Guide to RMB bond market
32
Guide to RMB bond market
Transcript of Guide to RMB bond market
Guide to RMB bond market
Important Risk Warning
1. Bonds are investment products. The investment decision is yours but you should not invest in bonds unless the intermediary who sells it to you has explained to you that the product is suitable for you having regard to your financial situation, investment experience and investment objectives.
2. Bonds are NOT equivalent to a time deposit.
3. Issuer’s Risk – you rely on the issuer’s creditworthiness. The bond is subject to both the actual and perceived measures of credit worthiness of the issuer. There is no assurance of protection against a default by the issuer in respect of its repayment obligations. In the worst case scenario (e.g. upon insolvency of issuer), you might not be able to recover the principal and any coupon if the issuer defaults on the bond.
Additional risks are disclosed in the section of “Risk Disclosure” below. Please refer to it for details.
Risk Disclosure
1. Investment involves risk. You should carefully consider whether any investment products or services mentioned herein are appropriate for you in view of your investment experience, objectives, financial resources and circumstances.
2. Bonds are mainly for medium to long term investment, not for short term speculation. You should be prepared to invest your funds in bonds for the full investment tenor. You could lose part or all of your investment if you choose to sell your bonds prior to maturity.
3. It is the issuer to pay interest and repay principal of bonds. If the issuer defaults, the holder of bonds may not be able to receive back the interest and principal. The holder of bonds bears the credit risk of the issuer and has no recourse to HSBC unless HSBC is the issuer itself.
4. Indicative bond prices are available and bond prices do fluctuate when market changes. Factors affecting market price of bonds include, and are not limited to, fluctuations in interest rates, credit spreads, and liquidity premiums. The fluctuation in yield generally has a greater effect on prices of longer tenor bonds. There is an inherent risk that losses may be incurred rather than profit made as a result of buying and selling bonds.
5. If you wish to sell the bonds purchased through HSBC, HSBC may repurchase them based on the prevailing market price under normal market circumstances, but the buying price may differ from the original selling price due to changes in market conditions.
6. There may be exchange rate risks if you choose to convert payments made on the bonds to your home currency.
7. The secondary market for bonds may not provide significant liquidity or may trade at prices based on the prevailing market conditions and may not be in line with the expectations of the bond holders.
8. If a bond is early redeemed, you may not be able to enjoy the same rates of return when you re-invest the funds in other investments
For Renminbi (RMB) products:
1. There may be exchange rate risks if you choose to convert RMB payments made on the bonds to your home currency.
2. RMB is currently not freely convertible and subject to regulatory restrictions (which might be changed from time to time). For personal customers who are Hong Kong residents, conversions conducted through RMB deposit accounts with banks in Hong Kong are subject to the limit of up to RMB20,000 per person per day. Personal customers who are Hong Kong residents should allow time for conversion of RMB from/to another currency of an amount exceeding the daily limit. Non-Hong Kong residents are not required to observe the corresponding limits and requirements regarding Renminbi conversions for Hong Kong residents.
3. RMB debt instruments are subject to interest rate fluctuations, which may adversely affect the return and performance of the RMB products.
4. RMB products may suffer significant losses in liquidating the underlying investments if such investments do not have an active secondary market and their prices have large bid/offer spreads.
