IFR Asia RMB Bonds Roundtable 2018: Part 2

IFR ASIA: Is the risk to the property sector about companies accessing finance, or is it more about house prices?

TONY TANG, PENGYUAN: There are multiple fronts. On the policy front, the tone from the top leadership has clearly changed. Before, policymakers always said they want to have slower price growth, but now they don’t want any price increases at all!

Even though the economy has faced so many obstacles, we haven’t seen a massive relaxation on a policy side because it’s a worry about the money continuing to go to the property sector, further blowing up the bubbles. Price definitely will be another big factor, because that has a big psychological impact on the buyer’s side. We are already observing some protests in Guangdong and even in Shanghai, after people bought apartments and then the property developers cut the price 30% or 40%. All the property developers are rushing to get their cash back. The Vanke chairman said in the annual meeting that he just wanted to survive. The whole thing has changed.

IFR ASIA: While we’re talking about policy, does anyone have a view on the way the trade war will play out for the RMB markets?

STEVE WANG, CITIC CLSA: The trade war was probably the most important topic of conversation at the CLSA Investors’ Forum this year, and it will not go away any time soon. What we’re seeing right now is probably a little more ideological than anything else. Depending on President Trump’s results in the mid-term elections, it is unlikely that he will turn down his tone with China unless China meets his demands.

I’m quite cautious about what the US and China might bring about in the short term. Right now, China is not in a great spot but it does have sufficient policy levers to pull to defend growth. It’s going to be a good lesson for everybody.

On Tony’s section about the property sector, that has been such a major driver for China’s growth. This is happening at a very important moment in history and I’m happy to see China putting the brakes on housing prices. I don’t think they can see housing prices go lower either and we can’t afford to see protests popping up everywhere, but they are serious about it this time.

China has to build a market-based economy, meaning that there’s a chance that you will lose money on your investments. It’s a learning curve and it’s a good time to change. China still has a lot of energy. Just as an anecdotal example, you saw how crowded Nathan Road was during this year’s Golden Week holiday? That’s very much due to the opening of the high-speed rail station. This is China in its finest moment: it is building infrastructure and bringing people to new places.

TONY TANG, PENGYUAN: Just to echo what Steve says, China still has huge potential. Even though we have seen more than 30 years of rapid growth, the GDP per capita is still less than US$10,000. China has a huge population that is underserved and underdeveloped, and if their needs are met it’ll create so much value for the economy.

Also on the trade war, I don’t think the trade war will have an out-of-control economic impact on China. Yes, the headline numbers around the tariffs and the US trade deficit of US$375bn are very big. But compare that with a US$12tn-$13tn economy and it’s still a small percentage. We still expect China to have an overall trade surplus over the next few years. China is also pretty agile at dealing with situations like this. If the policy responses are quick and proper, they can minimise the impact. Some short-term pain may be felt, but China’s long-term economic outlook is still determined by its structural reforms and R&D investments.

IFR ASIA: We talked a bit about what might be holding investors back. Ko-Wei, what about the issuers? How do your issuer clients decide whether to fund in China, Hong Kong, Taiwan or wherever else they can find RMB?

KO-WEI HSIUNG, HSBC: It’s part of the learning curve. If you look at the Chinese market, for example, HSBC is the first foreign bank to have a majority owned entity to operate in the Exchange Market. We also have the banking entity that operates in the Interbank Market. You really have to understand how the local market works, how the different regulators are responsible for different markets and the relevant regulations. This all takes time, especially for someone who doesn’t speak Mandarin to really understand the details.

The regulators have so far been very helpful in terms of helping offshore issuers understand how it works, and changing some of the local ways of doing things to match international market standards.

IFR ASIA: What sort of global standards are you talking about there? Is that the ratings?

KO-WEI HSIUNG, HSBC: It could be the ratings; it could be the application process itself. Those are all relevant for offshore issuers looking at this market.

The offshore RMB market, meanwhile, is much more similar to what we’re doing in the G3 market which makes it easier for issuers to understand. Even on the Formosa Bond side in Taiwan, there is no specific requirement on governing laws or languages. That makes a difference why people take less time to adjust to the Dim Sum market or the Formosa market, versus the onshore Panda market.

IFR ASIA: Paula, is there still a lot of interest in the offshore CNH markets?

PAULA CHAN, MANULIFE: No, there’s not. It’s coming down quite quickly. I think the key reason is that the duration of the market is too short, compared to the onshore market. So if I’m a duration player on the bond side, it’s very hard to express a view. It’s more about benefiting from the sporadic opportunities in the market. As we speak the CNH short-term interest rate (HIBOR) is squeezing very hard, and that creates some opportunities for investors.

