IFR Renminbi Capital Markets Special Report 2015

For all the desire of market participants to get China’s Panda bond market going, there has been little to talk about over the years. To date, these renminbi-denominated bonds from non-Chinese issuers in the PRC have been slow off the mark. Panda bonds date back to 2005, when International Finance Corporation and the Asian Development Bank became the first issuers. Each bond was for 10 years, with IFC’s Rmb1.13bn (US$182m) at 3.4% and the ADB’s Rmb1bn at 3.34%. The offerings were greeted with some fanfare, but the market never took off. The most recent offering was in March 2014, when Daimler became the first and only foreign firm to issue a Panda bond. It printed a Rmb500m one-year bond at 5.2%. Corporate issuers say an onerous regulatory framework and the inability to convert bond proceeds are keeping them away from the market. China’s strict capital controls mean foreign issuers face great difficulties in repatriating money offshore. Cheaper onshore Accounting regulations complicate the matter further as the Chinese Government requires three years of financial statements in its own version of the GAAP standards. Bond issuers must produce audited accounts, adding to the cost of documentation for foreign aspirants. They also need extensive regulatory approvals and a local credit rating. These rules reflect the concerns of regulators that opening the capital account too fast could expose China’s economy and markets to substantial volatility. Tough domestic rules have helped fuel the rapid growth of Dim Sum bonds, which are denominated in renminbi, but issued offshore. The overseas route gives borrowers more flexibility to manage proceeds and a familiar legal framework, typically through international MTN programmes. However, bankers say the Panda bond market is likely to pick up in the longer term and they expect it to attract more attention in coming years. Some have gone as far as arguing that Panda bonds, if comprehensively liberalised, may eventually make the Dim Sum market irrelevant. “Recently, more issuers have been considering Panda bonds. However, there are still some obstacles for issuers to move the bond proceeds out of China. Therefore, the types of issuers are likely to be those who have capital needs in China. In theory, capital controls have been relaxed in the Shanghai and Qianhai free-trade zones, but that hasn’t really been tested yet.” Although Panda bonds have slightly lost ground in recent months, onshore yields are now cheaper than their offshore equivalents. Talks to resolve disagreements over capital controls and accounting are said to be making progress, with a possible compromise that would see issuers take advantage of more flexible rules in the free-trade zones of Shanghai and Qianhai. “It would be a huge boost to the Panda bond market, because, at the moment, it’s just too difficult for it to be meaningful,” said a knowledgeable Hong Kong-based DCM banker. “If they made accounting and capital movement easier, it could be a huge step forward.” Many remain sceptical. Connie Cheng, a partner at Clifford Chance in Hong Kong, worked on the first Panda bond issue and has also been involved with a number of Dim Sum deals. As she sees it, capital controls are a huge sticking point and, even if the free-trade zones help to alleviate some of those problems, the market remains very immature. “Recently, more issuers have been considering Panda bonds,” she said. “However, there are still some obstacles for issuers to move the bond proceeds out of China. Therefore, the types of issuers are likely to be those who have capital needs in China. In theory, capital controls have been relaxed in the Shanghai and Qianhai free-trade zones, but that hasn’t really been tested yet.” To set up a business in a free-trade zone can take over a year, a period of time when an issuer’s circumstances, not to mention market and regulatory conditions, may change dramatically. For now, companies wanting exposure and access to China’s