5. You could lose part or all of your investment if you choose to sell your RMB bonds prior to maturity.
Prologue
Overview
1.1 Introduction to RMB bond market 41.2 Milestones of RMB bond market 6-71.3 Key differences between onshore and offshore RMB bond markets 8-91.4 How can retail investors access the market? 10-111.5 What is RQFII? What is an RQFII fund? 12-131.6 Are CNY and CNH two difference currencies? 15
Characteristics of onshore RMB bond market
2.1 Market composition 162.2 Duration 172.3 Yield 182.4 Credit quality 19
Characteristics of offshore RMB bond market
3.1 Market composition 20-213.2 Duration 223.3 Yield 233.4 Credit quality 24
Looking forward
4.1 Market view 25-264.2 Currency view 27-284.3 Outlook 29
Contents
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Source: 1. HSBC Global Asset Management, includes liquidity funds, as of 31 March 2014. 2. Asia Asset Management Best of Best Awards – Asian Bond House (2008, 2009, 2010, 2012 and 2013). Based on performance data as of 30 November 2008, 2009, 2010, 2012 and 2013
Fixed income capability of HSBC Global Asset Management
Leading position in Asia fixed income markets, with AUM at USD46.7 billion1
One of the first asset management companies in Hong Kong to launch an
offshore RMB bond fund in 2011
A highly recognised investment team who has been awarded “The Best Asian
Bond House” for 5 years2
PrologueOne of the most exciting developments in Asian fixed income has been the
development of the renminbi (RMB) bond market. RMB bonds of any type have only
been readily available to foreign investors in the past few years, but opening up the
China's bond market and internationalising the currency are among key priorities
within China’s reform agenda. The establishment of the offshore RMB bond market
was an important step towards driving this development.
Consequently, there has been an emergence of an onshore and an offshore RMB
bond market. While both markets are offering “RMB bonds”, the markets interestingly
have their own distinct features.
The growth of the RMB bond market has been impressive in recent years. As the
market may still be relatively new to investors, understanding the factors and risks
affecting the asset class is important.
This guide aims to provide an outline of the RMB bond market, highlighting
the key differences between the onshore and offshore markets and the
investment opportunities.
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Overview1.1 Introduction to RMB bond market
Onshore RMB bonds are traded exclusively within mainland China. The Chinese capital markets are still mainly closed to foreign investors (except with certain licences, which will be explained later), but the Chinese government has made it clear that an important part of economic and financial reform is to open up its capital account, which would mean foreign investors having easier access to onshore markets in the future.
Offshore RMB bonds are RMB bonds which are traded outside mainland China. As a step towards gradually opening up its markets to foreign investors, the Chinese government established the offshore RMB bond market in 2007, making further important moves in 2010 to make the market attractive to both international issuers and investors. The market is commonly referred to as the “Dim Sum” bond market as Hong Kong was the first place to offer offshore RMB bonds and remains by far the largest centre for RMB bonds. However, companies can now issue offshore RMB bonds in places outside of Hong Kong, with Singapore, London and Taiwan also being offshore RMB bond hubs.
Developments in the RMB bond market#
The onshore RMB bond market is one of the largest in the world and continues to grow at a rapid pace. Since 2000, the onshore bond market has seen phenomenal growth from above RMB1.3 trillion to over RMB29 trillion, it now stands at around 22 times its size just 14 years ago. The offshore RMB bond market has also seen substantial growth since its launch in 2010, however its size is just a fraction of the onshore market, at RMB692 billion.
Growth of onshore RMB bond market
06/97 04/98 02/99 12/99 10/00 08/01 06/02 04/03 02/04 12/04 10/05 08/06 06/07 04/08 02/09 12/09 10/10 08/11 06/12 04/13 02/14
35,000
Siz
e (R
MB
bill
ions
)
30,000
25,000
20,000
15,000
10,000
5,000
0
RMB29 trillion(31 March 2014)
Source: Asian Bonds Online, data as of 31 March 2014# Source: HSBC, data as of 31 March 2014
4
Low Res5
1.2 Milestones of RMB bond market
Onshore RMB bond market
Offshore RMB bond market
ICBC Bank was the first to issue a financial bond, of RMB500 million for loans of special purposes
Interbank bond market established
Introduced QFII, allowing foreign institutional investors to buy and sell A-shares in Shanghai and Shenzhen stock exchange for the first time
PBOC allowed some strategic foreign institutional investors with QFII to have direct access to interbank bond market
