AllianceBernstein applies for RQFII quota

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AllianceBernstein applies for RQFII quota

An RQFII quota is increasingly desirable in the face of QFII limitations, an expensive dim sum market and the inevitable fall of China property bonds, says AllianceBernstein.

AllianceBernstein has applied for a Renminbi Qualified Foreign Institutional Investor (RQFII) quota due to the flexibility it will offer when investing onshore, and the 200 basis point (bp) pick up domestic bonds offer over offshore equivalents.

The asset manager currently has access to Chinese onshore bonds through the QFII programme. But under the more restrictive QFII rules, asset managers are only able to trade bonds on the Shanghai and Shenzhen stock exchanges, which comprise around 1% of the total liquidity onshore. The remaining 99% is in the interbank market, which is where RQFII comes in.

“Under RQFII we can trade interbank, and the programme looks more flexible, particularly from a bond investors’ perspective. Under the current QFII you have to have at least 50-50 in bonds and equities. I imagine under RQFII we will be able to invest 100% in bonds,” said Hayden Briscoe, director of Asia Pacific fixed income at the asset manager.

This will be important due to the wave of global institutional clients that have begun looking for direct Asian exposure.

“Japanese clients are gearing up to go into emerging markets with a focus on Asia in particular at the end of the year or into the New Year. In addition, large institutional pension plans [are] coming to our Asian offices looking to understand, research and try to gain exposure to Asia. That’s a big change, it’s a subtle change, but I didn’t expect institutional clients to move so quickly,” said Briscoe.

At the moment, institutional money is flowing to investment grade credit as well as to local currency government markets, in countries such as the Philippines, he says.

“Your typical pattern is that a government gets upgraded to investment grade, starts buying back its dollar bonds and issues local bonds. The next move will be state-owned enterprises (SOEs) and quasi-sovereigns issuing in the local markets.”

China control

However, once the renminbi is internationalised, China’s bond market will take centre stage.

“Everything will become about the RMB bond market, in credit. We see Southeast Asian companies becoming big borrowers in RMB as well. We expect the RMB will be as big as the Euro or the US dollar and we expect it will move to reserve currency status in the region within the next five years,” said Briscoe.

He is overweight the renminbi, but said that AllianceBernstein’s RMB Income Plus Portfolio contains very few dim sum bonds, as the market is overvalued for investors. Chinese government dim sum bonds and onshore Chinese government bonds currently trade around 100bp apart.

“In our dim sum fund we own other Asian bonds and hedge them back into RMB. I absolutely believe in the long term dim sum market but there’s not enough issuer diversification,” he said.

“Every time more supply comes those yields tend to ramp back up. At the moment we’re waiting for the NDRC [National Development and Reform Commission] to announce the new quota. We expect that to at least double, if not triple last year’s quota, so there’ll be more supply and yields will rise again,” he said.

He argues that it would make sense for many dim sum funds to apply for an RQFII quota to attach onto it, in order to develop a more flexible approach. This would be especially beneficial due to the yield pick up onshore, which is between 100bp and 200bp.

Property problems

He is also positive on the fact that onshore regulators are trying to clean up China’s bond market.

“There is a new growing underlying universe in the bond class – whether you call them enterprise or corporates or local bonds. I think through time we may see defaults through that.”

The outcome of Chinese power companies LDK Solar and Suntech’s defaults will be important for investors, particularly if onshore and offshore investors are treated differently, he said. If this happens it will be due to a structure that intrinsically favours onshore investors, ranking offshore investors pari passu with equity holders.

“The main reason this was done is because the regulator didn’t want Chinese banks to have too much exposure to the property market so it forced them to do something different by getting equity involved rather than bank lending,” said Briscoe.

“It just happened that this structure has now ended up with the bondholders offshore, and it is not appropriate for bondholders. If you’re getting equity like returns, maybe, but at this point you’re not. We don’t have any property bonds at all.”

He argues that while a downturn is not imminent, Chinese property names are at a higher risk than other property companies due to the high leverage levels.

“I’ve been investing in property bonds for over 20 years and all the well-defined property groups have learned their lessons in previous cycles. They keep the leverage in their structure at around the 10% to 30% range. But we’ve got Chinese property names running in the 60% to 80% range. I don’t care who you are, or what market you’re in, when you’re running that much leverage in your structure you will come unstuck,” he said.

“These [China] property bonds have only been around for four years, so they haven’t seen price declines or a cyclical downturn yet. And when that happens, as with all the well-heeled property firms that have been around for a long time, you can’t survive. And that’s ignoring the already very poor bond structure so that’s why we’re not holding any of those names.”

The China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE) are considering applications for new RQFII products. The total quota was raised to Rmb270 billion (US$43.67 billion) from Rmb70 billion at the end of last year, but none of the new quota has been approved yet.

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