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In all the investor conferences and investment seminars that I have attended over the last six months, there has been one topic that has been talked about with relentless enthusiasm by one and all – the offshore renminbi (RMB) bond market (also known as the dim sum bond market).In fact at an investment seminar organised by a large US bank in Singapore recently, the talk on CNH (offshore RMB) bond market was so well attended that the room felt short of space and the organisers fell short of chairs. Consequently over 50 per cent of the audience jostled against each other and stood for the entire duration of the 40 minute talk.
But I didn’t hear even a single person whine about it. That is a testament to the level of interest China and more specifically the offshore RMB market has been generating among asset managers, banks, companies and investors.
The ‘Chinese Internationalization story’ has been the new macro theme after the ‘India private domestic consumption story’ and ‘Explosively growing Asia story’ that is being touted by fund managers on their fundraising trips. The dim sum bonds have suddenly given them a new product to market to their clients.
The ‘Exposure to the appreciating RMB and high growth Chinese companies at the same time’ rhetoric is music to ears of investors in the West who are aggressively increasing their allocation to Asia. It is no wonder then that the offshore RMB bonds (along with RMB-denominated PE funds) are being watched very closely by everybody who has even a dollar to invest.
Many blue chip non-Chinese companies have also tapped this market with Volkswagen slated to be the latest entrant. Some of the others are:
However while this market holds tremendous potential, some key issues have been blindsided by its rapid growth trajectory.
Development of a parallel synthetic offshore RMB bond market: The dim sum market has been accompanied by the development of the synthetic offshore RMB bond market which refers to the RMB-denominated but US dollar settled bonds. Consequently this format has been able to attract a much wider pool of investors (with deeper pockets) enabling issuers to raise large amounts of debt as compared to those in dim sum bond market.
Obtaining Chinese regulatory approval to repatriate offshore RMB: Only about 12-13% of the offshore RMB bonds (as a percentage of the total bonds outstanding) are corporate bonds. This is despite the fact that CNH bond market is more attractive to potential issuers as its yields are considerably tighter than the onshore market. However firms find it difficult to repatriate funds (unlike in synthetic offshore RMB bond market) and understandably are a bit reluctant to come to this market. Getting Chinese regulatory approval to bring offshore RMB back onshore is cumbersome, fraught with uncertainty and poses the biggest roadblock to borrowers till date. A streamlined procedure would attract more international companies to tap the CNH market.
Lack of liquidity in the offshore RMB bond market: As a result of the above mentioned point, there is a ‘chicken and an egg’ problem. The current supply of bonds is only about a quarter of the total RMB deposit base of in Hong Kong and see strong demand mainly from banks (which have large RMB deposits) and private wealth clients. Both of these don’t actively look to trade the bonds (which are already in less supply) and consequently there is lack of liquidity in the market. This discourages hedge funds (which have liquid strategies) from becoming active players in the market thereby preventing the liquidity situation from improving.
Volatility of CNH: The CNH has traded at a premium over the CNY (onshore RMB) for the better part of the last few months. Consequently an investor who is long CNH may incur losses if it moves at a different pace from the CNY. Freeing up cross border flow of RMB capital shall go a long way in addressing this problem.
Lack of liquidity in USD/CNH trades: The trading volume for USD/CNH has been growing at a steady pace but is still less than fifteen per cent of the daily USD/CNY volume. The inflow of tourists in Hong Kong who would spend CNH is expected to increase liquidity but that may take time and/or may not be enough.
Lack of sufficiently developed swap market: Recently the Monetary Authority of Singapore (MAS) became the latest of the eight foreign central banks to receive a CNY swap line from the People’s Bank of china (PBoC). Going forward Singapore is widely expected to emerge as an alternate offshore RMB centre along with Hong Kong. However for trading volumes to go up, China will need to increase the number of swap lines with other central banks.
Lack of a proper benchmark: The dim sum bond market lacks a proper benchmark rate as a reference point for floating-rate bonds unlike the HIBOR (for Hong Kong dollar-denominated floating-rate bonds) or SHIBOR (for dollar-denominated floating-rate bonds in mainland China).
The offshore CNH bond market is one of the initiatives China is deploying to internationalize the RMB. Another one is the RMB-denominated PE funds that are being launched thick and fast. The next one will probably be RMB-denominated shares listed on the Hong Kong stock exchange. China is largely expected to push hard for the RMB to be included in the Special Drawing Right (SDR) when it comes up for review for currency composition in 2015.
If they are successful, it shall be a major step towards the RMB becoming the world’s reserve currency in the next decade. Hence, we can reasonably expect China to address all the above mentioned issues sooner than later and to its credit the policy makers have been up to the task. China is the first country in the world that has attempted to open up an offshore market before developing its onshore market and that is not something that has gone unnoticed by the investors.
(Tanuj Khosla is currently working as a Research Analyst at 3 Degrees Asset Management, a fund management firm in Singapore. He can be followed on Twitter @Tanuj_Khosla. Alternatively he can be reached at [email protected] Views expressed are personal.)