• RQFII was introduced, but 80% of quota must invest in fixed income and no more than 20% in China A-shares
• Only Hong Kong subsidiaries of Chinese fund management companies and securities companies were permitted to apply
• RQFII regulations relaxed to allow more institutions to apply for the licence, while investment restrictions are removed
• PBOC allows QFII licence holder to access the interbank bond market
• NDRC promulgated measures that allowing onshore financial institutions to issue RMB bonds in Hong Kong
• The first offshore RMB bond was issued in Hong Kong in July 2007 by China Development Bank
• The Chinese government authorised a second group of issuers to issue offshore RMB bonds, including foreign financial institutions incorporated in mainland China, such as HSBC (China)
• The Chinese Ministry of Finance issued the first sovereign dim sum bond
• Issuer’s eligibility expanded from mainland financial institutions to include multi-national corporations and international financial institutions
• The first corporate offshore RMB bond was issued
• Mainland corporates can issue RMB bonds in Hong Kong
• Formalisation of RMB Foreign Direct Investment (FDI)
NDRC formalized the rules for Mainland non-financial institutions to issue offshore RMB bonds
2013201220112010200920072005200219971985
QFII: Qualified Foreign Institutional InvestorRQFII: Renminbi Qualified Foreign Institutional Investor
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Onshore RMB bond market
Offshore RMB bond market
ICBC Bank was the first to issue a financial bond, of RMB500 million for loans of special purposes
Interbank bond market established
Introduced QFII, allowing foreign institutional investors to buy and sell A-shares in Shanghai and Shenzhen stock exchange for the first time
PBOC allowed some strategic foreign institutional investors with QFII to have direct access to interbank bond market
• RQFII was introduced, but 80% of quota must invest in fixed income and no more than 20% in China A-shares
• Only Hong Kong subsidiaries of Chinese fund management companies and securities companies were permitted to apply
• RQFII regulations relaxed to allow more institutions to apply for the licence, while investment restrictions are removed
• PBOC allows QFII licence holder to access the interbank bond market
• NDRC promulgated measures that allowing onshore financial institutions to issue RMB bonds in Hong Kong
• The first offshore RMB bond was issued in Hong Kong in July 2007 by China Development Bank
• The Chinese government authorised a second group of issuers to issue offshore RMB bonds, including foreign financial institutions incorporated in mainland China, such as HSBC (China)
• The Chinese Ministry of Finance issued the first sovereign dim sum bond
• Issuer’s eligibility expanded from mainland financial institutions to include multi-national corporations and international financial institutions
• The first corporate offshore RMB bond was issued
• Mainland corporates can issue RMB bonds in Hong Kong
• Formalisation of RMB Foreign Direct Investment (FDI)
NDRC formalized the rules for Mainland non-financial institutions to issue offshore RMB bonds
2013201220112010200920072005200219971985
PBOC: People’s Bank of China (the central bank of China) NDRC: National Development and Reform Commission
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1.3 Key differences between the onshore and offshore RMB bond markets
While both the onshore and offshore markets are offering “RMB bonds”, the two actually have very distinct characteristics. Details on their distinguishing features are further explained in Chapter 2 and 3.
Characteristics summary of onshore and offshore RMB bond markets
Onshore Offshore
Where are the bonds traded?
Mainland China Hong Kong, Singapore, London and Taiwan
Market size around RMB29,000 billion over RMB700 billion
Eligible investors Onshore institutional investors Offshore institutions must
invest through– QFII and RQFII quota– Special quota for foreign central
banks, monetary authorities, clearing & participating banks, insurers
Retail and institutional investors
Fund managers, private banks, commercial banks, insurance companies, corporate and central banks are all active investors
No quota restriction
Issuer composition Mainly China China, Hong Kong: ~78%Overseas corporates: ~22%
Issuer Mainly Chinese Government, PBOC, policy banks and financial institutions
Corporates and enterprises as well
Mainly private corporates
Source: HSBC, Asian Bonds Online, data as of 30 April 2014
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1.3 Key differences between the onshore and offshore RMB bond markets
While both the onshore and offshore markets are offering “RMB bonds”, the two actually have very distinct characteristics. Details on their distinguishing features are further explained in Chapter 2 and 3.
