China’s dominance in Asian bonds

China’s dominance in Asia ex-Japan’s dollar bond market has grown from one of supply to demand. Since this year, Chinese borrowers have printed $134 billion notes, contributing to roughly 60% of the Asia ex-Japan market, up from about 40% for the whole of 2013.

While this increase in terms of volume from Chinese borrowers has been a theme for several years now, what has changed in the last year and a half is the burgeoning Chinese demand.

Chinese buyers themselves now take up a vast majority of dollar bonds sold in the region. Gone are the days when the markets anticipated a lull during the month of August because European investors were on their summer vacation.

This command over the Asian bond markets is unlikely to disappear as Chinese companies look abroad to expand. Additionally, the Belt and Road Initiative tied to some $900 billion worth of projects, will require more to be raised via the bond markets.

When Moody’s cut China’s rating by one notch to A1 in May this year, the nation’s first downgrade since 1999 fuelled concerns of spiralling debt levels. Yet this move hardly made a dent on bond volumes as China sold its first US dollar sovereign bond since 2004. The $2 billion bond split into a five-year and a 10-year received an overwhelming response from the market with both tranches being 11 times oversubscribed. Standard Chartered, acting as a joint book runner, helped both pieces tighten significantly to price the five-year tranche at T+15bps and the 10-year at T+25bps. This is one of the tightest spreads among Asian sovereigns and even tighter than some AAA-rated governments. 

Companies also have not shied away from the market after the sovereign rating downgrade as Beijing Infrastructure Investment sold a $700 million three-year bond at a price of T+125bps in September. The deal achieved the tightest spread ever for a local government financing vehicle and the biggest single tranche sold to a borrower of that type.

Currency is one of the big factors behind a company’s decision to fund offshore or onshore. Renminbi depreciation was a hot topic last year, making Chinese companies think twice about increasing their dollar debt. But this is not the case anymore as China is benefitting from a weak dollar, ending three years of renminbi depreciation. China’s currency has risen almost 5% since the start of the year.

Regulations also play a big role in Chinese companies’ funding methods. The National Development and Reform Commission needs to approve any overseas debt issuance and this can often turn into a waiting game for companies. And while the State Administration of Foreign Exchange relaxed the rules regarding repatriating funds in January this year, certain questions surrounding approval procedures still prevail.

For investors, the country’s gradual opening of the world’s third largest bond market has been welcomed with open arms. Trading on the China-Hong Kong bond connect started in July 2017 and saw Standard Chartered’s imperative role in introducing the market to its clients and holding market briefings. Agricultural Development Bank of China, with Standard Chartered acting as a joint global coordinator and special underwriter, became the first issuer to raise funds through Bond Connect. The lender sold a one, three and five-year onshore bond for a total size of RMB16 billion in July. 

Bond Connect is now the fourth route that overseas investors can seek to gain entry into Chinese bonds after the Qualified Foreign Institutional Investor (QFII); renminbi QFII and the China interbank market direct schemes.

Increased ease through Bond Connect is also boosting attraction to issuers of Panda debt, which are renminbi-denominated debt securities issued on the domestic market by non-domestic entities. The allure for mainland investors is to be able to take foreign credit risk without the currency exposure. Standard Chartered was also involved in Hungary’s RMB1 billion Panda bond in July, the first sovereign renminbi deal via Bond Connect. Now Portugal, the Philippines and Belarus are reported to be among the next sovereign issuers poised to tap the market.

A panellist from a recently conducted Euromoney conference mentioned that one issue about buying debt onshore is the operational risks due to the number of channels involved. Instead of four different channels, investors say a simpler system and access to the repo market are needed. Typically, bond structures tend to be better onshore, whereby the notes are directly issued by the Holdco or Opco and are often closer to the assets. However, this is offset by much weaker covenants. Liquidity is also not easily accessible, as investors in China use different trading systems from those offshore and have a tendency to hold for maturity.

Taxation is also an area that is clouded with uncertainty. With the Stock Connect currently temporarily exempted from withholding tax, QFII and RQFII investors are not sure whether to continue accruing for withholding tax, or to prepare to unwind previous accruals.

Investors also have to take heed as different credit cultures and lending patterns in China often produce a very different rating system compared to international credit agencies. Size and net worth are two of the most important aspects for an onshore debt score. And with limited bankruptcy cases, Chinese investors tend to pay less attention to covenants. Meanwhile, for international agencies, refinancing risks and subordination play a big part in their assessments.

There can be no doubt that China’s onshore bond market has grown by leaps and bounds in the past few years. And with China’s GDP forecast being revised upwards to 6.7% from 6.5% this year by the Asian Development Bank amid higher demand for Chinese goods, this strong macroeconomic story acts as a brilliant background for companies and investors alike.

China’s first sovereign dollar bond issuance in more than a decade drew around 300 investors in each tranche, with around 50% of the investors from outside Asia. The tight spread, size of the order book and widespread interest from international investors confirms the success of this transaction and will help set up a much tighter pricing benchmark for Chinese issuers especially state-owned enterprises or others rated similar to the sovereign.

What is definitely clear through all the steps China has made through the years is the country’s desire to develop and deepen China’s bond footprint within its borders and internationally. Standard Chartered seeks to play a key role in making sure their clients are a part of this development.