Published: August 01, 2011
by Travis Spence, Managing Director, Head of Global Liquidity Asia, J.P. Morgan Asset ManagementFollowing a decade of double-digit growth, China is now the world’s second largest economy and is considered by many to be the workshop of the world. The continuous growth of exports has given it the world’s largest trade surplus and also the largest foreign exchange reserves. However, until recently it was difficult for international investors to tap into this growth. The creation of the offshore CNY (known as CNH) and the subsequent growth of the CNH bond market - known colloquially as the dim sum bond market – fulfills this need. The opening of the dim sum bond market is potentially the most exciting development in the international bond markets since the creation of the Eurobond market in the 1980s. While challenges and pitfalls exist, not least regulatory opacity abound, the potential is huge.
From a long-term perspective, the offshore CNH market has just begun.
CNH Deposit: The CNH deposit market has been growing exponentially in Hong Kong. The outstanding CNH deposit has jumped over 500% in the last 12 months[1] since the regulations were loosened (from RMB 90bn in June 2010 to RMB 549bn in May 2011). The main drivers for the rapid growth are the RMB appreciation, as well as the Chinese government’s RMB liberalisation move.
CNH (Dim Sum) Bond Market: In June 2007, China Development Bank became the first offshore RMB issuer in Hong Kong, after PBoC allowed qualified domestic financial institutions to issue RMB bonds in the city. The dim sum bond market developed rapidly in 2010 in response to the growth in demand for CNH. Hopewell Highway Infrastructure (RMB1.38bn, 2yr, 2.98%) and McDonald’s (RMB200m, 3yr, 3%) became the first HK and foreign corporate names to issue CNH bonds in Hong Kong, in July and August 2010 respectively. Caterpillar followed in November with a RMB1bn, 2yr, 2.0% issue. We have since seen the issuer base expanding greatly in volume and credit rating. As at May 2011, total outstanding bonds amounted to CNY 110bn; over 50% was issued in 2011 alone (fig 2). The top three issuers are China Ministry of Finance, China Development Bank and China Import Export Bank.
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Disappointment that the CNY is not appreciating more rapidly
The growth of the deposit of RMB in the offshore market is mainly driven by the expectation of RMB appreciating between 3-5% as implied from the 12 month NDF forward rate. A lower appreciation rate would put pressure on the CNH bond. In June we saw the implied 12 month forward NDF appreciation slip down from 3% in April to 1.25% (fig 4). This is one of the main reasons we saw a weakening of the secondary CNH bond price in June.
Onshore and offshore yields for the same issuers are significantly lower for CNH – due to the demand driven market for CNH bonds. For example, the CNY 4 bn 2 year certificate of deposit issued by Bank of East Asia in July 2009 was at a coupon rate of 2.80, much higher than the 1.00 coupon paid by Bank of Communications Hong Kong issued on March 2011. With CNH bond yields becoming more expensive, to the point where time deposits are looking more attractive, investors will tire and switch.
On the other hand, offshore CNH deposit rates have been diverging from onshore RMB rates given that offshore demands are mainly driven by expectations of an appreciating RMB rather than just yield. A reversal of the trend where we start to see interest rates rising for CNH will negatively impact CNH bond prices in the secondary market.
Chinese regulators ultimately dictate the pace for market expansion. Change in the speed of expansion or tightening of the market, or opening of the investment quota from CNH to onshore bond markets in a larger scale could have significant impact given the difference between the onshore and offshore bond yields. The regulators however have been very cautious of this point and have been taking every precaution by taking baby steps and more pilot trials on the side to avoid any moves that would have significant impact on the market.
From a long-term perspective, the offshore CNH market has just begun. With the increasing internationalisation of the RMB, as a trade currency and investment denomination, there is little doubt that the offshore market will continue to deepen. In addition, the economics are attractive for issuers, especially when proceeds are allowed to be remitted back into China. However, in the short term, investor sentiment will continue to be driven by speculation of currency appreciation and investors should expect some volatility as the market develops.
Note
1 Data as of May 2011, Source:HKMA
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