Ample liquidity and buoyant investor sentiment have sent China’s stock markets to their highest levels since the initial stages of the financial crisis in early 2008. The sustained rally is encouraging more companies to sell shares locally rather than in Hong Kong or the US, even at the expense of artificially low IPO prices. Beijing Baofeng Technology, the first internet company to remove a Variable Interest Entity (VIE) structure to list domestically, provides a vivid example of why the A-share market is so attractive. The online video company had to price its March IPO on the Nasdaq-like ChiNext at an 85% discount to its quoted peers because of Chinese restrictions on listing valuations, to raise just Rmb214m (US$34m) as a result. However, the stock has rocketed more than 34-fold since trading began. As of May 20, the company was valued at Rmb36bn, more than its much larger US-listed rival Youku Tudou and nearly seven times bigger than Xunlei, another US-listed competitor. Chinese regulators, keen to stem the tide of technology stocks heading to the US, could not hope for a better showcase. As part of its IPO reforms, China has been working on the first major amendment to securities law in a decade to allow unprofitable companies to list domestically. Officials at the China Securities Regulatory Commission and individual stock exchanges say the amendment is intended to allow internet and other strong growth technology companies to tap domestic capital markets. “Many large-cap state-owned enterprises were already listed in the last round of the bull market. In the future, more sizable IPOs may come from high-growth companies in emerging industries,” said Kefei Li, head of ECM for China at UBS. “On a 10-year prospective, the CSI-300 is still reasonable on both PE and PB. However, the level of margin financing has run up very quickly to about 16% of turnover in Shanghai and Shenzhen exchanges at the end of March, which means there are many weak hands in the A-share market should there be a meaningful correction.” The Shanghai Stock Exchange recently said it planned to open a strategic emerging enterprises board to facilitate market access for start-ups in the computer, information technology, internet and biopharmaceutical industries. The move may help cool the overheated ChiNext market, which is trading at the highest level since it was established in 2009 and has notched a gain of around 120% year to date. “The potential launch of Shanghai’s strategic emerging enterprises board will help to digest the huge investor demand for high-growth companies in emerging industries, which can effectively ease the bubble in ChiNext market,” said Steve Yang, A-share strategist with UBS Securities. IPO freeze Until recently, Chinese issuers were reluctant to list domestically due to a year-long IPO freeze in 2013 and overloaded pipelines. However, since the beginning of the year, IPOs have multiplied on the back of the stock rally. Markets in Shanghai and Shenzhen have risen about 33% so far this year and doubled in value since last June. The Shanghai Stock Exchange surpassed the Stock Exchange of Hong Kong and even the mighty New York Stock Exchange to become the world’s most active bourse for IPOs in the first quarter of the year, according to Deloitte China. China’s two bourses, the Shanghai Stock Exchange and the Shenzhen Stock Exchange, saw 70 A-share IPOs with total value of Rmb48.3bn during the quarter, up 44% from a year earlier, Deloitte said. The market is on course for a good second quarter after the CSRC began stepping up its approval of IPOs in April and allowed bigger deals to come to the market. Following the Rmb10.03bn listing of Orient Securities in March, China National Nuclear Power is set to seal the biggest A-share IPO in five years at around Rmb14.5bn. In an effort to allow more companies to come to market for lower individual amounts, the CSRC removed its restriction on IPO sizes in favour of a valuation limit instea

With the issuance of Dim Sum bonds all but collapsing earlier this year, Taiwan’s Formosa market has emerged as a fast-growing source of renminbi financings. The amounts raised were relatively modest, but the trail of deals caught the attention of bankers and international issuers, while the rest of the offshore renminbi market struggled. There were whispers that Taiwan, though a long way behind, could emerge as a strong challenger to Hong Kong’s dominance of Dim Sum issuance. The prospects for Formosa bonds, particularly in renminbi, were excellent for the second half of 2015, said Tee Choon-Hong, managing director and regional head of capital markets for Greater China and North-East Asia at Standard Chartered. His bank recently obtained a licence to underwrite bonds in any currency in Taiwan. “Investors there want higher yields and more diverse investment options,” said Tee. “It’s a very interesting market and the prospects for Formosa bonds are very good.” The surge began in March with a three-year offering of Rmb1bn (US$161m) from the Export-Import Bank of Korea, or Kexim, at 4.4%. Yield-hungry Taiwanese insurers, which were recently given access to a more diverse menu of assets, heartily gobbled up the bonds. Next in line were Deutsche Bank, Societe Generale, BNP Paribas, Goldman