In Hong Kong, renminbi bonds are never likely to generate the same kind of feverish excitement among local investors as equity IPOs, demand for which is now surpassing the levels seen at the height of dotcom mania in Hong Kong.
The early rush for new issues in the RMB bond market saw a transaction such as the deal for China Development Bank (CDB), last November, covered 17 times. Thats not bad. But it pales into insignificance compared with the record-breaking oversubscription level of 2,179 times achieved by Milan Station in May.
There are plenty of obvious reasons why RMB bonds can scarcely hope to compete with hot IPOs for the attention of the investing public in Hong Kong. Yields and currency appreciation may be dependable enough for RMB fixed income investors, but they are a pin-prick compared to the get-rich-quick returns that some IPOs have offered. And while IPOs are offered to the public in the form of double-page advertisements in the English and Chinese language press, marketing of new RMB bond issues is generally much lower key.
Demand for RMB bonds, however, comfortably exceeds supply, both at a primary and secondary level. "Up to now, issuance sizes have been fairly small, and demand has been such that bonds have tended to rally massively on the break but dont trade very much in the secondary market," says Daniel Mamadou, co-head of capital markets and treasury solutions at Deutsche Bank in Hong Kong. That, say bankers, has ensured that for many of the higher grade issues, there has been very little activity on the offer side, driving secondary market prices higher.
Underpinning this demand has been the explosive growth in RMB retail and corporate deposits at Hong Kong banks over the last year. Counting those deposits is not easy, with official figures for the deposit base apparently out of date within days of being released.
According to figures published by Standard Chartered Bank, these deposits grew by a compound annual growth rate (CAGR) of 31.5% between 2004 and 2010. It is since the start of 2010, however, that this deposit base has exploded, rising from a little over Rmb50bn in January 2010 to Rmb451bn at the end of March 2011.
With few outlets available for this cash mountain paying anything other than miserly deposit rates, much has found its way into the offshore RMB bond market. According to a recent Morgan Stanley update, "contrary to popular perception, CNH bond demand comes not mainly from retail investors but is instead driven by banks needs to deploy deposits and funds, enabling broader RMB exposure. Excess demand remains a key feature."
Much of this demand has inevitably been a big currency punt. Why else would investors be happy to buy three year corporate bonds yielding as low as 1.15%, as Unilevers did? More to the point, why would investors wanting exposure to a credit such as China Resources buy a 2015 bond in CNH at a spread of 100bp, or a yield of 2.51%, when the same issuer has dollar bonds outstanding at 221bp over Treasuries, or an all-in yield of more than 4%?
The allure of an appreciating currency seems enough to underpin continued support for lower-yielding CNH exposure. How resilient that support will be over the longer term is open to question. "Retail investors are such an important source of demand, and nobody knows how sensitive this group of investors would be to a macro sell-off," says Annisa Lee, credit analyst at Nomura in Hong Kong. "If we see a shock such as a major slowdown in China, retail investors who are not buying on the basis of credit fundamentals might be tempted to switch back into US dollars because the coupon differential is substantial and there will be lower expectations of RMB appreciation."
Bankers insist, however, that the investor base isnt exclusively currency-driven. Dominique Jooris, head of investment grade capital markets for Asia ex-Japan at Goldman Sachs in Hong Kong, points out that corporate money is a key direct and indirect component of deposits underpinning demand for shorter term RMB bonds.
Estimates published by Daiwa Securities reinforce the view that corporate deposits outweigh retail inflows. It calculates that as of December 2010, deposits by personal customers accounted for 43% of the total, with the average deposit reaching just under Rmb59,000. Deposits by corporates accounted for the remaining 57%, averaging Rmb1.41m for each account.
Bankers say that the structure of the investor base for offshore RMB bonds is evolving and maturing. "If you look back two or three years the investor base was mainly commercial banks recycling deposits and trade financing facilities in RMB, with Bank of China in Hong Kong the largest player in terms of RMB liquidity," says Paul Au, head of Asian debt syndicate at UBS in Hong Kong. "Demand in the early phase of the market was driven by individuals moving their deposits from savings accounts to securities accounts in order to subscribe to new offerings from issuers such as CDB and China Exim Bank. As the market has evolved and liquidity has improved we started to see the emergence of an institutional investor base."
One important source of that institutional demand has been the new troupe of dedicated RMB bond funds, which started to emerge soon after the announcement of July 2010 which opened a new chapter in the internationalisation of the market.
First off the blocks was Haitong Asset Management, which launched its global RMB bond fund as early as August 2010. Another early mover in the market for RMB bond funds is the Hong Kong-based Income Partners, which launched its IP Renminbi Credit Fund in November 2010. At the time, Income Partners anticipated a potential lack of supply as a roadblock to the build-up of more institutional involvement in the RMB market, which is why it identified reverse enquiry as a key pillar of its strategy. Its product, IP announced at the time, was "the first RMB-denominated fund... launched in conjunction with a group of leading international banks to address the shortage of RMB denominated issuance in the market."
