Panda bonds set to take off

Category: Asia, China, Hong Kong, Global
By Natalie Leung

Market to benefit from increased demand for China debt

Panda bonds, renminbi (RMB)-denominated debt sold by foreigners on the Mainland, are drawing interest with growing global demand for Chinese bonds, but regulations remain a matter of concern for foreign issuers looking to tap the country’s onshore bond market, the world’s third largest.

Introduced in 2005, Panda bonds are just a small fraction of China’s onshore bond market. Only 78 of the more than 15,000 bonds in the market are Panda bonds, according to Eric Liu, portfolio manager of fixed income at Manulife Asset Management.

However, the Panda bond market is expected to show increased momentum in a low global interest rate environment.

“The global interest rate environment is still very low relative to China, and investors will be able to increase yield returns by investing in Panda bonds,” says Dr. Sean Chang, head of Asian debt investment at Barings.

Issuing Panda bonds will be more manageable as interest rates on the Mainland are expected to remain stable compared to the US, which is tightening monetary policy, he adds.

Global issuers have long been looking for different markets to raise funds while diversifying their investor base, and China is a key focus because of its size.

China accounts for a significant portion of global sales for many foreign companies, which means they have huge financing needs in the country to operate their businesses.

“Directly raising funds in RMB can mitigate some of their concerns over risk management and capital requirement, as financing in other currencies incurs greater uncertainties and higher costs,” says Mr. Liu.

Currently, about 19 trillion RMB (US$2.75 trillion) of financing is raised through the bond market in China, compared with $110 trillion RMB from bank loans, according to Mr. Liu. By contrast, 50% or more of financing in other countries is raised via the bond market, so “there is still much room in the China bond market to grow, and the demand to finance in (the) bond market in huge.”

He continues: “We estimate after China’s inclusion in major global bond indexes, the 36 OECD (Organisation for Economic Co-operation and Development) member countries will have investment needs [totalling] US$1.1 trillion in Chinese bonds for their pension and private investment, which will lift issuers’ incentive to sell bonds in (the) China bond market,” says Mr. Liu.

China has already been included in some major global bond gauges, mostly recently in four of Citibank’s indices and Bloomberg’s new fixed-income indices

“However, it is important to note that in terms of the overall impact on demand, the indices that have included China onshore [bonds] may not have a material impact yet,” says Jamie Grant, head of Asian fixed income at First State Investments. “Yet, it is an important step and one we believe will continue.”

Investors’ interest also hinges on the stability of the RMB. Although its devaluation in 2015 caught many by surprise and resulted in slower demand, Mr. Grant sees a sustained period of stability in the currency as a trigger point for flows to return.

Foreign participation still comprises only a tiny fraction of China’s total onshore bond market. The size of issuances remains relatively small due to issues such as differences in auditing and accounting standards, credit rating, and the use of funds raised, according to Alicia Garcia Herrero, Asia Pacific chief economist at Natixis. “The challenges still persist,” she says.

However, the Panda bond market has been catalysed by the relaxation of regulations last year, especially for overseas Chinese companies that are familiar with Chinese accounting standards, Ms. Herrero says. She adds that Chinese regulators have also been more accepting of non-Chinese accounting standards.

“As the market is still small and not as mature as others, it takes time for the market to justify if the price is a fair value,” says Mr. Liu, who expects the Panda bond market to grow 5%-10% in the next two-to-three years.