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When in mid-January Chinese President Hu Jintao went to Washington DC – home of the US Treasury, the US dollar and global regulators such as the World Bank and the International Monetary Fund (IMF) – he had the renminbi, China’s non-convertible and hitherto hard-to-obtain currency, at the top of his country’s agenda.
This state visit would not be all about its undervaluation in the eyes of the Americans so much as China’s bold new efforts at expanding its internationalization. And not surprisingly; for the first time ever renminbi-denominated offshore bonds were taking pride of place in the international debt capital markets above the seemingly eternal global crutch of US treasury bonds.
“The ongoing pilot programmes for renminbi settlement of cross-border trade and investment transactions are a concrete step that China has taken to respond to the international financial crisis, with the purpose of promoting trade and investment facilities,” answered Hu in a statement to questions sent in by the media ahead of his landmark trip. “They fit in well with market demand as evidenced by the rapidly expanding scale of these transactions.”
Indeed. In Asia’s debt capital markets renminbi-denominated bonds issued in Hong Kong were blazing their way to prominence among global issuers and investors in an almost unprecedented burst of primary market activity in one new currency in just a few weeks, with scores more deals being lined up by banks in the special administrative region for the months ahead. The market had grown in less than a year (really) to more than 60 billion renminbi (US$9.1 billion) of outstanding bonds from over 50 issuers.
Take the first week of January in the banking sector alone: Bank of China (Hong Kong), the clearing bank for renminbi transactions in Hong Kong, announced a programme with the Hong Kong Exchanges and Clearing (HKEx) allowing it to issue up to 20 billion renminbi bonds in two-to five-year maturities by the end of 2012; Bank of Communications (Hong Kong), christened an identical programme it had set up on the last day of December, by issuing a 500 million renminbi, two-year certificate of deposit (CD), while Royal Bank of Scotland (RBS) issued a 100 million renminbi, three-year bond.
World Bank puts dim sum on the map
Adding gravitas to that scramble for investor attention was the World Bank. It launched a 500 million renminbi two-year note issue in early January in a move that would “further deepen the market and permit investors to diversify their currency holdings and expand renminbi exposure in the fastest growing capital market in the world”, according to Doris Herrera-Pol, global head of capital markets at the World Bank.
With China set to gain a greater say in the World Bank/IMF after a restructuring last year that saw its voting power increase to the third largest player and Zhu Min, the former Bank of China mastermind of its internationalization in the past decade, given a role close to the centre of global supranational power, it was seen as a symbolic act of support for China’s drive to internationalize its tightly controlled currency abroad by using Hong Kong – with its unique financial skills and ambivalent identity – as its laboratory.
Coming in a week when the odds-on next prime minister of China, Li Keqiang, was touring Europe and offering to prop up Spanish debt,
Nigeria was the latest country to announce it would add the renminbi to its trading currencies and the Bank of China rolled out renminbi products for its customers in the US, China is clearly on a serious mission to counterbalance pressure from the US government and its ubiquitous dollar. It is determined to shape a new global financial order for itself that will not see its trade with the world shut down when the US financial system cracks and its economy declines.
The World Bank’s global reputation would have helped put the market on the map of many international investors reflecting the rising demand for renminbi financial products, as well as enlightening potential issuers to its pricing efficacy. The two-year fixed-rate bond offers investors a semi-annual coupon of 0.95% – the first bond to pay less than China.
For bankers, the dynamic market performance is the perfect storm of both push and pull factors with both supply and demand thriving.
“There is huge demand from global investors for renminbi assets in both the traditional dim sum market (offshore renminbi market) and the more recent synthetic renminbi market,” says Stephen Williams, head of global capital markets for Asia-Pacific at HSBC.
At the same time, global issuers are excited about getting exposure to renminbi and China as well as much cheaper pricing than they can get for funding in their own markets.
Synthetic guise
The fact that Williams can use the word ‘traditional’ for a market only in its nascency says it all, especially when the “tasty digestible morsels” nomenclature (as used by Hong Kong’s finance secretary John Tsang in a speech the same week) comprises deals that both require the issuer to retain the proceeds offshore and those specific deals that enable the borrower to remit funds into mainland China, often having worked out interestingly flexible uses to secure legal approval for them.
The synthetic market is a way in which issuers can gain exposure to the currency without needing the renminbi – when previously the greatest restraint was getting hold of it. It is here that China has it coordinated to make a dent in the G3 bond market as well, says one mainland Chinese banker, by allowing its corporates to tap the renminbi market but in an international guise – synthetic renminbi bonds that follow the route of convertible bonds in being settled in US dollars.