For us, if we want to play the yield curve, we would definitely play the onshore yield curve, because its monetary policy cycle is clear. Policy divergence versus the US is something we can play. In the primary market, the longest you can get in the onshore market is 50 years – there are not a lot of markets that can give you that kind of duration.

Investors will have their own focus and their own mandates, but even for our third-party mandates where we have flexibility, we like the onshore yield curve. The offshore market is more interesting for the derivatives markets, e.g. forward speculation, FX hedging and so on. For underlying bond investments, I would probably recommend the onshore market. I know that the Panda market is still young, but we are seeing more issuers tapping that market and hopefully we can have more selections there. For now, definitely the flow is all onshore. We are actually revamping a lot of our existing products to include Bond Connect, and one new product we are developing will be much more dynamic, allowing us to go onshore, offshore to give ourselves more leverage and extend the long-term shelf life of the product. In our 10-year vision, it’s all about the onshore market, for sure.

KO-WEI HSIUNG, HSBC: From what we’re seeing, the offshore market is an opportunistic market. A lot depends on the depth of offshore RMB deposits. Definitely there are some investors who will swap their home currencies into CNH to invest, but again that would depend on the derivative market, liquidity, and how it fits into their overall investment strategy.

A lot of it still boils down to the pool of offshore RMB savings. That has not really been growing over the past few years, so it creates a phenomenon where you only see new issues coming in when there have been redemptions in the market. You’re not going to see a big growth in the market, unlike how it was many years ago.

IFR ASIA: Where do you see that ending up? If you go forward five, 10 years, will there still be a deep and liquid offshore market?

PAULA CHAN, MANULIFE: No.

KO-WEI HSIUNG, HSBC: There will still be an offshore market; it’s not going to go away. Then I would say it really depends on the progress of RMB internationalisation. One possibility is that the offshore RMB takes the same path as the US dollar market, for example, where you have both an onshore US dollar market and an offshore US dollar market. On the other hand, given the correlation between the onshore and the offshore RMB market, the growth of onshore market will have an impact on how the offshore RMB market will look in the future.

IFR ASIA: Any views on Taiwan? There used to be a fairly active Formosa market in Taiwan.

KO-WEI HSIUNG, HSBC: There still is. But I would say it’s very regulation-driven again. There have been a lot of new regulations introduced in the local Taiwanese market this year, and that has had an impact on the appetite for various instruments. Having said that, Taiwan is still the second-largest offshore RMB market, in terms of RMB reserves held by corporations and the banking sector. It’s still a market that you cannot just ignore, but would depend on the level of reserves and whether there are sufficient funds to support transactions.

IFR ASIA: Ricco, we’ve talked about the idea of RMB internationalisation through Silk Road bonds. Did we ever get anywhere with those?

RICCO ZHANG, ICMA: One angle is to basically combine the Belt and Road Initiative with the Panda bond. The Chinese authorities have made it clear that any Belt and Road issuers are welcome to tap the Panda bond market - that applies to both the interbank market and the exchange market. I expect Panda bond guidelines for the exchange market will follow by the end of this year, and the two exchanges will compete with each other to attract issuers. We all know the Belt and Road initiative is about infrastructure financing, and the biggest players are Chinese corporates. RMB would be the ideal currency for them when they consider funding such projects, and I expect you will see more of them issuing bonds as a result.

I would also echo what has already been said that the onshore market would be better than the offshore market. Offshore liquidity is definitely not doing great. When people talk about RMB internationalisation, they used to expect a lot of Dim Sum bonds, but that has shifted. First it is again about the currency. We’ve moved from appreciation to depreciation. Second is a very substantial change in regulations. The Keepwell structure is one example. The format has been widely used by Chinese issuers in Hong Kong as an alternative to a guarantee structure, because if the bonds are guaranteed by the onshore parent company the money cannot go back to China. The Keepwell allowed the funds to be repatriated back to China. Now, the regulatory requirements are gone, so you can just put the guarantee on the table and the money is free to go.

Ask anyone to predict the next five or six years and the answer will always be “We don’t know”, because it’s always shifted so quickly.

TONY TANG, PENGYUAN: Also on the Belt and Road initiative and Panda bonds, I think Chinese investors are so used to investing in their domestic market. Understanding the credit risks in all these Belt and Road countries is a challenging task for onshore investors. So for the Belt Road credits to take off in the Panda bond market, I think that the onshore investors have to be comfortable first.