Sachs, Morgan Stanley and a host of other Western lenders. Banks from Asia-Pacific and the Middle East also jumped on board with Nomura, Macquarie and First Gulf launching issues in offshore renminbi. Most of the deals had tenors of three to five years, with coupons ranging in the 4%-5% area. Although banks and corporations had explored the Taiwanese market before the Kexim deal, conditions were particularly favourable in March as a result of one of the most attractive cross-currency swap rate in years. Selling bonds in renminbi and swapping the proceeds into US dollars allowed issuers to borrow more cheaply than through direct issuance in US dollars. Tellingly, most of the early Formosa issues in renminbi were from banks, which are usually faster than corporate issuers to spot opportunities and, subsequently, bring out issues quickly, through through a medium-term note programme for example. After a while, the swap rate became less attractive and renminbi bond issuance decelerated, but this did not stop banks from continuing to tap the Taiwanese market. In the period from February through to mid-May, banks issued over US$5bn of 30-year callable, zero-coupon bonds denominated in US dollars. “The Taiwanese are clearly becoming more aggressive in attracting deals, and they can do it because they have an investor base willing to buy almost anything.” Several factors then combined to make offshore renminbi issues more attractive. Offshore liquidity increased with the help of the Shanghai-Hong Kong Stock Connect scheme and when China cut onshore interest rates for the third time in six months on May 10, with expectations of more cuts to come as early as the summer. Sentiment also improved regarding the value of the renminbi, which had lost considerable ground to the US dollar in January and February, but started stabilising in April. Taiwan’s Dim Sum market was jolted back to life on May 14, when Deutsche Bank issued the island’s biggest renminbi-denominated bond of the year, a five-year Rmb1.65bn at 4.3%. The issue had 10 firms working on it as bookrunners. Bankers say the Deutsche deal received a lot of attention from other potential issuers, confirming Taiwan’s ability to devise new ways of attracting borrowers, be it in renminbi or other currencies. “The Deutsche deal is actually kind of annoying for us,” said a Hong Kong-based Dim Sum specialist. “Since then, everyone is calling us and trying to get the same rate, but we can’t offer that to everyone. Some companies may not feel as comfortable working in that market, but, if they are, it’s basically free money. However, the Taiwanese are clearly becoming more aggressive in attracting deals, and th

It has been a tough start to the year for Dim Sum bonds. Unfavourable forex moves and illiquidity have silenced what had once been an exciting and growing market. After setting a record in 2014, when Dim Sum issuance hit Rmb324bn (USD52.2bn), the market screeched to a halt in the first quarter of 2015. February was emblematically dire with issuance totalling just Rmb4.3bn, down from Rmb17.8bn in the same month last year, according to data from Thomson Reuters. Yet, beneath the doom and gloom, Dim Sum bankers are becoming more upbeat about the prospects for the remainder of the year. The liquidity situation for offshore renminbi bonds has been improving steadily, partially due to Chinese interest rate cuts and the Shanghai-Hong Kong Stock Connect trading link, which added to the flow of funds from mainland China into Hong Kong. With that have come a few small, albeit successful issues. The most recent was an April 29 offering of three-year Dim Sum bonds of Rmb1.3bn from China New Town at 5.5%, which drew orders of Rmb6.6bn, and Deutsche Bank’s May 21 issue of five-year Formosa bonds of Rmb1.65bn at 4.3%. Back to trend “The Dim Sum market is definitely coming back,” said Peter Szekely, managing director for debt capital markets, Greater China at Standard Chartered. “It’s been very quiet, but the liquidity situation has improved and more currency is moving offshore. The cost of funding has improved and we expect to see the pipeline build.” The improvement in offshore liquidity appears to be one of the main factors behind bankers’ optimism. Waning offshore demand pushed Dim Sum yields to record highs this year, just as a series of interest rate cuts pulled mainland benchmarks lower. However, offshore yields have recovered from their March highs, and the spread between onshore and offshore bonds is beginning to stabilise. “It’s been very quiet, but the liquidity situation has improved and more currency is moving offshore. The cost of funding