Also in the first few days of the year, Sinochem (HK), with Deutsche Bank and Citic Securities as joint bookrunners, issued the second deal in the synthetic renminbi market, first opened by real estate developer Shui On Development, which launched a three billion renminbi issue of three-year renminbi-denominated US dollar settled senior notes through Deutsche Bank, Standard Chartered Bank and UBS.
Sinochem’s US$2 billion in November 2010 was the largest ever international bond from a Chinese issuer and promised more to come from top-ranked China Inc candidates ‘going out’, but no sooner had it gone offshore than they were here again issuing offshore in their own currency.
Issuing in renminbi and settling in US dollars makes the deal part of the “local currency going global” portion of the international market that is growing elsewhere in the region, notably with the issuance of the Republic of the Philippines, which launched the market in September 2010 and then came again in early January as well.
But, importantly, such deals take away from the main G3 segment of the overall Asian bond market and suggest that 2011 will see a full-scale onslaught of renminbi-denominated products in an offshore market under the wing of the People’s Bank of China (PBOC), China’s central bank. Could renminbi-denominated bonds in Asia this year possibly top those in US dollars?
China appreciating
For Chinese issuers this is a boon at a time when the authorities have clamped down on lending at home. But those with a genuine need for renminbi in the real economy are more likely to be encouraged by the authorities than in the synthetic one, which is preferred by real estate developers, believes Williams at HSBC. Indeed, China’s Ministry of Finance curve is 150bp to 200bp more expensive domestically than what issuers are securing now in Hong Kong while in contrast the perceived risk of investing in Chinese debt internationally has fallen dramatically. Five-year credit-default swap contracts on government bonds declined 11bp in the first two weeks of 2011.
A parade of other issuers – multinationals, banks and companies – have raised funds in a market that has sprung from nowhere in just a few months, threatening the orthodoxy that a currency has to be exchangeable to be internationally accepted as a trade and reserve currency.
Probably more significant than the World Bank’s issue in kick-starting the renminbi market in Hong Kong was a 1.2 billion renminbi, 10-year bond from the Asian Development Bank (ADB) in October, lead-managed by Deutsche Bank and Bank of China (Hong Kong), that was the first publicly listed bond to be traded and settled in renminbi and the first CNH bond (the technical name for dim sum bonds) from a triple-A rated entity and by a supranational borrower.
“The bond will act as a useful benchmark for other potential borrowers, helping develop the CNH bond market into an important source of funding for borrowers as well as an investment destination,” said Bindu Lohani, vice-president at the ADB at the time. He was referring to the fact that building a pool of renminbi deposits had proven to be the easy part; finding paper to invest in was proving a struggle. That dysfunction in the market was partly addressed in July when the PBOC opened the door to foreign investment in China’s interbank market as a boost for the growing pool of renminbi in Hong Kong.
"These issuances will both add top quality issuers in Hong Kong’s renminbi bond market and demonstrate the importance attached by international financial institutions to the development of a CNH platform in Hong Kong and their interest in using Hong Kong to raise renminbi funding,” observed Norman Chan, the chief executive of the Hong Kong Monetary Authority (HKMA) at the launch ceremony. “The renminbi bond market is part of the ongoing efforts to develop renminbi business in Hong Kong.”
Expanded use in trade
“What’s most important for China is that it wants the expansion of the renminbi for trade settlement,” says one head of debt capital markets in Hong Kong. “The renminbi bond market in Hong Kong is the most obvious way that China is trying to internationalize the renminbi.”
“We saw [in 2010] a number of groundbreaking renminbi financing arrangements, including the 70 billion renminbi loan facility extended by the China Development Bank to Venezuela to fund oil production related projects; and renminbi fund-raising by the Hopewell Holdings and McDonald’s in Hong Kong to finance their projects in mainland China in the form of foreign direct investment,” says Peter Pang, HKMA deputy chief executive. “These landmark transactions underline the importance of building a two-way channel to connect Hong Kong’s capability in international financial intermediation with the real economic activities that are denominated in renminbi.”
However, the HKMA cannot be totally delighted either with running a market which gets switched on and off according to Beijing’s arbitrary whims via a quota system. After fears of hot money sneaking into China, it limited the banks’ net open positions in renminbi – or their bets on its future movement – to 10% of their assets or liabilities denominated in the currency. Bankers and traders say the new rules will increase funding costs for local banks, and limit their ability to offer currency futures or other derivatives that many have viewed as a source of future revenue growth.
The opening of the interbank market to foreign holders of renminbi was the price Beijing had to pay to encourage banks to take up its Hong Kong challenge and offer investment products for renminbi deposit holders. Offering juicy potential opportunities in the domestic market is the bait with which the authorities hope to lure foreign banks into their ambitious plans to boost the power of the renminbi offshore, without having somehow to open their capital account. (Maybe not coincidentally, J.P. Morgan and Morgan Stanley have just had their joint ventures in China approved.) But some think the banks are being steamrollered into the whole process anyway.
