And the country’s borrowers are set to continue leading the way in terms of deal flow, with bankers expecting some new sectors and credit structures to emerge from the strong pipeline, writes Rev Hui.
A slowing economy and the first offshore bond default by a Chinese property developer mean that Chinese issuers have taken a more cautious approach to funding this year — and are taking their time to come to the dollar bond market.
But while the number of deals has gone down compared to the same period of time last year, from 19 to 14, dollar volumes have gone the other way. A surge in proceeds has seen Chinese issuers raise a total of $14.1bn, a year-on-year jump of more than 61%, according to Dealogic.
Bankers attribute the spike in volume to a change of approach, with issuers favouring a size-over-price strategy.
This approach reduces the need for issuers to return to a market that has the potential to be even more volatile in the months ahead thanks to a depressed commodity cycle and the start of US interest rate rises. Among the 14 dollar bonds issued by Chinese issuers this year, five were above the $1bn mark.
“China is a country with a $9tr-plus GDP, so it needs a lot of money to keep the economy going,” said one Hong Kong-based head of syndicate. “Volatility does not reduce the need for capital, but it changes the way funding is obtained, which is why we’re seeing companies print bigger deals. Volume-wise, at least where dollars are concerned, we’re expecting 2015 to be roughly the same as last year.”
Filling the gap
In 2014 Chinese issuers tapped the dollar market for a total of $92.2bn. But if the same heights are to be reached this year, a new group of issuers will have to emerge with the ability to compensate for the potential loss of oil and gas companies, one of the largest and most consistent issuers of offshore debt.
China’s oil and gas industry raised a combined $13.7bn from dollar bonds last year, representing close to 15% of the country’s dollar bond volumes. Its impact in 2015, though, is expected to dwindle thanks to a spectacular 40% drop in the price of oil over the past six months.
“The upstream companies are definitely suffering, but the downstream guys are actually benefiting from this,” the syndicate head said. “Still, with no clear direction of where prices are going to go, it might be tough for them to tap the market.”
That leaves a big chunk of volume waiting to be covered and one group that could do so are local government funding vehicles (LGFVs), according to a Hong Kong-based credit analyst. LGFVs are one of the largest issuers in the onshore market, with close to Rmb21tr ($3.4tr) of bonds outstanding, according to a Goldman Sachs report on February 7.
But the sector has come under fire in recent months as China clamps down on city governments using LGFVs to fund anything apart from infrastructure projects. The state council released a set of guidelines (directive 43) in October 2014 that restricts local government borrowings (link in Chinese).
“A lot of questions have been asked about directive 43, but if the proceeds are strictly for approved infrastructure projects, then it should be fine,” said the analyst. “The offshore market offers LGFVs a nice alternative, especially when they’re facing increased scrutiny domestically.”
There is already some evidence of this. Qingdao City Construction Investment Group (QCCI), a LGFV owned by the Qingdao municipal government focusing on urban planning, managed to raise $800m with a dual trancher split between a 4.75% 2020 and a 5.95% 2025 at the start of the month.
New credit structures
But since Chinese issuers are still relatively new to the international bond market, their increased prominence is also expected to bring along some new credit structures to go alongside existing tools such as keepwell deeds and equity interest purchase undertakings.
“In the US and Europe, where the markets are fully developed, there’s little incentive for structural innovation,” said one Hong Kong-based capital markets lawyer. “The Chinese, on the other hand, are still developing, so there’s plenty of room for structures that are specifically designed for their needs.”
One such innovation, according to the lawyer, is to allow international investors to have direct recourse to certain onshore assets, similar to the usage of a cash escrow.
“We’re speaking with the authorities and the banks to see if there’s any way for us to come up with a way to ring-fence onshore assets for offshore bonds,” the lawyer said. “If it works, this will be a huge boost to investors since they won’t have to fear being treated like a shareholder rather than a bondholder in a Chinese court anymore.”
While the syndicate head is more than happy to see the structure work, he remains doubtful on how it could be implemented since having direct recourse would suggest a guarantee of some sort, which will require the approval from China’s State Administration of Foreign Exchange (Safe).
But going through Safe is a huge deterrent for many issuers, since the application process can be tedious with no telling when an approval will actually come.
“I’m not sure how that will work, but I’m sure we’re due something new this year, or having some variations of existing structures,” the banker said.