Characteristics summary of onshore and offshore RMB bond markets
Onshore Offshore
Duration Typically longer, at around 5-6 years
Typically shorter, at around 2-3 years
Yield 5-year onshore government bond yields is 104 basis points higher than the equivalent offshore yield
Rating agencies Local rating agencies, e.g. Chengxin, Dagong, Pengyuan, etc.
International rating agencies, e.g. Moody’s, Fitch and S&P
Benefits Vast investment opportunities due to the market size
Higher potential yield than offshore market
Easier to access by international investors
Lower interest rate sensitivity due to the shorter duration
Risks Higher interest rate risk Greater geographic
concentration risk Risk of regulatory changes
relating to required licences
Lower liquidity due to smaller market size
CNH rate may be at a premium or discount to CNY rate
Source: HSBC, Asian Bonds Online, data as of 30 April 2014
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1.4 How can retail investors access these markets?
Offshore RMB bonds are theoretically available to all foreign investors through Hong Kong, Singapore, London and Taiwan, so retail investors can more easily and readily invest in offshore RMB bonds either directly or through a fund structure. But there are now ways allowing retail investors to have access to onshore RMB bonds through mutual funds.
Ways to access the offshore RMB bond market
Pros Cons
Offshore RMB bonds (Direct investment)
Flexibility in choosing different bonds
Fixed maturity Fixed coupon payments
Large minimum investment requirement
Very high credit risk concentration
Lower liquidity
Offshore RMB bond funds (Pooled investments managed by a fund manager)
Low minimum investment requirement
Diversified portfolio Daily liquidity Active management for
risk-adjusted returns by professionals
Individual investors have no flexibility in choosing the fund’s underlying investments
Incurs management fees
RMB bond ETF (Passively managed investment funds tracking an index)
Low minimum investment requirement
Diversified portfolio (depending on the benchmark index it tracks)
Lower management fees
May trade at a price above or below the fund’s net asset value (i.e. trade at a premium or discount) on the stock exchange
Passive management with no discretion to choose underlying investments
Difficult to track underlying market performance cheaply, given that the offshore RMB bond market is relatively illiquid
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The onshore capital markets (including both equities and bonds) are only accessible by foreign investors with certain licences. Certain eligible institutions can apply for a QFII (“Qualified Foreign Institutional Investor”) or RQFII (“Renminbi Qualified Foreign Institutional Investor”) licence through the China Securities Regulatory Commission (CSRC) and then a specific quota (investment amount) will be granted to the institution by the State Administration of Foreign Exchange (SAFE) in China. Retail investors can access the onshore RMB bond market through such institutions with QFII or RQFII licences and quotas.
Ways to access the onshore RMB bond market
Pros Cons
RQFII funds (Managed by a fund manager with RQFII licence and quota to access the onshore capital markets)
Direct exposure to RMB as the ability to denominate and settle in RMB
Low minimum investment requirement
Diversified portfolio Daily liquidity Active management Regular income potential
from dividend payouts
Risk of regulatory changes relating to required licences
Incurs management fees
QFII funds(Managed by a fund manager with QFII licence and quota to access the onshore capital markets)
Low minimum investment requirement
Diversified portfolio Active management
Most QFII funds focus on investing in equities
Incurs management fees Lower liquidity (depends on
fund)
RQFII bond ETF(Passively managed by a fund manager with RQFII licence and quota. They are listed on the Hong Kong exchange and track an underlying benchmark)
Low minimum investment requirement
Diversified portfolio (depending on the benchmark index it tracks)
May trade at a price above or below the fund’s net asset value on the stock exchange
Passive management with no discretion to choose underlying investments
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1.5 What is RQFII? What is an RQFII fund?
RQFII (Renminbi Qualified Foreign Institutional Investor)
Established since 2011
Denominated and settled in RMB
Can invest 100% in bond market
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RQFII is a scheme that allows foreign institutional investors to channel funds from abroad
to invest in mainland China. Established towards the end of 2011, the RQFII scheme is
relatively new. Like the QFII scheme, it is intended for institutional investors and retail
investors may access it through mutual funds.