has improved and we expect to see the pipeline build.” According to HSBC’s Dim Sum Bond Index, the average yield of offshore renminbi bonds fell 35bp in April, the biggest drop in 20 months. Bankers are expecting the next wave of Dim Sum issuers to come from mainland China, as companies seek to take advantage of declining yields to diversify their funding sources. These companies will be mostly state-owned enterprises and banks needing to raise capital. So far this year, a few Chinese banks have issued Tier 2 bonds, but none have opted for Dim Sum. However, a few foreign banks, such as BPCE and ANZ, did so earlier in the year. “You’ll see that most issuers will likely be Chinese,” said Frank Kwong, head of Asia Pacific bond syndication at BNP Paribas. “They are taking advantage of rates that are coming down. There are still a lot of SOEs that need to come to the market, especially Chinese banks. We haven’t seen benchmark deals from Chinese banks and I’m sure that they are all looking at the market. They need to raise diverse forms of capital and grow their benchmarks. So, we need to monitor that market as there could be opportunities there.” Foreign issuers that had launched a spate of arbitrage-driven Dim Sum deals in March as a way to take advantage of attractive cross-currency swaps and reduce their US dollar cost of funding are not expected to play as big a part. Many of these opportunistic issuers – mostly banks – had rushed to the Taiwanese market to issue Formosa bonds in renminbi and swap them back into dollars. The advantageous rate, however, has since dissipated and issuance in Taiwan has slowed considerably. Deutsche Bank recently issued the largest renminbi-denominated Formosa bond for the year to date, but it was the first of its kind in over a month. While the offshore liquidity situation has certainly improved, bankers say the currency will remain the key issue. The exchange rate versus the US dollar may have stabilised in recent weeks, but the prospects of further renminbi depre

China’s muddled thinking over the rising level of debt trapped within its financial system was thrown into stark relief due to two interlinked events in the last two weeks of April. First came a long-expected announcement that still held an element of surprise: a state-owned enterprise was finally being allowed to default on its debt. Power equipment manufacturer Baoding Tianwei Group, a unit of a leading military contractor, missed an interest payment of Rmb85.5m ($13.8m) due on bonds of Rmb1.5bn, after racking up huge losses. Earlier that week, Kaisa Group Holdings became the first Chinese developer to default on its US currency debt. Now, Baoding Tianwei, a small-but-vital cog in the state machine, was being forced to admit in public to its financial failings. The default appeared to mark a genuine shift in the thinking of a government determined to open a cooling economy to market forces. China was also effectively breaking a longstanding taboo over moral hazard, the ingrained belief that the country’s state-owned enterprises could do what they wanted, on the assumption that government would always bail them out. The government was sending a clear signal to investors: risks existed in the financial system, and should be factored in when buying debt securities. CICC, China’s largest investment bank, described the default as a “landmark” event in the history of the country’s bond markets. As it turned out, this was not true at all. Far from being China’s pivotal moment, it was just another example of Beijing’s signalling its intention to do something big and brave, before scuttling back into its shell. In this instance, the volte-face came just six days later, when state lender China Construction Bank handed Baoding Tianwei an undisclosed loan, ensuring that it would meet its bond repayments. “When it comes to the domestic bond markets, the first order of priority is clearly the issuance of local government debt. Until that is completed, the timing of a default on an SOE may have to be deferred.” Analysts were quick to describe this as a missed opportunity for a country burdened with rising liabilities at all levels. Mainland corporations are now among the world’s most indebted. As at the end of 2014, the ratio of debt to economic output, including all corporate and central and local government liabilities, stood at more than 250% of GDP, an increase of 90% since 2008, according to data from the People’s Bank of China. Worse, Beijing stood accused of misleading the investment community, having signalled right before turning left. “They sent mixed signals over Baoding,” said one renminbi market