Bonding over Dim Sum

Dim Sum bonds are bonds denominated in Chinese RMB and issued outside China, typically in Hong Kong. Dim Sum bonds provide exposure to yuan-denominated assets to foreign investors, as China’s capital controls currently limit foreign investment flows in mainland Chinese debt. Issuers of Dim Sum bonds are usually corporations from China or Hong Kong, however there are many foreign companies that also issue them. Dim sum bonds can be issued as either retail bonds settled in RMB or synthetic bonds settled in other currencies such as EUR or USD. Retail bonds must be approved by the People’s Republic of China (PRC) Central Bank and PRC National Development and Reform Commission (as regulator of foreign debt) and only institutions in China and Hong Kong are allowed to issue them. Retail bonds must have a registered prospectus to enable retail investors as well as institutional investors to buy into them. Proceeds from retail bond issues also must be taken back into the PRC and cannot remain in Hong Kong or elsewhere. Synthetic bonds do not require any PRC or Hong Kong approval.

The China Development Bank was the first to issue dim sum bonds in July 2007. This nascent bond market has seen further growth since then and especially as a currency play for foreign investors seeking to take advantage of RMB appreciation. Hopewell Highways Infrastructure issued the first synthetic dim sum bond in July 2010. McDonalds were the first non-financial overseas company to issue dim sum bonds in September 2010. Many multinational issuers have issued synthetic dim sum bonds including the World Bank, Unilever, BP, Volvo, and Caterpillar. There has even been an issuance requiring an islamically structured dim sum bond issue by Khazanah. More recently in November 2012, China Construction Bank became the first Chinese bank to issue a one billion yuan dim sum bond in London. Furthermore, growth in dim sum issuance has been exponential from 36 billion yuan issued in 2010, 131 billion yuan in 2011, 265 billion yuan in 2012, and an expected 350 billion yuan in 2013.

Expectations for 2013 are highly positive for the Dim Sum bonds market. Bond prices and yields have an inverse relationship and companies have had to issue their bonds at higher yields to compensate for a more uncertain yuan as a result of PRC Central Bank’s policies that targeted the yuan’s appreciation. However, these yields have had the positive effect of attracting investors to the dim sum bond market with average interest paid on corporate dim sum bonds around 4.25%, comparing favourably with US corporate bonds with the same maturities yielding 3.95%. Additionally, 2013 looks to be a better year for RMB trading, with an expected 3.5% appreciation. Investors in dim sum bonds would therefore earn both the yield plus any yuan appreciation. That the PRC Central Bank keeps the yuan within a narrow trading range also provides more security to investors by reducing the risk of sudden currency moves wiping out bond returns.

Tighter Bonds this year?

The attractiveness of the dim sum bond market will also be helped by statistics suggesting the end of the Chinese economy’s two-year slowdown. China’s economy grew by 7.8% in Q4 2012 and the CSI300 index of Shanghai and Shenzhen listed stocks rose 33% since the beginning of December 2012. The pool of yuan deposits held in Hong Kong bank accounts is also at 624 billion yuan and dim sum yields are more attractive than the average yield for other Asian bonds. Just this week, speeches from the PRC’s incoming leaders Premier Li Keqiang and President Xi Jinping, committing to liberalizing the economy and exchange rates as well as the RMB strengthening to a 19-year high against the USD at 6.20 yuan is spurring Chinese companies to increase issuance of dim sum bonds. Furthermore, February 2013 has been the busiest month for corporate dim sum bond issuance since March 2012, with 7.5 billion yuan raised.

It is not just Chinese companies that make up the issuers; foreign companies are also getting in on the act. In fact in Q1 2013, Russian companies have issued more dim sum bonds than Chinese companies, emphasizing the dim sum bond market’s appeal as a cheap source of funding for emerging market borrowers. Yields have become less competitive for investment-grade multinationals, yet it has made dim sum bonds an increasingly attractive alternative for lower-rated borrowers, even after accounting for the costs of swapping RMB raised into USD or EUR. Yet investment-grade multinationals desiring to expand in mainland China would consider issuing dim sum bonds due to their cost of funds averaging around 3%, which is roughly 3.5% lower than their average 6.5% funding cost for a two-year RMB loan from a mainland Chinese bank. This is a strategy followed by several of the multinationals, including McDonalds, who tapped the dim sum bond market to fund expansion in the mainland Chinese market where they themselves own the majority of their restaurants.

There are a few reasons to be cautious about the dim sum bond market. It is a nascent market and there can be liquidity problems when investors are looking to sell their bondholdings to buyers. There are also many investors who prefer to buy RMB directly to gain exposure to China. Furthermore, investors are concerned that many dim sum bond issuers are not rated by credit rating agencies such as Moody’s, S&P, and Fitch. Yet, this is improving with 70% of dim sum bonds issued by companies with credit ratings, up from 48% in 2011. In addition, rumours that the PRC’s new leadership will open up the mainland Chinese bond market, with the allure of higher yields, would divert investment flows from the offshore RMB market. The mainland Chinese RMB bond market has outstanding volumes of 24 trillion yuan.

However the dim sum bond market is not expected to be affected – after all, it affords greater flexibility and transparency than any potential access to the mainland Chinese bond market. The dim sum bond market is also expected to continue to expand as long as there is a surplus of RMB deposits offshore (namely in Hong Kong). These deposits are inevitably going to continue to expand, with the result that dim sum bonds become even more widely issued and traded in the years ahead.