The RQFII scheme differs from the initial QFII scheme in that it is funded in RMB, while
the QFII scheme is funded in a foreign currency. Furthremore, the RQFII quota allows
an institution to invest as much as 100% into onshore RMB bonds, while most QFII
schemes currently focus on investing in equities.
Investment managers registered in Hong Kong, who have obtained an RQFII licence from
Chinese regulators, are able to create RQFII funds for investors. The scheme is being
expanded to allow managers from other countries such as UK, Singapore and Taiwan to
participate and this should lead to greater investment choice and more funds launched
to allow investors across the world access to the onshore RMB bond market. RQFII can
also invest in other asset classes such as ETFs and equities.
An RQFII fund is simply a fund which invests its clients’ money into the onshore markets
through the RQFII quota. The RQFII licence has now been developed with flexibility for
the fund manager to invest up to 100% of the quota into bond markets or the China
A-shares market.
RQFII fund
Retail investors invest in RQFII fund
Onshore markets (bond/equity)
Fund manager obtains RQFII licence and quota from Chinese regulators
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1.6 Are CNY and CNH two different currencies?
Alongside the distinction between onshore and offshore RMB bond markets, there is
also a distinction between the Chinese currency traded onshore and offshore. “CNY”
and “CNH” have no official status, but is market convention to refer to the onshore
and offshore RMB respectively. As the currency operates in two different markets, it
trades at slightly different exchange rates in each market.
As the financial borders between China and the rest of the world come down,
more participants can operate in both markets and aibirage is increasingly possible.
Therefore, the onshore and offshore rates now trade very closely together.
Eventfully, as the currency internationalises, the distinction between the CNY and
CNH will disappear.
Onshore and offshore RMB exchange rates
31/12/201331/12/201231/12/2011
6.7
6.6
6.5
6.4
6.3
6.2
6.1
6.0
5.9
5.8
5.7
CNH CNY
31/12/2010
Source: Bloomberg, data as of 30 April 2014
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Characteristics of onshore RMB bond market
2.1 Market composition
The onshore RMB bond market is dominated by central government bonds, PBOC
bills and financial bonds, which amount to 65% of outstanding issues, as of end
March 2014. However, the market is becoming well-diversified and balanced, as the
share of corporate bonds has been rapidly increasing in recent years. The importance
of corporate bonds should continue to grow, as bank disintermediation becomes a key
goal for authorities.
There are six major types of fixed income instruments traded in the market:
1. Central government bond 2. People’s Bank of China (PBOC) bill
3. Financial bond 4. Enterprise or corporate bond
5. Medium term note 6. Commercial paper
Source: Chinabond, WIND, data as of 31 March 2014
Do you know? Financial bonds are bonds issued by policy banks or financial institutions. There are three
policy banks in China: China Development Bank, Agricultural Development Bank of China and Export-Import Bank of China
Enterprise or corporate bonds, medium term notes and commercial papers are bonds issued by non-financial enterprises, including state-owned enterprises (SOEs). The bonds
differ in their issuance procedures and years to maturity
Central government bond 28%
PBOC bill 2%
Financial bond 35%
Enterprise & corporate bond 10%
Medium Term Note (MTN) 10%
Commercial paper 5%
Others 10%
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2.2 Duration
The onshore RMB bond market has duration (a standard measure of interest rate
sensitivity) of 5.45 years, as of end March 2014. The market’s duration is not short,
and this can be attributed to the fact that a large portion of the market is made up of
government bonds, which tend to have longer tenors.
As we can see in the chart below, as of end March 2014, 10% of the bonds issued
have a maturity of over 10 years and around 36% have a maturity of over 5 years.