That goes back to the first topic we talked about. The rating agencies going into China can provide a rating service from an international perspective, and then hopefully onshore investors will also get used to those risks. At the same time, I think it is also important that the onshore agencies provide more credit opinions outside of China for the Belt and Road projects. That is also a challenging task. You need to have a criteria system and a model that works. You also have to have an analyst who’s actually experienced in covering those countries. Yes, it’s easier for a Belt and Road company to decide whether to come to Chinese onshore market and issue bonds, but it will take some time for a young market to understand the outside world. To get a proper understanding on the credit risks of that particular company, you probably need to have an understanding of that sovereign first. All these things will take time to develop.

IFR ASIA: Do we think that RMB bonds will play a big part in the Belt and Road?

KO-WEI HSIUNG, HSBC: I am very assured that it’s going to play a big part in what we’re going to see going forward. We’ve been talking to many different issuers in Belt and Road countries, and a lot of them have expressed very strong interest in what the RMB market would be able to bring to them.

I think some of the issues that they face - whether it’s understanding the foreign exchange regulation or about the market itself - those are obstacles that will eventually fall away, and then we will see a very strong participation from the Belt and Road countries in the onshore market. We are already starting to see that now, actually.

IFR ASIA: Is it true that a Belt and Road issue has a chance of getting a much quicker approval?

KO-WEI HSIUNG, HSBC: Yes. There’s actually a fast track channel for the Exchange Market.

IFR ASIA: Do you see any possibility that an onshore credit enhancement agency will get involved in some of these Belt and Road bonds?

TONY TANG, PENGYUAN: The credit enhancement agencies themselves are going through a change in China right now. The regulations around the financial guaranty companies are still not fully settled. A lot of those credit enhancement providers were actually called financial guarantors in the onshore market, but they’re not true guarantors in some cases. There have been many cases that these financial guarantors refused to fulfil their payment responsibilities in the event of default. The legal system around this industry needs a lot of improvement, I must say. For them to expand offshore is a much bigger challenge. To provide a professional service they’ll need to take a fee, like 1% or 2% on the issuance, and if they don’t understand the credit risks of an issuer then they probably will charge more. And even if they do provide some kind of credit guarantee, how can they enforce the repayment and model the recovery to protect themselves? That will be difficult.

Chinese investors don’t really have a lot of experience with the global capital markets. In the domestic market they are very direct. For example, if they are investing in the pharmaceutical sector, they probably will buy funds, patents, shares, bonds – that’s all fine. When it comes to cross-border activities, it’s still very much limited to that direct style. I don’t really think they have the confidence and experience in more sophisticated financial services. Maybe the policy banks can provide some credit enhancement mechanisms, but for the regular commercial financial services companies to do that it’s very difficult now, in my opinion.

IFR ASIA: What do you worry about between now and the end of the year?

STEVE WANG, CITIC CLSA: The biggest risk towards the year-end is refinancing. We are facing some significant maturity schedules against a backdrop of policy changes and trade tensions. The refinancing pressure for property developers is quite severe and we still haven’t seen the biggest player come into the market so there’s a constant fear around the trading floor.

The market doesn’t have a lot of risk appetite at the moment and it’s the same for any trader providing liquidity. We have had multiple years of a strong bull market and this year is very different. It’s still going to be very challenging in the fourth quarter and into 2019.

My analysis shows that the refinancing schedule really picks up into the second quarter of 2019, so the market needs to sort itself out, stabilise, and work its way through some of the refinancing challenges. If not, then we may see some more blood on the table towards the year end. That being said, we are still optimistic that policies will shift and things will stabilise in the fourth quarter, but I would say refinancing is the major risk.

IFR ASIA: Is that the same for you, Paula? Is that (refinancing risk) what you worry about?

PAULA CHAN, MANULIFE: For us, we are more concerned about secondary market liquidity, even in the IG space. Bank balance sheets have been strengthened, but their staying power is not as great as before, from our observation. If we want to exit the market in a block trade it is just very, very difficult. So we protect ourselves by staying in benchmark names, and we’re very nimble. We’re doing a lot of work on position sizing, making sure that we can exit if we want to. The market is going to be very nervous into the year-end, because the mid-term presidential election is due.

The dollar strengthening story is bothering me. I think the central banks here in Asia have been proactive with rate hikes. They are doing their jobs much better compared to 1997 and the global financial crisis, so I give them credit for that. The problem will come if markets start to get crazy and feel that the Fed is behind the curve. We’re seeing wages picking up in the US with some feel-good factors. Friends of mine are looking at what to do with their tax rebate. They are spending. Mercedes Benz just said they are building their new SUV in the US. So if the capex is also starting to work, it will be a powerful engine in the US.

I’m not sure how Asia is going to play out if we head into an inverted curve in 2019. At the moment, not a lot of people are talking about it but that’s something I’m looking at. On the rate side, I can use the Treasury market to do hedging. For credit, especially in Asia, I don’t think we have had to deal with an inverted curve for a long time, so that’s something I’m thinking about.

