China's dilemma over developing offshore RMB
There are question marks over how far China will develop its offshore RMB market, since at some point, perhaps in the near future, there will be a convergence with the onshore market as Beijing targets full convertibility and reserve-currency status.
It won’t be long before RMB-denominated instruments onshore, whether the divergence takes place or not, are viewed as a G4 (if not G2) medium for funding in Asia, said Devan Selvanathan, head of the global debt platform for Asia Pacific at Natixis.
He was speaking yesterday on a panel discussion entitled 'Offshore RMB in your investment portfolio' at the Southeast Asia Borrowers and Investors Forum, jointly hosted in Singapore by AsianInvestor and its sister publications FinanceAsia and The Corporate Treasurer.
The conference heard how the offshore RMB (CNH) bond market had evolved from a simple currency appreciation play in 2009/10. At that time any RMB bond was snapped up without regard to credit risk or coupon.
“That is a far cry from what is going on now,” said Suanjin Tan, director and portfolio manager for credit strategies in Asian fixed income at BlackRock. “In 2010 there was a lot of anticipation about the growth of this market. I think that enthusiasm was right, if somewhat misplaced at that point in time.”
He pointed to a shakeup of the market in the middle of 2011 amid uncertainty over the euro, a period when some bonds rose by 30 points. This forced people to start thinking about whether they were applying the right risk premium to the bonds they were buying, recalled Tan.
Selvanathan agreed that the idea of investors buying RMB bonds purely for currency appreciation was two years out of date. He noted that while the market was still in development, he was under no illusions as to its importance.
“The internationalisation of the RMB has been one of the most significant stories in the financial markets since the foundation of the euro,” he said.
Selvanathan acknowledged the market was illiquid in many senses, with bond pricing not related to any benchmark issue owing to the fact there are not enough names in any one sector. He added that close to 30% of the market was still unrated, with many of the rated names tending to be foreign issuers that brought ratings with them from other yield curves. “There is a lot to get your head around,” he said.
But he said that dim-sum bonds were a viable and diversified investment vehicle and that the market was headed towards the Rmb1 trillion-plus mark, with about 700 billion CNH in Hong Kong's clearing system, Rmb70 billion in Taiwan and Rmb50-60 billion in Singapore.
“It is still relatively small from the broader onshore position of CNY stock and it is something people need more avenues to invest in, but there is true ALM [asset-liability matching] offshore that this market is now serving.”
He noted that in June a CNH interbank benchmark rate was introduced through Hong Kong that would add energy to the loan syndication market offshore.
On the question of arbitraging between onshore and offshore markets, Selvanathan urged caution, noting that authorities viewed the demand-supply situation of the two markets as distinct.
Nevertheless, he acknowledged the differential was as high as 100-150 basis points. But he said that investors tended to make a distinction between those playing synthetic solutions and those with a natural requirement for funding.
Tan noted that in terms of offshore bond issuance, this year got off to a strong start and that corporates had started to come in until June, when fears of tapering took hold and emerging markets suffered a sell-off. Multinationals subsequently have played a role in re-opening the market and extending the yield curve from three to five years. But this is a gradual process.
“We need a lot more support from the sovereign and quasi-sovereigns to issue in extended duration and provide a benchmark," he said. "That would give you a good, well-defined and functioning curve and you would be able to benchmark it.”
Asked if he saw the market becoming more swaps-driven and opportunistic, Selvanathan noted that the asset swap between dollar and CNH was very positive. “Once you have pent-up demand for CNY offshore, this asset swap is going to prevail for some time. We have the two currency systems that have yet to diverge meaningfully, the arbitrage for issuers is obvious and we certainly look to entertain an idea on raising funds offshore on a fixed-rate basis.”
Tan sees more convergence between the onshore and offshore CNH and CNY curves. “Setting up the dim-sum market in Hong Kong was a test case for them to see how to integrate onshore and offshore markets. The trend is for those curves to converge, and I think we are seeing that at the long end.”
He said there was potential to develop an offshore RMB-denominated equities market and other securities, but the challenge was getting critical mass. “If a typical Hong Kong resident thinks about their future liability in a scenario where the Hong Kong dollar might no longer exist, their liabilities in the future could be in RMB. From that perspective, RMB-denominated insurance products have possibilities. You should get more innovation.”
To take the market to the next level and have more instrument structuring was challenging as you tend to need the regulation to follow, said Selvanathan. “We all know there are questions with recovery of assets in China under Chinese law, which have yet to be tested. I sense if you go too far into anything outside of a vanilla bond product, you are going to get certain disconnects.”
He suggested the issue was quite how quickly we will see convergence of the offshore and onshore markets, with some predicting it will happen as soon as the end of next year.
Selvanathan argued that the regulator was faced with a dilemma in terms of how far to set up its offshore market, knowing that at some point it will have to be reconciled with onshore.