Breakdown of issuance maturity
0-1 year 15%
1-3 years 26%
3-5 years 23%
5-7 years 14%
7-10 years 12%
more than 10 years 10%
Source: Chinabond, WIND, data as of 31 March 2014
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2.3 Yield
Generally, the onshore RMB bond market offers higher yields than the offshore RMB
bond market, with the average yield at 4.45%, as of end March 2014. However,
the average yield cannot fairly be compared to the offshore market’s average yields
given the difference in market composition and bond types. If we take the 5-year
government bond yields, the onshore market is offering 104 basis points more than
the offshore market is, as of end April 2014.
Offshore vs. onshore central government bonds
04/11 07/11 10/11 01/12 04/12 07/12 10/12 01/13 04/13 07/13 10/13 01/14 04/14
5.0
4.0
3.0
2.0
1.0
0.0
Onshore 5YSpread Offshore 5Y
Yield (%)
Source: HSBC, data as of 30 April 2014
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2.4 Credit quality
The Chinese government has a sovereign credit rating of AA- (S&P) or Aa3 (Moody’s)
which is considered as a “high” investment grade quality and hence has a very low
credit risk (probability of default).
Other bonds in the onshore market tend to be rated by Chinese local credit rating
agencies, which may have different standard to those of international credit rating
agencies. Therefore, it is difficult to make a direct general comparison of credit quality
in the onshore and offshore RMB bond market.
Chinese local rating
Sovereignrating
AAA
AAA
AA+
AA
AA-
A+
A-
A
BBB+
BBB
BBB-
BB+
BB
BB-
B+
B
B-
CCC
AA+
AA
AA-
A+ andbelow
International rating (S&P)
The table is provided for discussion purposes only. There is no official mapping to convert local rating into international rating. The rating criteria and methodology used by Chinese local rating agencies may differ from those adopted by established international credit rating agencies. Therefore, the Chinese local credit rating system may not provide an equivalent standard for comparison with securities rated by international credit rating agencies.
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Characteristics of offshore RMB bond market
3.1 Market composition
The offshore RMB bond market is composed primarily of corporate bonds. Unlike
the onshore RMB bond market, government bonds only make up 9% of the overall
market.
The large certificates of deposits (CDs) market is also considered to be part of the
RMB bond market, and in fact makes up the largest portion, amounting to 50% of the
market, as of end April 2014.
Breakdown of the market (including CDs)
China Financial 9%
Foreign Financial 6%
Greater China Corporation20%
Foreign Corporation 5%
Sovereign 9%Supra-national 1%
CD 50%
Source: HSBC, Bloomberg, data as of 30 April 2014
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Source: HSBC, Bloomberg, data as of 30 April 2014
Although investors may naturally relate RMB bonds to China, the offshore RMB bond
market is geographically diversified, with a significant representation from foreign
issuers. If we look at the market excluding CDs, foreign companies make up 22% of
the outstanding issues.
Breakdown of the market (excluding CDs)
China corporation (SOE) 38%
High yieldforeign corporation 2%
China corporation (private) 19%
Investment gradeforeign corporation 20%
Sovereign 19%
Supra-national 2%
Do you know?
Certificates of Deposits (CDs) are tradable deposits issued by financial institutions (mainly large banks). They are the senior unsecured obligations of the issuing entity and have maturities under three years, although most tend to be issued for one year or
less. They are the standard short term funding vehicle for large banks and trade actively in the secondary market
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3.2 Duration
The offshore RMB bond market has relatively short duration of 2.65 years, as of end
March 2014, which means that investors are less sensitive to interest rate rises.
CDs have a very short maturity and duration and its 50% portion in the market helps
explain the extremely short duration in the overall offshore market. In fact, 58% bonds
in the market have less than one year until its maturity.
Breakdown by remaining tenor (including CDs)
less than 1 year 58%
3-4 years 3%
1-2 years 17%
2-3 years 14%
4-5 years 4%
more than 5 years 4%
Source: HSBC, Bloomberg and data as of 30 April 2014
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3.3 Yield
The average yield of the offshore RMB bond market is 4.36%, as of end March 2014.
On a duration-adjusted basis, yields offered in the offshore RMB bond market are very
attractive compared with other major global credit groups. The yield per duration ratio
of offshore RMB bonds stands at 1.6, while it stands at 0.95 for Asia and 0.4 for US
and European credit.
