China’s panda bonds: cute enough to attract investors?

China’s interbank bond market, already the world’s third-largest after the US and Japan, has opened up to foreign investors in the past year and so-called ‘panda bonds’ are likely to appeal to them most.

This was the forecast at last week’s 2nd China Capital Markets European Conference in London, held by the Asia Securities Industry and Financial Markets Association (ASIFMA) and the Association for Financial Markets in Europe (AFME), which noted the market’s rapid development over the past year.

Amid local stock market turmoil a year ago the People’s Bank of China (PBOC) confirmed that it would ease the rules and give major international investors greater access to its US$5.7 trillion interbank bond market. The PBOC said that foreign central banks, sovereign wealth funds (SWFs) and global financial organisations would no longer need pre-approval to trade bonds, interest-rate swaps and conduct repurchase agreements. Instead, completion of a one-page registration form would be the only requirement and they could also decide how much they wished to invest.

This move was followed in February this year by the PBOC extending the list of those eligible to commercial lenders, insurance companies, securities firms and asset managers, while the PBOC indicates that it also aimed to attract long-term investors such as pension funds and charities. The first batch of products following the opening up of the market was announced earlier this month and there is a pipeline of new offerings.

“There’s no reason for a global investor not to look at China, despite some issues over the repatriation of funds,” said Liang Si, head of bond syndicate Asia at BNP Paribas. “The regulator appears to be serious about opening the onshore market to foreign investors, with restrictions either being eased or lifted.”

Until quite recently, the offshore renminbi (RMB) – aka ‘dim sum’ – bond market was regarded as the main attraction for foreign investors. US blue chips McDonalds and Caterpillar, which first tapped the market in 2007, where among the early users of dim sum. However, dim sum issuance has slowed sharply in the past two years and the so-called ‘panda bond’ – a RMB-denominated bond issued by a non-Chinese issuer and sold in mainland China – is “probably now the way to go,” suggests Si. “It has been said that pandas will eat dim sum.”

Holding back the market

Although panda bonds go back more than 10 years – to October 2005 when the International Finance Corporation (IFC) and the Asia Development Bank (ADB) launched the first pandas- they attracted wider attention in early 2014, when Germany’s Daimler AG became the first western corporate to come to the market.

However, Si said that many foreign investors still need to familiarise themselves with the panda concept (ASIFMA recently issued recommendations on how the market could best be developed). Moreover, the bonds still face several obstacles such as accounting standards and repatriation issues – with the latter still lacking clear guidance from the authorities and each issue has to be reviewed by the PBOC.

“The process for panda issuance is quite a lengthy one and the market can move significantly in the meantime,” noted Si. “However, if regulatory guidance is forthcoming the market could be worth as much as US$50bn by 2020.” She added that panda bonds are attractive to Chinese onshore investors, while also requiring a level of disclosure sufficient to also make them appealing to international investors. However, while pandas are mounting a challenge it’s unlikely that they will “totally eclipse” the dim sum bond market, which is still somewhat easier to access.

According to Minny Siu, a partner of law firm King & Wood Mallesons, in addition to the regulatory regime acting as a brake on the panda bond market, foreign institutional investors and overseas banks may also be deterred by the language barrier as bond issues and supporting documentation must be in Chinese. However, China’s regulators recently visited Japan to see first-hand how that country’s ‘samurai bond’, or yen (JPY)-denominated securities market operates and whether features could be adopted to further the growth of pandas.

Other encouraging developments for foreign investors include China’s development of free trade zones (F-TZs) since the launch of the Shanghai FT-Z in September 2013. In April 2015, the State Council released framework plans for additional F-TZs in the city of Tianjin and also the provinces of Guandong – for Hong Kong and Macau investors – and Fuijan for Taiwan investors. Liang Si believes that they will co-exist over the near term but ultimately are likely to combine into one.

There is also the Shanghai-Hong Kong stock connect, a link between the two cities’ stock markets launched in November 2014 as a gateway for international investors. Although it has not yet lived up to market expectations due to regulatory differences between the two markets and restrictions such as a daily quota, it has sparked demand for more connect schemes.

In response, later this year will see the delayed launch of Hong Kong-Shenzhen stock connect; expected to be a “game changer”, according to Yin Ge, counsel Shanghai for law firm Clifford Chance. Shenzhen has many more mid- and small-cap stocks, which are popular with retail investors; moreover it will aim to address the inefficiencies that have hampered Shanghai-Hong Kong.

Further down the line, the Chinese government’s latest five-year plan approved in March envisages the stock connect initiatives to be joined by a bond connect scheme. However, as Liang Si observed, there are challenges as well as opportunities in bond connect and as the bond market trades over-the-counter (OTC) via market makers it requires some form of pricing mechanism to first be developed.

Removing the hurdles

While the PBOC is re-examining the regulatory hurdles that have slowed development of the panda bond market and further liberalisation is expected, European investors tend to demonstrate impatience according to Spencer Maclean, head of capital markets, Europe and Americas at Standard Chartered Bank. “As they’re more used to the eurobond market, they expect the Chinese market to come up to speed very quickly, but a little more sympathy is needed,” he suggested.

There is also the issue of investor protection. In a Q&A session, a delegate noted that there currently appears to be little afforded to panda bond investors. This suggested that until protection improves, only the best-rated issuers are being encouraged in order to instil confidence.

Lastly, with China facing very obvious environmental and pollution issues the authorities have given much thought to ways of driving forward a green agenda. Green bonds and green finance are part of the message and the International Finance Corporation has worked with regulators on the development of a ‘green panda’.

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