB bond market and at the same time providing a channel through which international issuers can tap the market, notes Olivier Grimonpont, Euroclear s Hong Kong branch General Manager and APAC Regional Head. One third of financial institutions now using RMB The initial focus of the internationalisation process was on trade rather than investment. The basic driver of the policy was trade flow-focused, says Mr Malcolm. Its purpose was to re-denominate current account transactions into RMB. China s long-standing trade surplus was creating problems not just abroad but also at home. Given China s currency controls, Chinese exporters had to convert foreign currency proceeds into RMB in China. That then had to be exported or invested. It has not taken the world long to adopt the RMB as a trading currency. Since the beginning of 2013, the RMB has climbed from 13th to 7th in world 2 Boom time for the offshore RMB bond market

3 payments currencies, and now accounts for 1.64% of global payments. SWIFT figures show that RMB payments worldwide have nearly tripled in value in two years. Significantly, more than one third of financial institutions around the world are now using the RMB for payments to China and Hong Kong. In Asia the figure is 40%. Corporates trading with China have quickly appreciated that they are likely to get keener prices if they pay in RMB, says Gaetan Gosset, Director, Product Management Asia Pacific for Euroclear Bank. The Chinese exporter doesn t have any foreign exchange risk or costs, he says. Overseas corporates increasingly accept RMB as payment for their exports to China. Together with a surge in corporate demand for RMB, this has stimulated a build-up in RMB deposits in Hong Kong and Taiwan for which there are limited investment opportunities. In the case of Taiwan, restrictions on the types of mainland companies that can borrow in RMB locally and the current absence (on October 2014) of any Renminbi Qualified Foreign Institutional Investor (RQFII) quota to invest in Chinese securities further restrict their borrowing options. This expanding pool of offshore currency has proved fertile ground for the development of an offshore RMB bond market. But Beijing has not left events to chance. China s Ministry of Finance has been the biggest issuer in the Hong Kong domestic market. Regular issues by the MoF, targeting both local Hong Kong and foreign investors, continue to expand the number of benchmark issues and deepen the yield curve. Last year, for the first time, the MoF made an effort to place their issues with other central banks, too, says Mr Malcolm. This is the first step towards the RMB becoming a reserve currency - encouraging the central bank of a major trading partner to hold RMB as part of that trading relationship. issuers in both Hong Kong (with dim sum bonds) and Taiwan (with Formosa bonds), often launched in dual listed tranches. Lion City bonds are the latest offshore variant. Lion City is the popular name for Singapore, deriving from the original Malay name. In September Industrial and Commercial Bank of China (ICBC) issued the largest Lion City bond to date, at RMB4bn (USD650m), with two tranches dual listed in Singapore and Taiwan. London has also got in on the act. ICBC opened the primary market with a heavily oversubscribed RMB2bn (USD325m) bond in November Bank of China then set a new record for an offshore RMB bond in London in January this year with a RMB2.5bn issue (USD400m), which was 40% allocated to European investors. In September, the UK government became the first western country to announce it would issue a government bond in RMB. Frankfurt, Paris and Luxembourg have similar aspirations to become offshore RMB centres. BOCI s Ms Wu points out that while the offshore RMB bond market serves as a new funding channel for Chinese banks and corporates, a lot of the proceeds from these issues are not repatriated: They are used to support their offshore business development, she says. There are other considerations, too. Some issuers may just want to show their names in the offshore market, she says. The maturation of the market is proving a benefit to China s banks which have been keen to exploit the capital-raising opportunities it presents. Maturing market The maturation of the market is proving a benefit to China s banks which have been keen to exploit the capital-raising opportunities it presents. In principle, Chinese entities can only issue offshore through an offshore entity (including Hong Kong), though China s banks can issue up to an annual quota without further approval. Faced with tighter monetary conditions on the mainland for the early part of this year, they were keen At Linklaters, Mr Malcolm says the round of bank capital raisings in the second half of 2014 may also reflect the introduction of new capital regulations. The Chinese authorities have introduced Basel III so Chinese banks are busy issuing preference shares. That is happening mostly in the mainland market but some will come to the offshore market to tap foreign liquidity and export some bank risk. Boom time for the offshore RMB bond market 3