Liquidity-gathering exercise
Pointing out that the pool of renminbi deposits in Hong Kong grew another 29% month on-month or 246% year-on-year to reach 280 billion renminbi by the end of November 2010, driven by an increase in trade-related receipts by corporate customers, Tom Quarmby, head of research at Barclays Capital, says that “because of limited renminbi investment options, these deposits are mainly parked with the PBOC – via Bank of China (Hong Kong) as the clearing bank – and generate a 86.5bp return for participating banks (and 99bp for BOC HK).
However, some of the mid-cap banks are paying in excess of 1.5% to customers with a one-year renminbi time deposit.” Quarmby calls the growing pool of renminbi deposits “a near-term drag on Hong Kong bank margins and profitability, albeit quite mild, since renminbi deposits still only account for 4.8% of system deposits”.
“The banks are quite happy to do it as a liquidity-gathering exercise comparing them to other savings rather than investment products like single premium insurance products – a market incidentally where HSBC noticeably leads AIA in Hong Kong,” says Quarmby.
Some 70% to 80% of a bank’s deposits are deployed as loans. But renminbi loans in Hong Kong are not allowed for the foreseeable future (nor would they be accepted by companies in Hong Kong), so where is the angle for the banks when their deposit holders are merely taking the yield on renminbi due to its expected appreciation, not the investment value-added?
Hong Kong as a laboratory
It is Beijing rather than Hong Kong that is in the driving seat when it comes to political will and Hong Kong’s agreement that is assumed. It was, after all, Hong Kong’s failure to come up with sufficient investment products that forced Beijing to open its own market in July – the single move that has most ignited the CNH market. An August 3 2010 report by Bank of China (Hong Kong) spells out clearly that China can achieve its goal “by using Hong Kong, thus preventing mainland China from direct exposure to any overseas financial shocks”.
“To better serve mainland China in the renminbi’s internationalization, Hong Kong needs to improve its function as a pooling centre for attracting more renminbi funds. To achieve it, Hong Kong must make every effort to develop renminbi business and products, and gradually diversify the channels for the outflow of renminbi funds,” continues the Bank of China’s research report. “With sound financial infrastructures and regulatory measures, Hong Kong can offer high quality risk management for renminbi business, gaining confidence from mainland China to conduct more trials in Hong Kong,” it said.
China’s recent measures to promote cross-border renminbi currency settlement for trade are a natural development for China as a trading power, but there was a suggestion from a few die-hards in Beijing – the counterparts to the old chauvinists in US Congress – that the World Bank should now adopt the renminbi as one of its basket currencies. They were the same people who took the World Bank’s bond issue as a stamp of approval for China’s attempt to make its currency available for reserve status.
No way, say bankers – so far; demanding trade without reciprocal rights to price is surely beyond the remit of the World Bank’s mission to oversee a system where all are equal and open. Will the World Bank encourage China to open its markets for short-term maturity bonds or short-term capital accounts to attain the goal of capital account convertibility in the near future? Does a currency have to be exchangeable to merit a position in its own basket of reserve currencies, or is that just its current status? Will China override any reservations anyway and make the renminbi a must-have by dint of its weight and potential ubiquity?
Financial revolution
What is happening in China’s internationalization of the renminbi is happening now; the crucial corner might already have been turned.
“We may be on the verge of a financial revolution of truly epic proportions,” says Qu Hongbin, China economist at HSBC. “The world economy is slowly but surely moving from greenbacks to redbacks.” He gives it three to five years before at least half of China’s two trillion renminbi trade with emerging economies is conducted in renminbi, by which time it would be in the top three of global trading currencies.
And what about Hong Kong? Liao Qun, chief economist and strategist at Citic Bank, suggests frankly that Hong Kong should take advantage of cash-rich mainlanders looking for somewhere legally safe to store their gains and foreign investors seeking to get into China by arbitraging the renminbi’s inconvertibility and “act like a firewall for the renminbi and the mainland Chinese financial markets to guard against external shocks”.
“As a result, when the renminbi becomes fully convertible by 2020, fully-fledged renminbi businesses will be developed as Hong Kong will make an easy transition into becoming an internationally-accepted renminbi offshore centre,” concludes Liao. Will Hong Kong become so successful at taking China into the world that it has found itself China’s offshore renminbi financing centre at the expense of being the international financial centre it thought it was?
Is the World Bank swivelling on its axis to a view that would accommodate some of China’s unique characteristics in light of the up-for-grabs nature of the global financial order in the aftermath of the financial crisis precipitated by the Western capitalist world? And are the same Western investment banks guilty of the latter becoming part of that process and the means to China’s end?