Historical yield (duration adjusted)
12/31 04/30 08/31 12/31 04/30 08/31 12/31 04/30 08/31 12/31
2
1
0
HSBC Asian Dollar Bond Index Yield HSBC Offshore RMB Bond Index Yield
Source: HSBC, Bloomberg, data as of 31 March 2014
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3.4 Credit quality
Credit quality of offshore RMB bonds in general is strong, thanks in part to the
market’s composition. The rating structure of the market has been stable with high
grade dominating the space. HSBC Global Research estimated that 88% of the
securities (including those un-rated bonds which are being considered of having
investment grade quality and unrated certificate of deposit) in the market are of
investment grade quality.
Plus, the banks which issue CDs in the offshore market tend to be the very
large Chinese or global banks which have high credit ratings. Hence, the large
representation of CDs also helps explain the market’s strong overall credit quality.
Breakdown by credit rating
BBB 4%
UnratedHigh Yields 7%
Unrated Centificateof Deposits 47%
UnratedInvestment Grade 10%
A 12%
AA 13%
AAA 2%B 2%
BB 2%
Source: HSBC Global Research Internal Estimate, Bloomberg, data as of 30 April 2014
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Looking forward
4.1 Market view
While the onshore and offshore RMB bond markets have numerous distinguishing
features at present, it is important not to think of them as segregated markets which
will evolve separately and remain distinct over time. The differentiation between
the two markets in this guide was for the purpose of describing their distinct
characteristics. However, the raison d’etre of the offshore market is to prepare the
ground for the eventual opening of the Chinese bond market as a whole, and we see
the two markets to be similar in the sense that they are both important parts of the
modernisation of the Chinese financial system.
Both the onshore and offshore RMB bond markets have seen rapid growth and
development in recent years and there continues to be a host of reason to believe the
continuance of this trend. As the Chinese government pushes ahead to accelerate
reform efforts, key goals which are often emphasised are opening up the capital
markets and internationalising the currency. In relation to these two goals, we will
inevitably see an increase in the usage of RMB worldwide, and the development of
the bond market is an important step to facilitate this growth.
Both supply and demand factors are at play here, and we list some of the factors
pushing ahead the RMB bond market development.
Supply will increase because...
Bank disintermediation: traditional bank lending has dominated the Chinese
economy for a very long time, but as this comes to an end, companies will start to
obtain funding through capital markets by issuing bonds
Foreign funding sources: as the Chinese bond market becomes more
sophisticated, we will see foreign companies coming in, using China’s bond
market as a channel for raising funds
Global need to borrow in RMB: the increasing use of the RMB worldwide, for
trade settlement, for example, means that the need to borrow in RMB will arise25
Demand will increase because...
Longer duration assets are needed to hedge liabilities: the development of
China’s pension markets, social security funds and insurance products, will give
rise for the need of long duration assets, mainly bonds
Central banks want RMB for reserve assets: central banks will have increasing
appetite for the RMB, in order to diversify their assets. Bonds are one of the only
investable assets which have sufficient liquidity to meet these demands
Discretionary demand for RMB income: we are likely to see an increase in global
investors’ appetite for RMB assets, as the market opens up
In early 2014, the onshore RMB bond market saw its first corporate bond default
in its recent history (since 1995), sparking investors’ concerns, partly because this
indicated that more defaults may be on their way, but also because the market
has been accustomed to thinking that the government has provided an implicit
guarantee on investment products. On the contrary, we believe this signals a shift
in the government’s stance and a move to remove these unrealistic expectations of
implicit guarantee. This is in fact evidence of the government’s determination towards
developing the bond market; allowing companies to default will promote better pricing
of credit risk and the development of a more sophisticated bond market.
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4.2 Currency view
The RMB is an integral piece of the overall Chinese bond market. Its strong
appreciation against the US dollar since 2005 and the expectation that this trend will
continue, have likely been key to driving investor demand for RMB bonds. However,
when the currency saw a sharper-than-usual depreciation against the US dollar in early
2014, the one-way appreciation bet no longer had its “certainty”.