4 Rates converging Cost of issuance relative to mainland rates is likely to play an increasing role in driving the decision on whether to raise capital onshore or offshore. Historically, it has been substantially cheaper to raise capital in the offshore RMB market. But lately the yield gap has narrowed as easing by the People s Bank of China has served to soften mainland interest rates. As China progressively opens up its domestic market, and works towards its goal of turning Shanghai into an international financial centre by 2020, rates are expected to converge, says Ms Wu, though that could take several years. As long as the two markets are separated, that won t happen, she says. Currency factors will also play a role. At present there are different exchange rates for the offshore and onshore RMB. Each has its own demand/supply dynamics, says Ms Wu. There is only partial convertibility between the two. If we see further easing of capital controls, the two rates will converge. Gosset, notes, A step-by-step easing is already apparent. The newly launched Shanghai Hong Kong Stock Connect programme, will give international investors the opportunity to trade more than 500 Shanghai-listed shares via Hong Kong brokers. There is also the proposed fund recognition passport between Hong Kong and China. This will allow investors in one centre to invest in the other. The relaxation of rules which previously required official approval of any guarantee given by a Chinese parent company for its offshore borrowing have also made it easier for Chinese banks and corporates to access the offshore bond market, says Mr Malcolm. The next step will be the opening up of the Shanghai free trade zone. Chinese enterprises that set up there will be able to access the international markets as if they were outside China. That right will in due course be transferred to other free trade zones, he says. Collateral boost The development of a proper repo market in offshore RMB securities is seen as another important step. As part of the preparations for Stock Connect, the Hong Kong Monetary Authority (HKMA) is providing an intraday repo facility of up to RMB10bn (USD1.6bn) to boost liquidity in the city s offshore RMB market. At the same time, moves are afoot to bring offshore RMB securities into the collateral net for repo. The global market of offshore RMB securities now tops RMB800bn ($128bn) and participants are actively looking at using this pool of securities as collateral, says Mr Gosset. Given the pressure from regulators for market participants to collateralise transactions, the world will welcome the arrival of more collateral, he says. Both the International Swaps and Derivatives Association (ISDA) and the Asia Securities Industry & Financial Markets Association (ASIFMA) are engaged in work that would pave the way for the use of offshore RMB securities in repo. The problem is that cash liquidity is still narrow. As a repo gets unwound the party returning the cash might not be able to find it in the market, says Mr Gosset. In fact, ISDA and ASIFMA are currently looking at solutions that will avoid technical default as a result of any lack of temporary liquidity. Given the pressure from regulators for market participants to collateralise transactions, the world will welcome the arrival of more collateral Gaetan Gosset Director, Product Management Asia Pacific for Euroclear Bank Euroclear Bank has also established a link with HKMA designed to give Hong Kong s local banks the reach to enter into repo transactions using offshore RMB. At some point, says Mr Gosset, liquidity might be needed in, say, London but the only way to access it might be to tap a local bank in Hong Kong. That bank may not be an international player. However, it is connected to HKMA, its central bank and domestic CSD, and HKMA can open an account in the bank s name in Euroclear Bank. Through that link, any bank in Hong Kong can engage in a repo trade with any bank in any part of the world. 4 Boom time for the offshore RMB bond market

5 Broadening access High levels of oversubscription for RMB bond issues in London demonstrate the appetite of international investors for RMB assets. The pullback in the RMB against the dollar in the first half of the year appears to have made little difference to investor attitudes, even though it reduced the total return on offshore RMB bonds from 2.8% in RMB terms to 1.5% in dollar terms over the first nine months, according to figures from BOCI. Ms Wu says investors have seen several such corrections in the RMB before: This was not the first time. Investors remain confident in the RMB over the medium term. Key issuance centres - Hong Kong and the ICSDs - are clearly keen to tap international demand for RMB assets. That goes for issuers too, both Chinese and international. Investor preference is for ease of access, with standardised frameworks and formats, straightthrough processing and certainty of settlement. Moreover, regulatory compliance services, which may not be present in some local markets, are a significant benefit to international investors. Especially, when it comes to tax and compliance. says Mr Malcolm. We foresee a substantial increase in activity over the next years. Given the sheer size of the Chinese economy and the number of Chinese enterprises that need financing, as capital controls are relaxed there will be huge demand from bank issuers in particular. Given mounting liquidity offshore, the evidence of unsatisfied investor demand and the multiplication of issuance centres, growth predictions for the offshore RMB market look well founded. Given the sheer size of the Chinese economy and the number of Chinese enterprises that need financing, as capital controls are relaxed there will be huge demand from bank issuers in particular. Andrew Malcolm Partner with Linklaters in Hong Kong With its established market infrastructure, Euroclear Bank now offers a seamless service through which international investors access all offshore RMB bonds. Its Taiwan link was established in April this year and allows settlement transactions to be routed from Euroclear Bank s account with Citi in Taipei to the local CSD, the Taiwan Depositary & Clearing Corporation. The ICSD has around 1,500 clients with some 500 accounts holding RMB bonds. Two-thirds of them are from outside Asia, a key attraction for issuers and the key issuance centres. Euroclear Bank s ability to offer investors standardised global solutions and robust post-trade processes has also given it the lead role as depositary for RMB bonds issued through an international structure by non-chinese issuers. Some 2,000 RMB-denominated securities are currently live in ICSDs, says Mr Gosset, almost three times the number in HK market and growing very fast evidencing the international dimension of the currency. For the foreseeable future, it is Chinese banks and corporates that are likely to continue to drive issuance, 2014 Euroclear SA/NV 1 Boulevard du Roi Albert II, 1210 Brussels, Belgium Tel: +32 (0) RPM Brussels number Euroclear is the marketing name for the Euroclear System, Euroclear plc, Euroclear SA/NV and their affiliates. If at any time in the future you prefer not to receive communications from Euroclear advising you of Euroclear products and services that may be of interest to you, please contact us at [email protected] and specify on what product or service you no longer wish to receive marketing information. MA3219 Euroclear is a carbon neutral company PAS2060 certified in 2014 Curbing collateral concerns 5