Panda bonds: great idea, no execution

IFR Asia, August 2009

The panda bond is a great idea with a problem: it’s all talk, no execution.

From an issuer’s perspective, the appeal is immense. China has vast liquidity looking for a home; borrowers find themselves starved of opportunities in most of the world’s traditional bond markets as investors there remain risk averse or short of cash. Putting the two together, with foreign issuers raising funds in renminbi on the mainland, seems a great idea, but it just won’t gain any traction.

Will it in future? There have been many steps in the right direction. When first suggested in 2005, panda bonds were intended as a tool for multilaterals: International Finance Corporation launched bonds in 2005 and 2006, and the Asian Development Bank in 2005. This was on the understanding that the proceeds remained in China for development purposes.

 In July 2008, China published a draft revision expanding the scope of Panda bonds from these development institutions to foreign banks and corporations with operations in China. Specifically, the issuing bank’s Chinese domestically incorporate branches had to have three years of profitability before being permitted to issue bonds. (It appears this means all domestically incorporated branches, rather than the first one to be opened by a bank; this is a key point and makes a big difference.)

 Part of the challenge is the sheer range of groups that need to be in agreement before a bond can get away. Even for the multilaterals, “it does require several regulators to work together towards that goal,” says Rita Chan, an executive director at Goldman Sachs. “Subsequently, with individual corporates, there are much more detailed issues to consider: what accounting principle they should use, what ratings they should use, can they use international ratings – a lot of technical details still need to be finalized among the regulators.”

 Specifically, the National Development and Reform Commission regulates the corporate bond market for unlisted companies; the People’s Bank of China regulates the structure – interest rates, and so on; the Ministry of Finance was involved in the supranational issues; the China Securities Regulatory Commission regulates the corporate bond market for listed companies and oversees the underwriters; and the National Association of Financial Market Institutional Investors regulates the commercial paper and MTN markets. If a listed company from overseas issues a bond, there are further questions about the authorities that govern that company. On top of that, if the issuer then wants to take funds offshore again, then the State Administration for Foreign Exchange gets involved too.

 At the heart of it is that China has to consider why it would want to let foreign issuers – and especially foreign sovereigns, a logical next step – into this market anyway. “The Chinese government has been careful in terms of making sure the development of the panda bond market doesn’t impact its foreign exchange policies,” says Patrick Tsang, head of cross border debt capital markets at Deutsche Bank. “But from an issuer perspective, we’ve definitely seen a lot of inquiry – from supranationals, to banks, to corporates who have business in China.”

 Still, even if it’s slow, the direction is clear. “There’s a lot of interest from international issuers who would like to be able to access the China domestic bond market,” says Ronan McCullough, an executive director at Goldman Sachs. “As bond markets in China continue to move towards something that feels like an international model, there’s definitely going to be room in investor portfolios for this type of credit.

 “And this will tie in with other initiatives we’re seeing: international banks looking to access the domestic bond market business; Hong Kong and Chinese banks trying to access the RMB market in Hong Kong. All these things are different strands that will lead to a situation where the market is sufficiently developed, mature and diverse to be really viable in an international context when the market is opened up to external investors.”

 So who’s first? Standard Chartered has confirmed it is working on issuing RMB bonds in China – making them the first locally incorporated foreign bank to do so. In June, Stanchart said it was targeting a RMB3.5 billion issue. HSBC and Mizuho have also expressed an interest in launching these bonds in China.

 Separately, HSBC and Bank of East Asia both have approval to launch RMB bond deals in Hong Kong – an interesting separate development. The legal framework for launching these bonds in Hong Kong has been in place since 2007, and mainland banks including Export-Import Bank of China, China Development Bank, Bank of Communications and Bank of China have already taken this route, although HSBC and Bank of East Asia would be the first foreigners to do so.

 This market has a slightly different rationale. “Hong Kong is clearly a market which has a very limited pool of investors from which to draw,” says McCullough. “It’s effectively retail deposits in Hong Kong – there isn’t any pool of institutional renminbi liquidity in Hong Kong. It’s been a useful alternative for investors who would otherwise be putting their renminbi on deposit at close to zero per cent in the bank.” While that’s obviously a limited market, the recent steps to allow RMB settlement in Hong Kong have the potential to give it a fillip. From the issuer perspective, foreign banks do need to raise funds in renminbi to fund their capacity to grow on the mainland.

 One other interesting development is Chinese corporate issuing onshore in China, in dollars, as China National Petroleum (CNPC) did in May. This raises another prospect: foreigners raising money in dollars in China. “The development of that market is definitely encouraging,” says Chan. “But it remains to be seen when and how much the regulators would be willing to open it up, because it involves taking US dollars out of China and into the home country of these corporates, where the actual use of proceeds would be hard to monitor.” Additionally, the onshore swap market is not very liquid yet.