As China continues with reform efforts, including opening its capital markets and
internationalising the currency, increased two-way volatility in the RMB can be
expected. This is especially the case as we have seen the PBOC widen the currency
trading band further from 1% to 2% early in 2014. The RMB (against the US dollar)
is still much less volatile than other major currencies though. Despite heightened
volatility in the currency, we believe that a number of factors are still supportive of a
continuance in its gradually appreciating trend over the medium term.
Do you know?
The PBOC fixes a daily rate for the currency. The currency trading band is the band within which the currency rate can deviate from the central fixing
27
Macroeconomic factors supportive of RMB
Low external debt
Heavy external debt burden tends to exacerbate currency depreciation pressures as depreciation leads to an automatic increase in the size of the external debt obligation
China’s external debt (money owed in foreign currency) is low compared to its historical levels, Asia and the rest of the world
Healthy current account surplus China’s healthy current account surplus
means that demand for RMB for trade purposes will remain intact and provide support to the currency
On the other hand, US is running a current account deficit
Interest rate differential Interest rates in China are higher than its western
counterparts This gives it room to appreciate against
currencies like the US dollar We see this differential to persist in the near
term, even if the PBOC starts to adopt a monetary policy easing bias
Currency depreciation an unlikelypolicy tool
Given its strong appreciation since 2005, a small margin of depreciation will not do much to boost competitiveness
China has many other policy options to support growth and currency depreciation would probably only be a last resort
Large FX reserves China has the world’s large foreign exchange
reserves, of close to USD4 trillion These are assets the PBOC can use to
purchase its own currency and consequently support its value if needed
Apart from supportive macroeconomic fundamentals, we also believe that global
demand for the currency will remain robust. The Chinese authorities have started to
allow an increasing amount of the currency to be used offshore for various purposes
including trade settlement and investment in an offshore bond market. We believe
that the ultimate goal is to make the currency fully convertible. At that point, the RMB
is likely to become a major global trading, investment and reserve currency. However,
this is likely to be a medium to long term process.
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4.3 Outlook
As mentioned earlier, it is important not to think of the onshore and offshore RMB bond
markets as segregated markets which will evolve separately and remain very distinct.
Ultimately, the birth of the offshore market is to facilitate the eventual opening up
of the Chinese bond market as a whole and the two markets’ characteristics may
begin to converge.
Meanwhile, we believe that it will continue to suit certain issuers to issue in the
onshore market and others to issue offshore. Thus, the eventual destination may be
something like the USD bond markets, where we have a domestic and a Eurodollar
market. Global investors will make little distinction between the two, and benchmarks
will cover both markets for the widest opportunity set.
The important thing for global investors to remember is that investing in RMB bonds
will not be a discretionary option for very much longer. RMB bond market is already
amongst the largest in the world and will become one of the most important asset
classes in the world when they are all fully available to foreign investors. The risk is
not whether this is expected to happen or that it will happen too slowly, the risk is that
it will happen even more quickly than expected and investors need to be ready.
Another important thing for investors is that the potential risks of investing
in the market:
Onshore RMB bond market
Higher interest rate risk
Greater geographic concentration
Risk of regulatory changes relating to required licences
Offshore RMB bond market
Lower liquidity due to smaller market size
CNH rate may be at a premium or discount to CNY rate
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Investment involves risk and past performance is not indicative of future performance.
The document is prepared for general information purposes only. All views expressed cannot be construed as an offer or recommendation by HSBC Global Asset Management (Hong Kong) Limited (“AMHK”). AMHK and HSBC Group shall not be held liable for damages arising out of any person’s reliance upon this information. Any person considering an investment should seek independent advice on the suitability or otherwise of the particular investment.
Issued by HSBC Global Asset Management (Hong Kong) Limited in mid July 2014
www.assetmanagement.hsbc.com/hk
