Chinese Yuan’s Growing Clout Spurs ‘Panda’ Bonds

'Pandas' could swallow up Hong Kong bond market, hurt foreign banks
By Fan Yu
Fan Yu
Fan Yu
Fan Yu is an expert in finance and economics and has contributed analyses on China's economy since 2015.
December 13, 2015 Updated: December 15, 2015

As the yuan takes further steps to become a global currency, the ways in which Chinese and foreign governments, banks, and corporations plan to use the currency are becoming clearer.

The bond market received a jolt recently, as South Korea declared it would become the first sovereign issuer of yuan-denominated bonds—also known as panda bonds—in China’s onshore financial markets. The three billion yuan ($465 million), three-year bond could close as soon as Tuesday, Dec. 15.

The announcement comes two weeks after the International Monetary Fund (IMF) decided to include the Chinese yuan in the basket of reserve currencies backing its special drawing rights.

Korea Dives In

South Korean government officials marketed the bonds to Chinese investors in Shanghai and Beijing this month. “The Korea and Shanghai stock exchanges agreed to research to link stock and bond trading as a longer term project,” according to the Korea Exchange in a statement.

Korean officials say that the issuance should serve as a pricing benchmark for Korean companies looking to issue debt in China going forward. China is South Korea’s single biggest trading partner.

Other governments are also close to issuing panda bonds. Canadian province British Columbia—home to half a million ethnic Chinese—is also contemplating onshore Chinese bonds. The province received Beijing’s approval for up to a six billion yuan issuance.

Financial Institutions Take Lead

The International Finance Corp., which is a unit of the World Bank, and Asian Development Bank issued the first panda bonds in 2005, raising a combined 2.2 billion yuan ($350 million).

China’s $6.8 trillion onshore bond market—the world’s third largest behind the United States and Japan—could be an important funding source for banks and companies doing business in China.

But bond issuances have been muted, with a total of $1.8 billion raised in the panda bond market to date, according to Dealogic, a financial software company. Outside of those international financial institutions, German automaker Daimler AG was the only other issuer, with a 500 million yuan private placement in 2014.

It’s not for lack of trying. China’s bond market has been largely closed off to foreign issuers. The People’s Bank of China (PBoC) and a slew of other regulatory bodies first drew up the rules in 2005, which had extremely strict requirements on what type of institutions were allowed to issue debt in China. Those rules are being loosened today as Beijing looks to boost investments and promote international use of its currency.

On Dec. 8, the PBoC gave approval to two Hong Kong-based financial firms, HSBC and Bank of China (Hong Kong), to issue 1 billion yuan and 10 billion yuan, respectively, in panda bonds.

“The central bank’s approval for one of the first issuances of its kind by a foreign financial institution could signal the opening up of an alternative source of funding,” Helen Wong, HSBC’s chief for Greater China, said in a statement.

Chinese regulators began lifting restrictions this year. In July 2015, the PBoC announced that foreign central banks, sovereign wealth funds, and other multinational financial firms would no longer need the central bank’s preclearance to invest in China’s interbank debt market, such as trading bonds, interest-rate swaps, and repurchase agreements.

That announcement later paved the way for foreign financial firms to issue bonds in China’s panda bond market for the first time.

Panda Versus Dim Sum

Why is Beijing just now opening the panda bond market to foreign firms? Yes, it will give its currency more international exposure, but another major reason is to boost China’s economy.

Approval of the banks’ panda bonds comes at a time of turmoil in Chinese financial markets. The Shanghai Composite Index, China’s biggest equities benchmark, has dropped almost 40 percent since peaking in June, while the country’s 10-year government bond yield has declined from 3.66 to 3.30 percent.

Confidence in the nation’s economic growth is floundering, with unofficial third-quarter GDP growth estimated to be between 2 and 5 percent. The PBoC cut interest rates five times in the last 12 months to spur growth.

This is a prime environment for multinational companies looking to issue yuan-denominated debt. Previously, firms seeking to sell yuan-denominated bonds looked to the offshore market, specifically in Hong Kong, which saw a huge uptick in yuan bond offerings after Beijing approved channels for capital flow between Hong Kong and Shanghai last year. These offshore yuan bonds are referred to as dim sum bonds.

Analysts believe such dim sum issuers are prime candidates to jump into the panda bond market going forward. “It’s very similar to the initial stage of the dim sum market when we saw a lot of interest from issuers trying to be the first ones to issue, mostly because of positive publicity,” Ivan Chung, head of Greater China credit research at Moody’s, told Global Capital.

The key to panda bonds taking off is whether China will lift capital flow restrictions, by allowing firms to redeploy debt proceeds abroad.

“The dim sum market, for example, that is mostly an arbitrage market in which most issuers will swap the proceeds back to U.S. dollars and redeploy them offshore,” said Chung.

“It’s unclear with the proceeds from a panda bond whether that is possible because of the tight capital controls.”

For multinational corporations, it’s cheaper to issue directly in China than Hong Kong. For China, a surge in panda bonds provides more liquidity, diversification for investors, and higher revenues for local Chinese governments and investment banks. More importantly, it’s another feather in the cap for boosting Beijing’s global yuan ambitions.

As such, experts believe that capital flow controls will be relaxed sooner rather than later. The PBoC expects to release more detailed guidelines by the end of the year. The panda bond prospectuses of both HSBC and Bank of China (Hong Kong) state that proceeds would be deployed overseas for foreign operations.

If that’s the case, it could be a death knell for the dim sum market in Hong Kong.

And that is bad news for the city’s financial sector, the overall CNH (offshore yuan) market, and the foreign banks—many of which were urged by Chinese authorities to help develop the Hong Kong offshore yuan market years ago.

Fan Yu
Fan Yu is an expert in finance and economics and has contributed analyses on China's economy since 2015.