China's Panda-Bond Boom Threatens Dim Sum Market Survival

The bond market’s penchant for nicknames for overseas debt markets sets up an irresistible metaphor for the phenomenon: pandas are eating dim sum. Sales of Panda bonds -- the yuan-denominated debt issued in China by overseas companies -- are outpacing Hong Kong’s Dim Sum market this year, boosted most recently by Hungary selling its first onshore note after previously issuing in Hong Kong, according to Bloomberg.

While Hong Kong retains an important role in the internationalization of China’s markets -- not least because of new "connects" allowing trading of onshore stocks and bonds in the city -- its role as an offshore yuan center may be limited. The Dim Sum market started fading in 2015, with a slump in the yuan’s exchange rate diminishing its appeal. Efforts by Chinese authorities to bar speculators from making bets against the currency in the offshore market also decimated liquidity in the city’s incipient money market.

"The offshore yuan bond market is destined to wither away -- it was a transitional product," said Han Tongli, chief investment officer in Hong Kong at DeepBlue Global Investment Ltd., who previously worked at Pacific Investment Management Co. "The onshore market offers a lot more variety in terms of bond types and terms, and at the same time has much better liquidity."

What’s changed is China’s progressive opening of its bond market to foreign investors, including last month’s Bond Connect program allowing purchases of onshore bonds via Hong Kong with less of the paperwork required on the mainland. That’s also boosting the attraction to issuers of Panda debt -- with Portugal, the Philippines and Belarus among sovereign issuers planning to tap the market.

• Panda bond issuance has totaled almost 48 billion yuan ($7 billion) so far this year, versus 27 billion yuan in offshore yuan debt -- a universe that’s mainly Dim Sum, but also includes the small Formosa bond market in Taiwan
• A legacy of Dim Sum issuance from the boom years means offshore yuan debt outstanding is still bigger, at about 431 billion yuan compared with 179 billion yuan.
• Offshore issuance peaked in 2014, when it reached 297 billion yuan
• Even China’s Ministry of Finance is souring on Dim Sum, halving its sales in Hong Kong this year compared with the pace in 2016

The Dim Sum market’s downfall is echoed in the shrinking pool of offshore yuan in Hong Kong -- known by the designation CNH, to distinguish from CNY, the onshore yuan. CNH deposits have tumbled to a six-year low this year.

Illiquid Market

“The real problem is the decline of Dim Sum bond liquidity,” said Becky Liu, head of China macro strategy at Standard Chartered Plc in Hong Kong. She explained that, given the potential difficulty of finding buyers in an illiquid market, it diminishes demand for the securities in the first place.

It’s all part of the evolution of China’s yuan internationalization. The Dim Sum market kicked off in 2007, two years after China ended its decade-old fixed yuan peg to the dollar, and climbed as issuers were drawn to the currency of an economy that at the time was still growing well in excess of 10 percent a year.

The Panda market, meantime, remained moribund for years, held back by reluctance outside the official development bank community to dive into a market that lacked much foreign participation and had convertibility questions. Starting in mid-2015, China began a broader opening of its onshore debt market -- part of what’s become a lopsided liberalization of its capital account. (Read more about that here.)

Still Demand

Until there’s a full opening of China’s capital account, there will probably still be a market for Dim Sum securities, said Edmund Harriss, a London-based fund manager at Guinness Asset Management Ltd., which has $1.3 billion assets under management.

"Foreign buyers of corporate bonds may prefer the offshore market where disclosure is better and where the improvement in bond structures has been significant over the last five years," Harriss said.

More broadly, prospects for overseas issuance of yuan bonds depend on the outlook for the exchange rate, investors said. China has benefited from a weaker dollar this year, which has seen the yuan end three years of depreciation. The currency is up 3.8 percent this year.

"The yuan has to stabilize if the authorities want the Bond Connect program to be successful," said Han, who helps oversee $200 million at DeepBlue Global and has 20 percent exposure to yuan debt.