Or is it China that is making itself vulnerable? The World Bank’s bond issue was part of the bank’s normal financing and in that sense no more important than its bond issue in Zambia a couple of months before. The fact is the World Bank issued in renminbi and is able to deploy it as it sees fit outside of China’s control. As indeed anyone who enters this market will.
Hopewell points the way
Début issue cements Hong Kong’s position as a global financial centre
While McDonald’s Corporation’s 200 million renminbi, three-year 3% CNH issue in August 2010, sole-led by Standard Chartered Bank, was the first by a multinational corporate and hailed as a breakthrough deal for international issuers, in fact any company in the world has been able to issue CNH bonds since February 2010. Beijing’s approval is only required if they want to move the proceeds from Hong Kong to mainland China.
It was the unlikely setting of the bond issue for Hopewell Holdings, controlled by Gordon Wu, earlier in July 2010 that highlighted the fact that China had irreparably lifted a series of restrictions on the use of the currency outside mainland China. McDonald’s issue was followed by US construction equipment maker Caterpillar, which sold a one billion renminbi offering in November 2010 with a coupon of 2%.
Hopewell, a toll-road infrastructure entity prominent in Guangdong province, then made an important contribution to the fledgling market in July when it became the first Hong Kong corporation to issue renminbi bonds in Hong Kong. It sold a 1.38 billion renminbi, two-year 2.98% bonds, with Bank of China (Hong Kong) as the sole bookrunner.
“The issuance of the first renminbi corporate bonds by HHI not only contributes a new class of debt securities to the local renminbi bond market, but also initiates a new funding channel for local companies with mainland Chinese investment,” He Guangbei (), vice-chairman and chief executive of Bank of China (Hong Kong) stated on July 7 2010.
“It further helps corporates to improve the financial structure of renminbi revenue and borrowings.” Considering such a good reception for his bond issue, He concluded: “The demand for renminbi corporate bonds is, therefore, a good sign of a healthy market. We anticipate more local companies to issue renminbi corporate bonds in the future.”
Importantly, the proceeds were for business development and were not being transferred back to China as a foreign investment capital account item. Or rather, further approvals would be required to do that. “The proceeds may be used outside China or for trade settlement purposes (as current account items) with a host of mainland China businesses under the recently expanded pilot scheme,” says Andrew Malcolm, capital market partner at Linklaters that advised on the HHI deal.
Malcolm calls the deal the début renminbi eurobond – in the sense that no China approval is required for issue of the bonds offshore and the bonds are freely clearable in the Central Money Markets Unit, Hong Kong’s debt securities system. “At the risk of some exaggeration, HHI’s renminbi bond is potentially the single most significant development since the Hong Kong handover in 1997 for Hong Kong’s ambition to remain as a global financial centre on the shore of the Chinese colossus.”
Market participants were initially puzzled by a laconic “Elucidation” published by the Hong Kong Monetary Authority (HKMA) in February 2010 in the form of a letter from its chief executive, Norman Chan, to all banks in Hong Kong, recalls Malcolm. In it, the HKMA noted that the range of eligible issuers of renminbi-denominated bonds, the issue arrangements and the target investors could be determined in accordance with the applicable regulations and market conditions in Hong Kong – so long as the use of proceeds did not entail the flow of renminbi funds back to mainland China.
HKMA chose the word “elucidation” carefully, because its short letter did not set out any new regulation or interpretation, it simply drew out some of the consequences and possibilities of the existing regulatory framework. What was not obvious to market participants was how to take advantage of the “Elucidation” to raise renminbi funds in Hong Kong, if the use of the proceeds onshore were not permitted.
Hopewell’s renminbi bond has given one answer to this question. It will in fact deploy the renminbi proceeds of the bond issue on mainland China: the proceeds will be invested in its joint venture, which is constructing Phase III West – a new toll road in the Pearl River Delta in Guangdong.
But Chinese approval is required only for, and relates only to, the remittance of the renminbi proceeds. No Chinese approval was required or obtained for the issue outside China of the bonds which raised the renminbi funding. The bond issuance leg of the financing rests squarely within the HKMA’s February “Elucidation” and it is this which is particularly significant, says Malcolm. He suggests that market watchers look out for similar veiled hints of the changing regulatory environment in future HKMA pronouncements.
Hopewell’s bonds were closely followed by the launch of Hong Kong’s first renminbi-denominated certificates of deposit by Citic Bank International arranged by HSBC. It marks the second fund-raising under the “Elucidation”. The Citic Bank issue is particularly interesting because, unlike Hopewell, Citic will retain the renminbi proceeds in the bank’s business in Hong Kong.
