By Bryan Richardson
China’s fixed-income market is picking up steam and attracting foreign investors.
With China rapidly evolving in both economy and regulation, how should treasurers manage cash when it comes to China? This was a popular topic at The NeuGroup’s Global Cash and Banking Group meeting in March, where one cash manager shared his experience.
The manager began by briefly describing the six options for investing excess cash in China that were available. Four of them were some form of bank deposit while the other two were government debt money market funds (MMF) and so-called “entrusted loans,” a three party loan arrangement where a bank coordinates a direct loan from one party to another. The upshot is that there simply are not enough viable investment options.
Fortunately, the Chinese government has come to the same realization and is accelerating change, particularly for fixed income securities and more importantly, access to them by foreign entities.
Financial Reform, China Style
Recently Celent, an international strategy consultancy to financial institutions, published a report examining the market size, structure, investors, market trends, settlement, and regulations in the Chinese fixed income secondary market. One general conclusion is that it estimates continued brisk growth in fixed-income trading in keeping with the trend shown in the chart below.
The key drivers to this growth are multiple. One is the combined relaxing and strengthening of certain regulations. For instance, the thrust of China’s fixed-income rules is to allow for a variety of bond products by easing guarantee requirements for corporate bonds and strengthening risk controls by requesting that commercial banks provide more information on their debt investments, wrote Hua Zhang, Celent analyst and author of the report. It is also loosening controls by “allowing foreign banks to conduct bond underwriting and trading.”
China has taken other measures including removing quota requirements for bonds issued by listed companies, relaxing rules on how funds raised through bond offerings can be used, eliminating a rule that prohibited issues below RMB 500 million (US $73.5 million) and allowing more overseas investment institutions to participate in the Chinese inter-bank bond market.
As a result of these aggressive improvements, foreign financial institutions are ramping up their Chinese operations. The Asia unit of Aberdeen Asset Management, Plc., announced in August that it had obtained the necessary license to invest in Chinese securities. Aberdeen, although chiefly known for its expertise in Asian equities, had sought permission for the license mainly with its growing fixed-income franchise in mind, according to a statement. Likewise, both Credit Suisse and Standard Chartered announced in the spring their plans to expand fixed income teams in China.
Big mac bonds
Clearly, these developments are worth noting for US institutional investors looking for better options in China. But perhaps most notable for treasurers as well as fixed-income investors was August’s trailblazing move by McDonald’s, which became the first non-financial foreign company to issue renminbi (RMB)-denominated bonds. Although small ($29mn), the sale was made possible by China’s rule changes in February allowing just such a transaction.
One banker described yuan bonds as a great opportunity if a company has RMB business, because “it allows you to match your currency to the debt, which is potentially more efficient than using the FX swap market given future/spot inefficiencies in the RMB.” The rub is that “you can’t do the transaction onshore yet, which means you still need approvals to get the RMBs into mainland China.” This being allowed could be one-to- five years away, he added. It also probably is not worth the trouble for smaller amounts unless it can become repeatable, e.g., as part of an RMB CP or MTN program.
Still, for all those doing business in China it is a positive sign that this deal got done, as it is another step in the direction of China opening up its FX and capital markets. But companies should think carefully before embarking on a MacDonald’s-like journey. Because the path right now is only for companies that know they can attract investors, handle the documentation and have good working relationships with SAFE, the People’s Bank of China and the Ministry of Commerce.
Cracks in the Wall
While all of the latest news surrounding China’s nascent bond market may sound encouraging, there are still weaknesses in the infrastructure.
Reliable sources for pricing remain deficient. The lack of maturity in the fixed income market and the operational infrastructure results in less liquidity than what US investors are accustomed to.
And, although bludgeoned in the US in recent years, the lack of widespread adoption of credit ratings leaves investors with extra uncertainty. However, if this rate of modernization continues, these weaknesses will likely be overcome with expedience.