The lead originating dealers for the IP fund are BOCI Asia, Deutsche, Standard Chartered and RBS, which were appointed, according to IP, "to help source primary issues by way of reverse enquiries... and help the fund to access a wide pool of investment instruments."
Foreign buyers get the taste
Another source of diversified demand identified by Au at UBS is what he describes as "non-core offshore RMB holders". "These are investors that arent natural holders of renminbi but which have access to RMB bonds via commercial banks and prime brokers, such as overseas asset managers and hedge funds that are attracted by the potential for new issue performance and currency appreciation," says Au. "So we are starting to see a much broader fixed income investor base taking shape."
Others confirm that foreign investors are becoming increasingly active in the CNH market. "We are now seeing about 10%-20% demand for each deal coming out of Singapore," says Tee Choon-Hong, regional head of capital markets for North-East Asia and Korea at Standard Chartered in Hong Kong.
It is not just investors from Singapore that are driving a rise in international demand for offshore RMB bonds. In an update published in May, Deutsche Bank reported that holdings by international investors from Europe, Latin America and Japan had increased from 5% of the CNH bond market cap to 15%.
Others have also detected rising international support for offshore RMB bonds. As Standard Chartered observes in a recent report, "the inclusion of RMB as a full settlement currency in Euroclear and Clearstream has also paved the way for global investors to participate in CNH bond issues."
Deutsches findings are supported by the distribution statistics for recent transactions such as Volkswagens five year Rmb1.5bn issue in May, less than half of which was placed in Hong Kong. European investors absorbed 26% of the VW issue, with placement into Singapore accounting for 25%. That represented a vast increase in European placement compared with previous RMB bonds from international issuers. According to data published by Standard Chartered, non-Asian investors were minor participants in the much smaller transactions from borrowers such as Unilever, Galaxy and VTB, accounting for just 3% of distribution in each of these deals.
"European investors were attracted to the VW transaction because they were comfortable with the name, the credit quality and among other things, the size of transaction, which will deliver a measure of liquidity," says Rod Sykes, managing director and head of Asia Pacific debt capital markets at HSBC in Hong Kong.
This increase has been underpinned by a conspicuous rise in liquidity over the last six months. Vishal Goenka, head of Asian local currency credit at Deutsche Bank in Singapore, says that monthly trading volumes have now crossed Rmb3bn, compared with just Rmb200m in January 2011.
"We are now trading about $125m a week in the secondary market, and the creation of this liquidity has encouraged some bigger players to become involved," he says.
"For example, we have seen a growing number of macro funds coming into the market, and we think that trend will continue as new issuance volume rises."
Liquidity can only grow as more institutional investors from the region and further afield are drawn to the RMB party. "Most of the institutional investors I speak to on roadshows in Hong Kong and Singapore are either considering setting up an RMB fund or have already done so," says Wallace Lam, managing director of debt capital markets at HSBC in Hong Kong. "End buyers can be retail or high net worth individuals but it is clear that these asset managers have genuine demand. I dont think Ive met a single investor who has told me he isnt looking at the RMB market."
Aside from the obvious draw of the prospects for the currency, bankers say investors are increasingly attracted by the diversification opportunities offered by Chinese companies in the offshore RMB market, which are more extensive than in other currencies. According to Morgan Stanleys research, "for Chinese issuers, sectors such as machinery, retail and utilities have been more represented or discussed in the early days of the dim sum market than during the entire life of the US dollar market."
"That means that investors looking for diversified credit exposure to the worlds fastest growing large economy may find few alternatives to the dim sum market," adds Morgan Stanley. "Unlike the US dollar market where Chinese issuers are mainly... quasi-sovereigns or... property developers, the CNH bond market already spans the consumer discretionary, industrials, energy and utilities sectors, which make up 80% of the total CNH bond market."
A greater diversification of borrowers would suggest that more opportunities for relative value trading emerge in the market.
But bankers are encouraged by the increasingly analytical approach that investors are adopting. "In the early days, it was very much a sellers market," says Sykes at HSBC. "Investors were much more focused on laying their hands on whichever issues they could, rather than on doing credit analysis. The result was that we saw huge oversubscription ratios in some of the early transactions.
"Today, it is maturing into a market where investors focus more intensively on credit analysis and identifying relative value," Sykes adds.A more intensive focus on relative value, says Sykes, will be supported by another sign of increased maturity in the market, which will be the emergence of more rated transactions, in turn giving investors more guidance on where credits stand relative to each other.