Four years after coming into existence, Hong Kong’s nascent market for renminbi-denominated bonds — a core plank in China’s drive to internationalize its currency — has burst into life.
The so-called dim sum bond market, named after the bite-size delicacies served in Hong Kong tea houses, has already seen more deals this year than in the whole of 2010.
Unilever, the European consumer group, and BYD, the Chinese carmaker backed by Warren Buffett, are among the 22 issuers that have raised a total of Rmb19.1 billion ($2.9 billion) through dim sum bond sales since January.
While the sums involved are still small, the market’s rapid growth — if maintained — could have big implications for how companies fund themselves, how investors access the renminbi, and ultimately for the future of the Chinese economy.
Dealmakers say dozens more companies are rushing to issue renminbi bonds in Hong Kong because the cost of funding there is ultra-cheap — hundreds of basis points lower than on the Chinese mainland.
“From the perspective of a Chinese issuer, it’s much more advantageous to raise funds in Hong Kong than to do it in China and this has been the key driver for the increase in volumes that we’ve seen this year,” says Dariusz Kowalczyk, a strategist at Crédit Agricole.
Beijing’s strict capital controls mean that interest rates on renminbi debt, as well as the value of the renminbi against the dollar, can — and do — vary dramatically between the mainland and Hong Kong, a special administrative region subject to its own laws and open to international investors.
As China has gradually opened up channels for the renminbi to flow out of the mainland, mainly through trade, the currency has amassed in Hong Kong, with total renminbi deposits reaching Rmb408 billion in February, more than quadruple the level a year earlier.
However, offshore holders of renminbi have had few ways to invest in the currency besides low-yielding bank accounts, a scattering of dim sum bonds and, as of this month, a renminbi-denominated real estate investment trust listed on the Hong Kong stock exchange.
“You have huge demand for dim sum bonds but the supply is very small compared with the pool of renminbi. So you have a case of a huge amount of money chasing very limited investments and this is driving yields very low and prices through the roof,” says Mr Kowalczyk.
Unilever pulled off something of a coup last month when it sold Rmb300 million of three-year renminbi-denominated bonds in Hong Kong with a yield of just 1.15 percent, a record low for the dim sum market. That compares with the People’s Bank of China’s guidance for the onshore one-year base lending rate of 6.31 percent.
International investors are willing to buy renminbi debt at such low yields because they expect to be compensated by the appreciation of the renminbi against the dollar in the coming months and years.
According to many market participants, it is all but certain that Beijing will allow the renminbi to strengthen by more than 4 percent against the dollar over the next 12 months.
Annisa Lee, credit analyst at Nomura, says many participants in the dim sum bond market are wealthy individual investors or other non-typical bond investors who do not carry out rigorous credit analysis of issuers. “I’m not too sure whether the market could actually withstand a potential sell-off,” Ms Lee said.
“Because this market is quite new, it’s really untested how this type of bond investor would react if we saw a big macro incident happening.”
International investors are almost unanimous in their belief that the Chinese currency will appreciate against the dollar over the next few years. But many are less willing to take bets on where the Chinese currency will be more than three years from now.
As a result, more than 90 percent of dim sum bonds have been issued with maturities two to three years hence. By contrast, the dollar bond market regularly sees bonds with maturity dates more than 10 years into the future.
But few people doubt that the market will continue to grow as more companies seek cheap renminbi funding in Hong Kong, having secured regulatory approval to remit the proceeds to the mainland.
For many Chinese companies, there is particular urgency to tap the offshore market, since interest rates have been rising on the mainland and banks have been told to rein in lending.
The problem is that, besides banks, mainland-incorporated companies are not allowed to issue dim sum bonds directly. So they have been structuring their deals in creative ways, typically using an offshore subsidiary to issue the bonds while providing some form of guarantee from onshore to give comfort to investors.
Yet dealmakers say the dim sum market will be unable to maintain its rapid growth for long unless the Chinese government introduces a formal route for mainland-incorporated companies to issue offshore bonds directly and then repatriate the proceeds.
“A big state-owned company is not interested in [indirect] structures. They want to do mega deals and they want to do them directly,” says William Liu, partner at Linklaters. “We need the government to allow direct issuance for the market to really take off.”
There are rumors that Beijing is looking at the feasibility of allowing mainland companies to issue bonds offshore directly.
But this may prove to be little more than wishful thinking.
With mainland interest rates continuing to diverge from offshore rates, policymakers may find it difficult to open the gates a little wider without causing a stampede.