Developed debt crises to fuel RMB currency, bond markets

As the only market of sufficient size, China will be called upon to support institutional investor needs for currency and credit diversification amid crises in the US and Europe.
Developed debt crises to fuel RMB currency, bond markets

Evolving debt crises in the US and Europe are expected to underpin a dramatic escalation in renminbi bonds and custody as the world's institutions target currency and credit diversification.

Speaking from a global portfolio management perspective, Jeffrey Yap, head of Asia fixed income trading at Mizuho Securities, pointed out that as the second largest global economy, China is the only market of sufficient size to accommodate such needs.

"A lot of investors are shying away from investing in Europe, while European investors themselves want to diversify from the euro," he told the audience at the Bloomberg Link China Conference in Hong Kong this week.

While he acknowledged that demand for currency diversification had been in play since 2002, he suggested that until now there had been no credible alternative from the US dollar. "RMB provides a lot of potential to meet institutions' diversification needs," he explained.

China's offshore RMB or dim-sum bond market has been expanding super fast in Hong Kong, with Rmb131 billion ($20.6 billion) in issuance already this year, compared with Rmb35.7 throughout 2010, according to Bloomberg data.

But the offshore renminbi bond market is dwarfed by its Rmb20 trillion onshore equivalent - counting as it does for just 0.1%.

In size terms China's offshore bond market (both RMB and US dollar denominated) is just 3.4% of the total market capitalisation of China's offshore equity market, noted Wang Yuan, director of Prudence Investment Management.

"The development of the Chinese offshore bond market is almost 30 years behind," he said, stressing that there is a lot of room for improvement in terms of talent and expertise. "We are sort of somewhere in the mid-1990s compared with the offshore Chinese equity market."

He said the majority of bond and credit investors are from the US and Europe, meaning there is a mismatch of talent in Hong Kong. "Because of the mismatch of talent, information and regulatory framework, some people can make money," he suggested. 

Prudence Investment Management launched its first RMB fixed-income fund this January but had added a second in July, primarily targeting Japanese investors.

However, Hong Kong's dim-sum bond market has undergone a period of correction recently over concerns of a slowdown in renminbi appreciation as China moves to protect its exports to counter a cooling global economy.

Bank of China (Hong Kong)'s Offshore RMB Bond Index dipped below par (100) on August 29 for the first time since its launch on December 31 last year. It dropped to a low of 93.99 on October 4, although by October 25 had rebounded to 95.22.

Wang is firmly of the view that high-yield dim-sum bonds have been oversold and he expects to witness a rebound.

Steve Wang, head of fixed-income research at BOCI Securities, suggested that the offshore RMB bonds of Chinese property names in particular had been oversold, pointing to the fact they had "higher yield than their global peers".

Kyungwon Lee, a partner at Shearman & Sterling, added that dim-sum bonds are increasingly being graded by credit rating agencies and he attributes this to the fact that investor distribution of these offerings has become far more international.

He pointed out that one recent dim-sum bond issue had a 14% allocation to European investors, with China and Hong Kong making up 76% and Singapore buyers the rest. "The evolution of investor diversification will drive the process [of credit rating] forward the most," he concluded.

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