specialist in Hong Kong. “It appeared that China had accepted a key inherent weakness in its economic and financial system – and that it accepted the need for all firms, even its prized SOEs, to fail.” Then, it backpedalled, leaving “the whole industry feeling very confused”. In dodging a painful, but necessary, event in the development of its capital markets, China also missed a chance to prove to the world that its reforms were on track. Growth is slowing even as debts soar. Steel and coal production both slipped sharply in April, with exports falling 6.2% year on year in April, as opposed to expectations of an increase. Beijing could have used Baoding’s failings to show domestic and foreign investors how an SOE would go about restructuring its debt and to demonstrate how creditors could recover capital in a default situation. Almost immediately, analysts started looking beyond the troubled firm for answers. Baoding may well have been, to use the words of Anne Stevenson-Yang, co-founder of independent Beijing-based consultancy J Capital Research, an “almost incredible debt scofflaw”. Balancing act However, Beijing and its leading state banks, including CCB, do everything for a reason. So, what was the logic behind its thinking this time? The answer almost certainly lies in two of China’s most pressing challenges: first, the need to t

Now that the highly anticipated Greater China cross-border link has started to gain traction, market participants around the globe are angling to step in and encourage authorities to incorporate into the platform other bourses, such as that in Shenzhen, as well as more asset classes like bonds. Trying to make Shanghai-Hong Kong Stock Connect work for multiple markets and classes of investors will pose many challenges for regulators. Nonetheless, the scheme has proved to be a solid initial step so far towards the opening up capital markets in the world’s second-biggest economy to outside investors. Foreign and local investors eagerly await changes to make the platform more inclusive. The Stock Connect platform was launched last November with much fanfare. After months of disappointing trading volumes, the pilot programme finally took off as regulators made amendments and investors became more comfortable with the terms. Escalating trading volume spurred administrators and others to start to sketch plans to include exchanges in Shenzhen and Taipei in the platform. Yet, while these plans remain in the early stages, the biggest achievement for the trading link’s administrators has been to draw unprecedented attention to the Chinese capital markets. “I think Stock Connect, in terms of overall volume, hasn’t been the massive success that a lot of people were expecting to see, but, overall, it has been fantastic progress in order to open the door to the onshore Chinese capital markets,” said Julien Martin, head of BNP Paribas’ RMB Competence Centre. Bull markets Foreign investors had been curious about Chinese equity markets long before Stock Connect launched on November 17. Mainland markets were already performing well on the back of regulatory changes and the increased use of margin financing to buy stocks. In fact, at the time of launch, benchmark indices on Shanghai and Shenzhen were already up 17% and 25% on the year, respectively. However, the new trading link, coupled with mainland interest rate cuts, helped push the indices much higher, market participants said. Shanghai and Shenzhen indexes are up about 73% and 90%, respectively, since regulators launched the initiative last November – a factor that has only further heightened foreigners’ desire for mainland stocks. Southbound trading volume from Shanghai-based funds into Hong Kong has not been as heavy, even though the Hang Seng Index has climbed about 15% since the platform was launched (versus a mere 1.3% increase all of 2014). “This concept of the scheme is scalable. It may not be technically scalable if you want to incorporate other asset classes, like bonds, but it’s scalable for equities, and other exchanges inside and outside of China are looking to participate.” Still, market participants say investments into Hong Kong and beyond through the platform will eventually grow as onshore money managers become more sophisticated and mainland regulators keep encouraging them to put more capital into other markets. “What’s important is that it is the first real two-way scheme,” said BNP’s Martin. “Regulators have realised that it’s not just about money going into China; it’s also about money moving out of China. Even though there has been only one day so far when the daily limit for southbound flow has been hit, it’s still important: mainland investors have more options.” Mainland investors used their full Rmb10.5bn daily quota for the first and only time on April 8. No major mishaps For many, however, the overall usage of the platform is not as important as the fact that there have been no major mishaps since launch. Trade errors or glitches in technology would have scared away investors far more than lower-than-expected volumes, sources said. That is partly why regulators are interested in expanding the platform at such an early stage. Many exchanges have been mooted as possibly additions to the existing Shanghai-Hong Kong network and these include Shenzhen, New York, Lond

