Chinese measures to steady its rocky markets are putting the future of the offshore yuan bond market at risk, prompting record redemptions from so-called dim-sum debt funds and choking new issuance.
Just a few years ago investors were lining up to buy these offshore bonds denominated in a currency that was uniformally expected to rise, underlining the impact of its tumultuous summer on the financial infrastructure built up around the yuan.
Beijing is making it easier for institutional investors to raise debt onshore, rather than offshore. The shock devaluation of the yuan in August also punctured the belief the currency is a one-way appreciation bet, reducing the attraction of holding yuan assets.
"Keep in mind, the offshore market exists because of the capital account restrictions that existed earlier," said Aidan Yao, senior emerging Asia economist at AXA Investment Managers Asia, in Hong Kong.
"As more reforms are taken, such as allowing greater access to the onshore bond markets, questions around the long-term viability of the offshore market grows."
Net outflows from dim-sum funds totaled $800 million in August and September combined, the biggest two-month loss on record, preliminary data estimates by Thomson Reuters Lipper show. Several funds have yet to report monthly data.
That's the first decline in assets under management for a sector which had grown every year since 2010. At the end of August, assets under management totaled $5.8 billion, compared with $8.4 billion at their peak in October 2014, Lipper data showed.
"There is no solid catalyst on the horizon for a turnaround in the fortunes of dim-sum bonds and as a result we may see more outflows soon," said a credit strategist at a bond fund in Hong Kong, declining to be identified because he is not authorized to speak with the media.
Under particular pressure has been the high-yield sector, dominated by Chinese property companies. Their bonds have fallen the most this year compared with other high-yield debt.
Two indexes measuring the yield performance of yuan-denominated bonds in the offshore market compiled by HSBC and Deutsche Bank are trading near their highest levels, indicating investors were demanding higher risk premiums for holding the debt.
Total issuance to the end of September stood at 138 billion yuan, less than half that of the same year-earlier period, Thomson Reuters data shows. For all of 2014, issuance was a record 337 billion yuan.
"Where we have suffered is more on the investor side because for years now the market has been a stable appreciating one-way bet on the currency," said a credit analyst at a hedge fund. "Now, we don't know if we can trust the government not to devalue more."
China's authorities are also taking big steps to allow greater and more flexible access for institutional investors to its $6 trillion mainland bond market, where funding costs are also cheaper, two people with direct knowledge said.
Late last month, Bank of China (Hong Kong) and HSBC became the first overseas commercial banks to issue yuan bonds on the mainland. Previous issuance had been rare and essentially restricted to global development institutions.
"With the opening up of the onshore market, more institutional investors will gravitate towards domestic debt than its offshore counterpart," said Andy Seaman, a portfolio manager at London-based Stratton Street Capital which manages $1.1 billion in funds.