IFR ASIA: Well, the RMB is the answer then!

PAULA CHAN, MANULIFE: Of course, yes. It’s still a work-in-progress, but this is something I’m looking at.

RICCO ZHANG, ICMA: I also want to respond to the point about liquidity and refinancing. 2018 and 2019 are big years in the capital markets for refinancing, so it’s quite critical. In the short-term or maybe in the next two or three years, the trade war may actually be expanded. Geopolitical factors will affect the market.

Liquidity has been a concern for at least the last three or four years. We publish a liquidity report every two years globally, and now we have extended the study to Asia. Because of Basel III, the banks that were supposed to be the dealers and market makers are not allowed to provide so much liquidity any more. That’s been really a big issue for the debt capital market.

IFR ASIA: Ricco, how does the RMB fit into the growth of the Green bond market?

RICCO ZHANG, ICMA: The green market in Asia is driven more by issuers and government policies. In 2016 the Chinese market was already the biggest in the world for Green bond issuance. Last year, it was second behind the US, but the difference is not that substantial. This year the market has continued to grow, and different countries have schemes and incentives to encourage more issuers.

The Hong Kong government is really committed to building Hong Kong into a green finance hub. They have put two schemes on the table. The first is a grant, covering the cost of verification, and a separate incentive for first-time issuers in the Hong Kong market, basically to cover 50% of their issuance costs with a cap. That’s all relevant to encourage more Green bond issuance in Hong Kong.

Second, last month the Hong Kong Green Finance Association was launched. I will be co-chair for the Green Bond Working Group. green finance also covers green insurance, green investments - everything. The Hong Kong government has also committed to more Green bond issuance to raise awareness in the community.

IFR ASIA: Just thinking about what we’re talking about today, will you get an easier approval route perhaps for a Green bond in the RMB markets – say a Green Panda bond?

RICCO ZHANG, ICMA: Well, exactly. One thing people worry about is that there may be too much labelling. Actually, the first Green Panda bonds were issued two years ago by the New Development Bank. Definitely if Belt and Road issuers tap the market they could do a Belt and Road Green Panda bond. I would say actually it’s a good thing. And as Ko-Wei said, there’s a fast-track to make the approval process faster than a conventional bond. I wouldn’t expect that to last forever, but at least for the next one or two years, being green will help.

KO-WEI HSIUNG, HSBC: From what we’re seeing, the Chinese regulators are definitely very welcoming for issuers considering something in the Belt and Road format or in the green format. I think those are the two priorities for the market. Also from HSBC’s perspective, the growth of Green bonds and Social bonds is definitely one of the big themes of the past year. Traditionally, this has been much focussed around some of the very large corporates or financial institutions trying to “green” their transactions, but now we’re seeing a broader issuer base.

It’s very difficult to quantify the benefit to an issuer on day one, but we are seeing that access to the Green bond market has a positive impact for issuers across the entire curve. As well as other intangible benefits, that’s a very strong argument to look at this market - no matter in China or elsewhere.

IFR ASIA: Is this something that Chinese rating agencies are aware of, Tony?

TONY TANG, PENGYUAN: Yes, you know, we will be publishing very soon our green evaluation criteria in Hong Kong. It’s not really about credit risks, that’s the first point, but credit agencies can rate how green the issuance is, and help assess the use of proceeds. The governance factors, reporting and disclosure are all part of it. The second point is that it’s a ‘point-in-time’ assessment, not like a credit rating, where we have ongoing surveillance.

IFR ASIA: Do you think that the typical Chinese investor looks at those as part of their investment decision?

TONY TANG, PENGYUAN: I think it was a big thing a few years back because the government was pushing it. Environmental protection has become a big topic for the government and also for society. From my observations, China’s investors are, I would say, less environmentally aware than, say, European investors. Green issuers in China are more about a policy incentive or aligning themselves purely for the policy benefits. I don’t think at this point it’s a nationwide social awareness and conscience yet.

IFR ASIA: I wonder if industries that are actually getting government subsidies for being “green” are going to be better credit risks in the future.

TONY TANG, PENGYUAN: Not necessarily. The credit risks are about financial performance and the ability to compete in terms of business, which in turn translate into the issuer’s willingness and capacity to meet its financial obligations. It’s separate.

RICCO ZHANG, ICMA: Actually, from the investor side, I think being green does make a difference. The policy alignment is there. If you have two identical issues in the market, would you choose the green one or the not green one? I guess the answer is probably quite straightforward. We think the green market is going to continue growing.

IFR ASIA: Ladies and gentlemen, thank you very much for your time.