For most of the year, Hong Kong’s “dim sum” bond market appeared invulnerable. Even as other asset classes suffered, renminbi-denominated bonds remained in strong demand from international investors.
In recent months, however, enthusiasm has waned. Dim sum bond prices have declined substantially since September, when investors started to question the widely-held belief that the renminbi will only appreciate against the US dollar.
“The game has changed,” says one fund manager. “There’s less excitement around appreciation and there are fears of a Chinese hard landing.”
Yet the dim sum bond market – a key part of the internationalisation of the renminbi – is far from dead. Baosteel, the Chinese state-owned steelmaker, last week raised Rmb3.6bn ($564m) in the biggest renminbi-denominated corporate bond issuance ever seen in Hong Kong.
Baosteel was the first Chinese company to sell renminbi bonds to foreign investors directly, rather than through a subsidiary incorporated in an offshore jurisdiction such as Hong Kong or the Cayman Islands.
While the deal broke records, its size fell well short of the Rmb6.5bn ($1bn) that Baosteel had been given permission to raise by Chinese regulators. That suggests that even the most creditworthy state-owned enterprises are unable to raise anything near $1bn in the dim sum bond market, at least not without paying punitive interest rates.
Baosteel sold its bonds in three tranches, including Rmb1bn of two-year bonds with a 3.125 per cent interest rate, Rmb2.1bn of three-year bonds at 3.50 per cent, and Rmb500m of five-year bonds at 4.375 per cent. At those rates, Baosteel was able to borrow much more cheaply than it would be able to on the Chinese mainland.
Even so, the company had to pay investors much more than it would have done just four months ago. In July, for example, Citic Pacific, the Hong Kong arm of China’s largest state-owned investment group, issued a Rmb1bn five-year bond with an interest rate of 2.7 per cent – almost 170 basis points lower than Baosteel achieved.
At the start of the year, even risky borrowers with no credit rating were able to tap the dim sum market, so strong was the demand from investors.
Owen Gallimore, Asia credit analyst at ANZ, reckons the recent decline is a “temporary phenomenon“ and that the market will come “roaring back” as soon as investors regain confidence that the renminbi will strengthen sharply against the dollar.
Most dim sum bonds are illiquid and total issuance is still relatively small – the equivalent of $13.4bn of such bonds has been sold this year – so the market could move sharply if there is a change in sentiment.
“If you have some big funds put together to specifically invest in dim sum, and the appreciation story turned very positive, it’s easy to imagine that the demand just dwarfs the physical possibilities of the market,” Mr Gallimore says.
But Augusto King, head of debt capital markets at Royal Bank of Scotland, says dim sum issuance by multinational companies is set to increase, building on deals done over the past year by groups from McDonald’s to Caterpillar. In October, Chinese regulators simplified the process for companies to bring offshore renminbi funds into China for investment, though approval is still granted on a case-by-case basis.
“There’s still a distinct discrepancy between the onshore cost of borrowing and the offshore cost of borrowing,” says Mr King, meaning the incentives for multinationals to fund their mainland operations through dim sum bonds are strong.
The other significant factor, says Mr King, is that in recent months the offshore renminbi swap markets have become more efficient. As a result, some companies can issue short-dated bonds in renminbi then swap the proceeds back into euros or dollars, and thereby fund themselves at a cheaper rate than they would be able to in the European or US bond markets.
The pool of renminbi funds held offshore still vastly exceeds the amount of dim sum bonds, meaning there is room for more supply. According to the Hong Kong Monetary Authority, renminbi deposits in Hong Kong totalled Rmb618.5bn ($97bn) at the end of October, down 0.6 per cent from September but still triple the amount a year ago.
As long as there is a surplus of renminbi deposits offshore, dealmakers are confident that the dim sum market will continue to expand, although growth in 2012 is expected to be much slower than in 2011 or 2010, when the market sprang to life.