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Shanghai breaks new ground with free-zone renminbi bonds

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China is drawing up a pilot scheme to give foreign investors easier access to renminbi-denominated bonds in the Shanghai Free Trade Zone as soon as this month.

[HONG KONG] China is drawing up a pilot scheme to give foreign investors easier access to renminbi-denominated bonds in the Shanghai Free Trade Zone as soon as this month.

The initiative will allow foreign investors to clear and settle the bonds using an international central securities depository account with a link to the Shanghai Clearing House. Many observers see the move as the first step to link the broader onshore bond market to offshore investors.

However, market participants are also raising questions over the need for such a middle-ground market between the existing offshore Dim Sum market and the massive onshore bond market, predicting that FTZ bond activity will be limited by a number of barriers.

While bonds issued in the FTZ will give issuers more freedom to move capital, there are concerns that the extra approvals investors require will end up limiting domestic demand and fragmenting further China's bond market.

Shortcut SCH, one of the three central securities depositories in China, held a conference in London a week ago to promote renminbi bonds in the FTZ and explain the scheme.

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Domestic and foreign entities need to file with the People's Bank of China or register with the National Association of Financial Market Institutional Investors to issue FTZ bonds. They have to release information on the website of the clearing house. The procedure does not differ much from the steps needed to issue regular onshore bonds or Panda bonds in the interbank bond market.

However, the scheme offers foreign investors the option to open settlement accounts via an international or local central securities depository, freeing them from having to deal with Chinese clearing houses as is the case for foreign investors that invest in regular onshore bonds outside the FTZ.

The programme also allows approved pilot commercial banks to transfer existing bonds from the domestic market to the FTZ, according to the presentation.

SCH did not respond to IFR's request for more details on the plan.

Limited interest SCH claims in the presentation that FTZ bonds "will provide a new market for offshore renminbi, offering corporate bonds with full range of credit profiles and yields".

Nevertheless, market participants are not convinced the FTZ will be an attractive venue. If issuers want offshore renminbi, they can tap the Dim Sum bond market, which is market-driven and has a diverse international investor base.

Furthermore, issuers may need to pay higher yields to issue FTZ bonds compared to regular onshore bonds, given the far lower liquidity in the offshore renminbi market and in the FTZ.

Chinese banks studied the feasibility of issuing renminbi bonds from their branches in the FTZ, but such plans were finally dropped, an onshore lawyer said.

"Issuers would not get any benefit from issuing the FTZ bonds," he said.

"The procedures are the same as that of regular interbank bonds."

Potential foreign issuers want FTZ bonds to be more aligned with international standards.

"If we see FTZ renmimbi bonds as an extension to the offshore market, foreign issuers should be able to use their existing international MTN programmes in the FTZ," said a banker at a foreign bank.

Market participants also doubt that Chinese credits will be of huge interest to foreign investors, as most of them do not venture beyond Chinese government bonds and financial bonds. However, as the majority of the bonds now deposited in the SCH are corporate bonds, it means that the majority of credits available in the FTZ for investors will be, too.

Liquidity is another obstacle to the development of the FTZ market.

"Not all domestic or foreign institutions are able to open FTZ accounts (cash accounts) in order to trade FTZ bonds, which means the renminbi liquidity flowing to the zone will be limited," said a Shanghai-based onshore underwriter who took part in early discussions with the SCH on the FTZ bonds.

Test ground

So, why bother creating a new market if the prospect of success is dim?

According to the bond underwriter, the Shanghai municipal government has been mulling the introduction of more financial innovations partly to save face, as the Shanghai FTZ, set up in 2013, has yet to deliver on its great promise.

The government had thought of issuing municipal bonds in the FTZ, but the plan was not carried out, he said.

Looking at the initiative in a broader context, it could be the testing ground for greater liberalisation of capital accounts as mainland Chinese entities and FTZ entities can move renminbi freely between them.

"They (SCH) don't intend to develop a huge market of FTZ bonds," said a source close to interbank regulators.

"What they are trying to do, I think, is to try out innovations that currently cannot be replicated across the country. For instance, direct access for foreign investors to renminbi bonds."

Rules remain vague, though SCH has said the renminbi business will be launched this month.

More clues may emerge soon as Shanghai International Port Group is marketing a debut FTZ renminbi bond after securing domestic ratings a few months ago, according to market sources.

"The market is eagerly waiting for the first issue and, if a precedent is set that an issuer has to use the SCH, that would make things more complicated for foreign issuers," said the banker at a foreign bank.

"For offshore renminbi bonds, foreign issuers want to use Clearstream. They don't want to use SCH, unless there are good and compelling economic reasons to do so."


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