The market for public sector and corporate bonds in Hong Kong's offshore renminbi market hit boom mode in about July 2009. The Chinese government removed some currency restrictions, and issuance accelerated. But the effect was only fully articulated in 2010, when RMB140 billion ($22 billion) in bonds were printed, from RMB40 billion the previous year.

Even with recently sharp volatility, the market is on track this year to better 2010's number by about RMB60 billion.

Traditional asset-backeds have yet to debut in this market, and players say it may be some time before they do. However, conditions for their introduction are ripening. Indeed, the debut last month of this market's first sukuk and the issuance of bank-guaranteed transactions show that already issuers are fanning out from plain vanilla.

The Teething Years

The offshore renminbi market, also known as the dim sum market, can be dated back to December 2003, when China and Hong Kong allowed Hong Kong's banks to provide retail service in RMB to local residents, according to Ivan Chung, senior analyst in the corporate finance group at Moody's Investors Service in Hong Kong.

The Chinese government allowed onshore financial institutions to issue RMB bonds in June 2007 and extended this to corporates in 2008. The door eventually opened to foreign institutions as well.

But a particular rule change in mid-2009 proved to be a major inflexion point.

"At that time, the Chinese government permitted the settlement of cross-border import/export trade in RMB in selected Chinese cities, Hong Kong and ASEAN [Association of Southeast Asian Nations] countries," Chung said.

That way, China's trading partners could hold RMB offshore, which boosted deposits in the currency, which reached RMB572 billion last July, or about 10% of total deposits in Hong Kong, according to Chung.

"Before then offshore investors weren't allowed to touch RMB," said Tee Choon-Hong, regional head of capital markets for Northeast Asia at Standard Chartered Bank. "[Since then] professional investors can set up dedicated RMB funds and buy the currency in the spot market to facilitate these deals."

Moody's estimates that issuance totaled RMB142 billion this year up to mid-September, with a total outstanding of RMB187 billion.

Growing Diversity within Limits

While issuers have come from a variety of sectors, debt has been overwhelmingly plain vanilla. Issuers have included China's ministry of finance, a double-A minus credit, and the multilateral Asian Development Bank (ADB), which is triple-A. Multinationals such as McDonald's, Caterpillar, Texaco and BP have also tapped the RMB market, apart from Chinese companies, sources said.

"In record time the market has grown both in terms of volume and the variety of issuers, from high-grade to the more high-yield types," said Choon-Hong. He added that the RMB bond market is "already larger than the Singapore dollar market and almost double the size of the Hong Kong dollar market."

As a relatively green market, tenors tend to be short and sizes small, at least by developed countries' standards. As of mid-September, more than 80% of the dim sum market consisted of deals of three years or less, with tranches typically under RMB2 billion, according to Chung. He said investors are primarily commercial banks with RMB deposits, private banking clients and select institutional investors. "This relatively short-term focus of buyers has made the dim sum market less attractive to issuers in need of longer-term funding," Chung said. He added that the absence of long-dated offshore RMB liabilities is part of why investors shy away from longer-term deals.

Choon-Hong said deals can go as long as five or seven years - and both the Chinese Ministry of Finance and the ADB in typical curve-creating fashion went out to 10 years - but the "sweet spot" of the market tends to be two to three years.

Many investors are also making bets on RMB currency appreciation rather than focusing on the credit, players said. Many swap back into their base currency, whether it is dollars or euros, but the swap market itself is nascent. Going out to two to three years, it is difficult to swap more than the equivalent of $50 million.

By and large, transactions have not been rated, but that is changing. "Investors have gotten more selective as the pipeline grew over the last couple of months," said Augusto King, co-head of debt capital markets Asia at Royal Bank of Scotland. "In the beginning of the year, investors were prepared to invest in high-yield types of credit without a rating [or...] a covenant package. Now investors prefer a rating, and they are looking for a covenant package."

In addition, the Chinese government continues to enact measures to fortify this market. Choon-Hong, for instance, said new rules passed only weeks ago by China's central bank and ministry of commerce offer guidelines to further facilitate the repatriation of offshore RMB FDI back onto the mainland.

First Sukuk

It is against this backdrop that the dim sum market has made baby steps into structured finance.

The first sukuk deal in RMB debuted on Oct. 13. Issued by Malaysia's sovereign fund Khazanah Nasional Berhad, the three-year deal totaled RMB500 million and priced to yield 2.9%, according to a press release by the institution. Demand led to an upsize from an initially planned RMB300 million. Over 35 accounts across Asia, the Middle East and Europe bought in. The joint lead managers were BOC International, Malaysia's CIMB Bank and RBS.

An e-mail to Khazanah seeking more details was not returned.

There have also been dim sum bonds with guarantees. StanChart, for instance, was an arranger on a three-year RMB900-million transaction for Hai Chao Trading Co., which was guaranteed by the Export-Import Bank of China. The issuer is a Honk Kong unit and trading arm of its onshore parent, Hangzhou Zhongce Rubber Co., the country's largest tire maker.

More Guarantees?

"Guarantees can provide additional support to a market by helping issuers who might not otherwise be able to tap the market to raise the funds they need," said Monish Mahurkar, principal treasury specialist at the Asian Development Bank. "There is currently a shortage of good-quality assets in the offshore renminbi bond market, so guarantees might spur a greater supply."

Some players said more elaborate structured finance deals such as true asset-backeds may require more time before coming into this market.

Prospects for Structured Finance

Jerome Cheng, senior credit officer at Moody's structured finance group in Hong Kong, pointed out that the onshore structured finance market has been quiet in China over the past few years, with only one transaction in 2011.

"As the second-largest economy in the world, the potential for structured finance issuance in China is huge," he added. "The question is more on timing - that is, when will the market take off? At the moment, some basic elements are lacking, such as a supportive legal and tax regime, approval from regulators, interest from investors and incentives to issuers."

RBS's King said that on the regulation side the dim sum market was ready for structured finance deals. "The offshore RMB market operates under the same framework as in other currencies," he added. "The key is whether there is liquidity and the type of credits and underlying [collateral] to make it work."

StanChart’s Choon-Hong pointed out that documentation in the market is fashioned after Reg S, with similar disclosures but he noted other barriers. “With the [dollar-renminbi] cross currency still at its developmental stage, it will take more effort to execute swap driven transactions. While the market has grown rapidly over the last 18 months, we’re still at the early stages of this market development,” he said. “Until we’ve had more experimentation with various credits, we won’t move on to more structured products.” 

The fact that investors have only recently begun drilling down into credit fundamentals in the market means that it may take time for the buy side to develop the capacity or interest in performing the more detailed due diligence required in a structured finance deal that goes beyond a simple wrap, players said.

At any rate, if Chinese government policy continues to push for the internationalization of the currency and encourages local and foreign issuers to use RMB as a funding platform, then an evolution toward some kind of asset-backeds would seem to be in the cards.

"The dim sum market is at a nascent stage, and we'd expect structured finance products to develop over time," said ADB's Mahurkar. "Since Hong Kong is a well-regulated and well-developed financial center, it would be well placed to house an offshore market in renminbi structured finance products." 

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