China’s currency is no longer a fledgling tender. For better or worse, the renminbi will define the 21st Century, just as the US dollar and pound sterling embodied the two that preceded it. Yet, many questions remain unanswered. How fast is it growing? What are the obstacles holding it back, and the incentives fostering its development? Also, what does Beijing really want its increasingly global currency to become? So far, it has been surprisingly smooth sailing. The turbulence that typically accompanies a rapidly developing currency has been kept to a minimum, thanks to the creation of an onshore (CNY) and an offshore (CNH) renminbi, with a thick wall of capital controls separating one from the other. The widely held assumption that Beijing’s ultimate plan is to reunite the two to create a single universal currency, has encouraged the development of a thriving offshore market. Outstanding Dim Sum debt, as the offshore bond market is known, has risen steadily over the past eight years to hit Rmb564bn in 2014, according to Standard Chartered. Primary renminbi debt issuance in Hong Kong last year nearly doubled to Rmb202bn, data from Bank of China (Hong Kong) show. Moreover, the renminbi is being used every day, and in every way, to settle commercial trades. Data from payment messaging network SWIFT show the renminbi jumping from the 20th most commonly used global currency in January 2012, to the fifth most widely used as at end-2014, leapfrogging the Australian and Canadian dollars. In December 2014, the renminbi accounted for 2.17% of all global payments, against just 0.25% three years previously. Two-way trading Christy Tan, a currency expert and National Australia Bank’s Hong Kong-based head of markets strategy, reckons that up to 35% of all annual trade with Chinese corporations will be conducted in renminbi by the end of the decade, against 22% last year. It will not always be plain sailing. China’s determination to create a global currency opens huge new opportunities for the country’s leaders, but also imposes on them new responsibilities – a burden they may not entirely be ready to bear. “RMB liquidity must be fostered outside Hong Kong and Asia to support investors’ confidence in trading in these assets on a daily basis – addressing both time-zone differences, and daily clearing and settlement needs.” A series of onshore rate cuts suggest the currency is in for a rocky 2015. The Dim Sum market’s recent expansion benefited from allowing borrowers to raise money cheaply in Hong Kong. Yet, that trend is likely to end this year, due to sharply higher funding costs, a weaker currency, and a sprinkling of bond defaults by mainland corporations. StanChart’s projection is for outstanding offshore bonds to shrink to around Rmb480bn–Rmb500bn this year, with HSBC forecasting around Rmb520bn. The challenge for China is to find a way to open up the renminbi without allowing too much chaos and uncertainty to penetrate a cooling economy. In order to create a global currency, says David Olsson, banking and finance partner at Hong Kong-based law firm King & Wood Mallesons, China “still needs to develop accessible, deep and broad domestic financial capital markets. This is a precondition to RMB convertibility.” Beijing is heading in that direction, enforcing rules designed to permit local capital to move offshore, while allowing foreign investors to shunt money into domestic securities. A “through train” scheme now allows shares to be traded between Hong Kong and Shanghai. New free-trade zones are being set up in Fujian, Guangdong and Tianjin, following in the footsteps of the Shanghai pilot. In early May, Beijing approved applications from HSBC, Morgan Stanley and 30 other foreign institutions to invest in the Rmb36.3tn onshore bond market. Every one of these developments, notes Scott Farrell, a securitisation and derivatives partner at King & Wood Mallesons, is key to China’s long view of its currency. “Each reform serves to t