Chinese corporates look set to take advantage of strong international investor demand for their debt to increase offshore dollar funding at the expense of domestic bond issuance, predict fund managers.
Companies from the world’s second-largest economy have been seeking more offshore funding at a time local funding costs are rising and credit lines are less available. The need to secure funding has overriden any concerns over the potential for major central banks to raise interest rates more aggressively in the coming year.
International investors are keen to supply them the capital. Chinese corporate dollar-denominated debt issuance doubled to $211 billion last year, according to French bank Natixis, an amount that accounted for 60% of overall emerging Asia dollar bond deal flow, according to Salman Niaz, emerging-market debt portfolio manager at Goldman Sachs Asset Management.
This year began in a similar vein. Chinese companies issued $22.3 billion in January, versus just Rmb1.5 billion ($238 million) in onshore bond issuance, according to Bank of China International.
Singapore-based Niaz believes this will continue, and that Chinese bond flow could over time hit 70% to 80% of Asia volumes on the back of strong international demand as investors ramp up on China exposure in their portfolios.
“We don’t think demand for emerging Asian US dollar corporate debt is even close to the point of saturation where investors are likely to stop buying,” he predicted. “The underexposure of investors to this asset class suggests structural demand will support a lot more issuance.”
HIGHER LOCAL COSTS
At heart, the rise of offshore funding is down to the ability of Chinese companies to gain cheaper funding overseas than they could onshore, while offering international investors a yield kicker versus comparable companies.
Fitch Ratings noted in a recent report that investment-grade corporates in China have seen the disparity in costs between equivalent local and international bonds become particularly pronounced in 2017 (see figure below).
Meanwhile, Chinese bonds look good to global investors. Rob Simpson, senior emerging-market debt fund manager at Insight Investment, a London-based subsidiary of BNY Mellon, noted that Chinese investment-grade dollar bonds typically offer yields 40 to 50 basis points higher than for their US counterparts, even for the very biggest names.
For example Chinese technology company Alibaba’s 10-year bond yields are trading around 4%, compared to 3.55% for US e-retailer Amazon’s 10-year debt (as of February 23), he said.
And Chinese dollar bonds only represent a small allocation of Asian investors’ fixed income portfolios, said Niaz. For investors further afield, the exposure is even smaller.
Another reason that investment-grade Chinese bonds could attract international investors? The fact some may effectively enjoy a government guarantee, even if being issued by private companies.
On Friday (February 23) the Chinese Insurance Regulatory Commission announced it was taking over the heavily indebted and privately-held life insurer Anbang, and would maintain normal operations rather than put it into bankruptcy.
The size of Anbang in China’s financial sector led observers to conclude it was too big to fail. But it indicates Beijing remains reluctant to see overly large local companies fall, and that it could well decide to support large corporates that employ many people.
DOLLAR BOND MOMENTUM
Mainland financial firms in particular could well seek to raise more dollar funding, said Simpson, reflecting their growing international expansion and activity. They were “huge issuers” last year, he noted, accounting for $77 billion of offshore issuance, and that is likely to continue.
Another factor in favour of increased offshore issuance is that the renminbi is widely seen as being less likely to weaken now, so corporates are increasingly comfortable to issue offshore, Simpson added.
Fitch agrees. In its January 31 report the rating agency said it expected the currency to depreciate “only modestly” against the dollar over the next two years; it now stands at Rmb6.332 to the greenback.
Some even feel the Chinese currency is set to rise against the greenback. Andy Seaman, chief investment officer at London-based Stratton Street Capital, told AsianInvestor that China needs a stronger currency as it tries to rebalance away from an export-led economy to a more domestically focused one, while the US has a huge current-account deficit and the dollar is very overvalued.
It won’t necessarily be plain sailing for Chinese offshore issuance. Regulatory obstacles are one potential concern, given that Beijing is generally looking to reduce corporate leverage and financial risk.
Offshore issuance by mainland corporates is subject to case-by-case approval, noted Simpson, so the Chinese authorities could dampen volumes if they wish to reduce leverage. “That is quite unpredictable and could change at any time.”
Still, Fitch said it did not expect to see regulators take harsh measures to restrict corporates’ access to offshore funding.
In the long run, investors are likely to put more money into China’s onshore bond market as Beijing gives foreign players easier access via channels such as Bond Connect. And more demand from investors means issuers can obtain better financing terms.
Ultimately, both the onshore and offshore markets will remain important, said Simpson. “As the renminbi market matures, domestically focused corporates will naturally seek to finance themselves in local currency, whereas Chinese multinationals will seek a mix of funding currencies.”