22 October 2018
Now that the renminbi is part of the SDR basket, the internationalization of the Chinese currency is expected to gain momentum. Photo: Reuters
Now that the renminbi is part of the SDR basket, the internationalization of the Chinese currency is expected to gain momentum. Photo: Reuters

How China’s onshore and offshore bond markets can work together

China’s bond market could see rapid growth in the wake of the renminbi’s inclusion in the International Monetary Fund SDR (special drawing rights) basket.

Global companies including Daimler, HSBC, Bank of China and China Merchants Bank (Hong Kong) have issued so-called “panda bonds” this year, driving volumes to record levels.

China’s bond market is expected to top US$50 billion in the next five years, estimates by the International Finance Corp. show.

Panda bonds are yuan-denominated debt by non-Chinese issuers sold in China’s onshore market, similar to Japan’s samurai bond and yankee bond in the US.

In 2005, China allowed foreign institutions to issue panda bonds on the domestic market.

However, the issue size remains relatively small and issues are subject to strict regulations on application procedure and use of proceeds.

Until 2009, only the World Bank and the Asian Development Bank had sold four tranches of panda bonds worth a combined 4 billion yuan (US$617.5 million) at the time.

Apart from foreign financial institutions, foreign corporates and governments have also entered the Chinese bond market.

The Canadian province of British Columbia and South Korea are planning to issue 6 billion yuan and 3 billion yuan worth of panda bonds, respectively.

But some say the rapidly expanding onshore debt market might weigh on offshore bonds, known as dim sum bonds issued out of Hong Kong.

Will the two markets compete against each other in the future?

Both are denominated in yuan and are geared to different issuers, which presents a number of possibilities.

First, global issuers might favor the onshore market given the widening interest gap between onshore and offshore bonds amid continued monetary easing.

We have already seen a growing number of issuers switch to the mainland market.

For example, nearly 60 percent of property developers, which used to dominate the offshore dim sum bond market, have issued onshore debt this year.

Their combined offshore bond issuance slid to US$9.6 billion from US$24.8 billion last year.

Second, issuers are now allowed to move offshore yuan funds to the onshore market to repay debt after authorities eased regulations on remittances.

The rule change gave issuers more flexibility over the use and movement of capital.

Also, the government expanded the list of eligible issuers to foreign companies and financial institutions.

That means foreign subsidiaries of Chinese companies can issue panda bonds.

Third, foreign institutions and multinational companies account for more than 40 percent of the dim sum bond market.

Most of them are financial institutions or sovereign governments with high credit ratings.

Their entry has helped the development of the panda bond market which in turn could divert liquidity from the dim sum bond market.

Onshore and offshore bonds have a marked difference in the way they are traded and how they function, as well as which body regulates them.

Panda bonds operate under all kinds of restrictions while dim sum bonds have no requirement for listing and are more convenient.

The depositary system and other financial infrastructure are more developed.

More importantly, panda bonds mainly target mainland investors while dim sum bonds are open to foreign investors.

Global investors and major central banks might increase their yuan assets after the SDR move.

However, they might not participate in the panda bond market given capital controls and other restrictions.

By contrast, the dim sum bond market is quite similar to the European bond market in terms of regulation, taxation and legal framework.

Since the secondary market is much more liquid, it has attracted global institutions looking to diversify into yuan assets.

Nonetheless, the two markets can complement each other, instead of being competitors.

That means dim sum bonds should target foreign institutions and panda bonds should focus on onshore investors.

This article appeared in the Hong Kong Economic Journal on Dec. 23.

Translation by Julie Zhu

[Chinese version中文版]

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