Conditions related to regulation and China’s macroeconomic conditions are making the offshore renminbi bond market increasingly attractive to central banks, which have ramped up their investor participation in the market in recent months. Yet, hurdles related to secondary-market liquidity and a still-slow pipeline of state-backed deals will continue making them conservative investors - at least in the short term, say debt syndicate sources.
The analysis comes after central banks from counties including South Korea, Thailand, Nigeria and Tanzania have either invested or voiced interest in boosting their participation in the offshore renminbi, or CNH, bond market, holding promise that the banks will play a greater role in dim sum’s development.
According to one debt syndicate banker, global central banks are in a unique position to place pressure on China’s government and state-backed banks to issue a steady pipeline of CNH deals. Because these central banks primarily invest in debt directly issued by sub-sovereigns and agencies (SSAs), these mainland agencies may feel pressure to issue debt to meet demand of their global peers, which would also help the country position the renminbi as a more prominent reserve currency.
The government and these SSAs – which are responsible for leading the offshore renminbi market’s development - could help to increase deal sizes and push out yield curves and include innovative structures in their deals. The Ministry of Finance (MoF) and China Development Bank (CDB) have already sought to do this, having issued the longest-dated dim sum bonds to date. This would help the overall market to mature.
The syndicate banker notes that this is why central banks are integral participants in a bond market.
“Central banks are among the most sophisticated investors globally, so if they have a demand for something in the market, depending on how much demand they have, issuers could begin to listen to them,” he said.
Central banks from worldwide geographies have become more visible participants in the CNH market since June, when China’s MoF issued Rmb23 billion (US$3.6 billion) of notes dated three, five, seven and 15 years. While central banks have had the opportunity to freely invest in the dim sum market, the MoF deal piqued interest by setting aside Rmb2 billion specifically for investment by monetary authorities outside the mainland – the first time the agency set aside an investment tranche for the investor base.
Likewise, when Export-Import Bank of Korea (Kexim) sold a Rmb1.75 three-year CNH bond on July 18, 20% of its deal reportedly went to central banks. And when CDB issued its Rmb1 billion of 20-year bonds and Rmb1.5 billion of three-year bonds on July 26, central banks came running again, buying a reported 58% of the 2015 bonds and 10% of the 2022 notes which at 20 years ranks as the longest ever dim sum.
Among the central banks that voiced interest in the MoF’s dim sum offer was Bank of Thailand (BoT), which holds 0.5% of its foreign currency reserves in renminbi, the bank’s assistant governor told media on June 15.
Nearly two months later, the bank’s deputy governor reaffirmed Thailand’s commitment to the dim sum market, noting that, because BoT exhausted the Rmb7 billion quota for bond investments on China's onshore interbank market, and has nearly used up its Rmb300 million quota to access onshore debt through the Qualified Foreign Institutional Investor (QFII) programme, it would turn to dim sum to gain ongoing exposure to the currency, reported Bloomberg.
While it’s unknown how many other central banks are in BoT’s position, one syndicate banker suggests that is unlikely to be the only one to have used up its quota, and want to turn to the dim sum market as an alternative.
“These days central banks are holding so much more renminbi in their reserves, so they need something to invest in,” explained the syndicate banker. “Dim sum absolutely creates this exposure, and even if yields aren’t as high offshore than onshore for Chinese government bonds, it’s valuable that global central banks can invest into the CNH market whenever they want. This freedom will become increasingly attractive.”
Other factors have made the market appealing. The yields between onshore and offshore bonds have been converging, putting a halt to the pattern where onshore debt prices higher than offshore.
For example, the MoF three-year offshore bond issued in August 2011 pays a coupon of 0.6%, compared to the 3.6% that it would have to pay onshore. By June 15, at the time the MoF issued its latest dim sum bond, the offshore note is traded at 1.5%-1.6%, compared to 2.5% for the onshore comparable.
This could mean that central banks, seeking yield, could be tempted by the CNH market.
“There’s a convergence between the onshore and offshore market,” said one debt syndicate banker. “This means that there’s going to be little difference between yield if you’re an investor and you would otherwise feel more compelled to look onshore.”
This is important as central banks worldwide are taking on more renminbi to hold as a reserve currency. Among these is Indonesia, Japan and Korea, and Standard Bank estimated that 20% of select African countries’ reserves will be renminbi-denominated.
These countries will need places to investment their renminbi. Given that central banks have limited access to the onshore market, and because there are only a handful of CNH-denominated securities available to invest into, dim sum bonds are poised to be a popular investment avenue. Case in point: Nigeria and Tanzania are said to have invested Rmb500 million in CDB’s July 26 bond issue.
However, most central banks actively investing in renminbi may find that the onshore bond market will continue to be more appealing in the short-term, largely because of limited liquidity in the offshore secondary market.
“It’s true that the offshore market is becoming more appealing because [the differences between] onshore and offshore yields are becoming smaller and smaller, but onshore liquidity is so much stronger than in the offshore market,” said one director of Asian debt syndicate at a bank. “Unless a central bank’s quota has been used then I don’t see why they would go into the offshore market.”
Further, there’s a stronger pipeline of government debt issued in the onshore market, and at larger sizes and longer tenors. Until this year, the dim sum market hadn’t seen debt issued for longer than 10 years.
Syndicate sources agree that the most important thing for getting central banks to invest in the dim sum market is to ensure a strong pipeline of deals by SSAs and creating more liquidity in the secondary market, which will come as more deals are completed, and as the market matures.
Despite the call for more government issuance, state-backed debt already dominates in the dim sum market, accounting for more than 75% of the market’s total volume in 2012 to date, according to data provider Dealogic.
“It’s really a situation where central bank interest is the determined by issuance – central banks don’t take much credit risk and so they are only buying into dim sum bonds and the CNH currency to diversify their reserves, rates and FX practices, and that’s why they only go for sovereign debt,” said one bank’s head of Asia Pacific debt syndication. “That means that the very best way to get their interest is for the government and state-backed banks to issue more and more debt. If we can get a stronger pipeline we’ll see the rest falling into place.”
Once this happens, central banks may not only be interested in buying dim sum bonds, but issuing them as well.
“At some stage at some point later on these central banks will begin issuing their own dim sum bonds, and that will be a very interesting development for the offshore market,” the head of Asia Pacific debt syndication concludes. “And if you look at other currency markets like US dollars, euros and the yen you see a lot of sovereign issuers from all over the place. That’s the benefit of being a reserve currency, and if China wants the renminbi to become that, we’ll start seeing it in the dim sum market first.”