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Talk of China Dim Sum bond market's death is greatly exaggerated

[TAIPEI] When Hong Kong hosted the first Dim Sum bond sale in 2007, it was where Chinese firms went for cheaper debt and global funds flocked to access the nation's closed markets.

Now the dynamics are changing. As China expanded overseas access to onshore bonds and an equity link that started in November made it easier for funds to flow between the mainland and Hong Kong, offshore yuan interbank rates surged. The spillover into Dim Sum funding costs slashed issuance 64 per cent this year. While a five-year Chinese sovereign note in Hong Kong yielded 218 basis points below its onshore equivalent at the end of 2013, the gap has since reversed.

"I expect the Dim Sum market to grow much slower than the onshore market and ultimately end up as a small niche market alongside a totally dominant onshore market," said Jan Dehn, London-based head of research at Ashmore Group Plc, which manages US$61 billion globally and has a 3 billion yuan Renminbi Qualified Foreign Institutional Investor quota. "It will end up trading with a liquidity premium over the onshore market as investors will strongly prefer the larger, more liquid onshore market."

Analysts from HSBC Holdings Plc and Standard Chartered Plc, the top two Dim Sum underwriters in the last four years, differ. They say that, with a larger variety of notes and more familiar legal proceedings, Hong Kong's market will pick up, especially as China seeks to internationalise its currency.

Global companies have preferred offshore markets to raise yuan, with only one foreign non-financial firm selling panda bonds in China as regulators have yet to issue comprehensive rules.

RQFII, QFII "The Dim Sum market isn't going to diminish as some people suggest," said Becky Liu, a rates strategist at Standard Chartered in Hong Kong. "Many issuers will continue to prefer issuing in this market."

Ashmore's RQFII license lets it invest yuan held offshore in domestic securities. The Qualified Foreign Institutional Investor program allows foreign currency to be invested onshore. The nation may do away with the two regimes this year, the China Securities Journal said in an April 14 commentary.

The following are the key questions on whether issuers will turn to the larger onshore market for cash, rendering Dim Sum bonds obsolete.

1. Which issuers will still use the Dim Sum bond market?

Global firms, which made up 34 per cent of Dim Sum issuance in the last four years, may keep selling, said Ms Liu. Panda notes, onshore yuan debt sold by non-Chinese companies, face regulatory questions and issuers don't want to restate financial statements to fit China's system just for a bond sale, she added.

Chinese companies expanding overseas will seek to diversify funding to expand their investor base, said Frank Kwong, Tokyo- based head of Asia-Pacific debt syndicate at BNP Paribas SA, the No 3 underwriter of Dim Sum bonds this year.

"We're increasingly seeing Chinese borrowers raise offshore yuan, even if the coupon is similar, and use the proceeds for acquisitions offshore." Prodded by the government's "going out" policy, Chinese companies have announced US$74.1 billion of overseas acquisitions in the past 12 months, data compiled by Bloomberg show.

2. Why will investors still want Dim Sum bonds?

The Dim Sum market has greater variety and Hong Kong is more aligned with global standards, Mr Kwong said.

"Global investors demand more financial transparency," said Patrick Liao, a Taipei-based fund manager at Fubon Asset Management Co, which oversees about US$4.6 billion and has the second-largest QFII quota among non-government firms. Issuers in Hong Kong are usually of a higher quality because they're willing to obtain international credit ratings and expose their financial statements to scrutiny, Mr Liao added.

3. Which market has better liquidity?

The onshore bond market's 35.3 trillion yuan (US$5.7 trillion) in outstanding notes dwarfs its offshore counterpart's 523 billion yuan.

The domestic market allows a bit more flexibility in selling because the market is much deeper, said BNP Paribas' Kwong. "A fund manager that wants to sell a big block can do that easily in the onshore market, whereas in the offshore one it's still relatively difficult."

Also, it has become easier for overseas investors to buy Chinese credit directly. The nation doubled the cap for global funds to invest yuan in onshore securities in the last 14 months to 330 billion yuan as of March 26.

4. Where would one be better off after a default?

With only three onshore failures so far, it isn't clear where foreign investors would stand in such cases. The familiarity of the legal proceedings offshore "is definitely a plus," said Standard Chartered's Ms Liu. "For onshore notes, people are not really sure."

It can get more complicated. Chinese companies often sell offshore notes through overseas units as the parent's foreign debt is capped by a quota. Bondholders are thus subordinated, without direct claim to onshore assets.

"Investors would prefer the entity that is solid, with a big asset base," said Crystal Zhao, a credit strategist at HSBC in Hong Kong. "The second layer is they prefer the company registered in the domicile they're more comfortable with, where, for example, they understand how the bankruptcy goes, what they can possibly get in the end. It's a trade-off."

5. How does yuan globalisation affect these markets?

Since Hong Kong banks started taking Chinese currency deposits in 2004, new centers such as Taiwan and South Korea have driven total offshore yuan savings to 1.9 trillion yuan at end-2014, Australia & New Zealand Group estimates.

While the yuan's first annual loss in five years in 2014 contributed to slower deposit growth last year, it has risen 0.1 per cent in 2015 to 6.1972 a dollar as of 12:14 pm in Shanghai Friday. Policy makers have used the yuan's fixing to stabilize the exchange rate ahead of an International Monetary Fund review in October on whether to include it in its basket of official reserve currencies.

Ten-year bonds Dim Sum notes offer 3.48 per cent, compared with 1.96 per cent for similar-maturity US Treasuries, 0.16 per cent in Germany and 0.29 per cent in Japan.

"The yuan yield is still relatively high," said Ms Liu at Standard Chartered. "The currency outlook versus most of the other currencies except for the dollar is quite solid. It's an attractive asset class."


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