Hong Kong's Dim Sum Bonds: Feast or Famine?

At the Asian Financial Forum 2011 in Hong Kong in January, Financial Secretary John Tsang toasted dignitaries and other guests at the cocktail reception and then took the stage to talk about – dim sum.

 
Not the tasty, bite-sized snacks that office workers typically consume for a hurried meal, but a new financial instrument denominated in renminbi.
 
“In the past year or so, the term ‘dim sum’ has taken on a whole new connotation in the form of the so-called ‘dim sum bonds,’” Tsang explained. “It is the nickname given to bonds denominated in renminbi and issued in Hong Kong . . . This new financial instrument was born out of the necessity to internationalise the Chinese currency in the current climate of financial opening up and reform on the Mainland.”
 
For CFOs, there’s a lot of yuan in Hong Kong to tap, and the pile continues to grow. Some 300 billion renminbi (US$45.5 billion) is currently sitting idle in Hong Kong’s banking system, earning next to nothing in interest but still expanding as much as 45% month-to-month in the last quarter of 2010, according to Moody’s Investors Service.
 
Some savvy finance chiefs have jumped in. Last August, McDonald’s issued an investment-grade two-year dim sum bond that paid just 3% a year. Three months later, earth-moving equipment maker Caterpillar floated a 2%-per-annum dim sum that raised the equivalent of US$156 million. The issue sold out within 20 minutes and was seven times oversubscribed.
 
At the moment, it’s looking distinctly like a bond seller’s market. “High demand from, for example, private banking clients, has frequently led to oversubscription . . . as supply has failed to keep up,” Moody’s observes in a report. As of January this year, dim sum bonds have soaked up just 66 billion renminbi (US$10 billion) of the yuan deposit base, less than a quarter of the total.
 
Even sub-investment grade names are finding eager buyers. In December, Hong Kong casino operator Galaxy raised the equivalent of US$207 million on a junk bond (rated B3 stable by Moody’s) that had a yield of around 4.6%. In contrast, MGM Resorts International is paying more than twice that in annual interest on its US dollar debt.
 
Case-by-Case Basis
In theory, any company can issue a dim sum bond. “For offshore RMB financial instruments, there is very light regulation,” says Ivan Chung, who is Vice President and Senior Analyst at Moody’s. “And so, as long as there is a market and investors are willing to buy, any organization can issue a dim sum bond.”
 
The problem is how to bring back the yuan proceeds to China. McDonald’s, Caterpillar and other companies that have issued dim sum bonds had to apply to the Chinese government to be allowed to do so.
 
Again in theory, such approval should not be too difficult to obtain, because it is to China’s interest that the foreign direct investment flooding into it should already be sterilized and therefore will not contribute to inflationary pressures. That’s because the monetary authorities would not need to issue more renminbi, which they would need to do if the FDI were in US dollars.
 
Still, it is always complicated to deal with the bureaucracy in China, especially because there are no set rules in place. “As of now, the regulatory framework is not so clear,” says Gary Lau, Managing Director, Corporate Finance, at Moody’s. “Approval [to bring renminbi back to China] is on a case-by-case basis.”
 
The process is similar to bringing foreign exchange to China, but "is less straightforward and may take 4-8 weeks," notes Bank of America Merrill Lynch in a report. The dim sum proceeds are typically repatriated trhough shareholder loans or equity injection, subject to regulatory approvals.
 
Even if a company gets the green light, it will have to content itself with short-dated offerings. So far, the only long-dated dim sum is an issue by triple-A-rated Asian Development Bank, which raised the equivalent of US$181 million in October on a ten-year bond. For corporates, the typical tenure is two to three years, which is roughly the time frame that investors reckon the RMB will appreciate.
 
Many of the 2.2 million renminbi bank accounts in Hong Kong were created basically to bet on a strong appreciation of the renminbi against the US dollar (and therefore against the Hong Kong dollar, which is pegged to the greenback). Some analysts say that the Chinese currency is undervalued against the US dollar by as much as 30%.
 
Synthetic RMB Bonds
Some issuers have opted instead to float synthetic instruments, which are denominated in renminbi but settled in US dollars or Hong Kong dollars. This neatly makes moot the need to bring back the proceeds to China.
 
Last year, Chinese developers Kaisa Group and Shui On Land issued synthetic RMB bonds. In January, China SCE Property issued a synthetic, five-year RMB2-billion bond with an annual yield of 10.5%, which is lower than the 14.5% on a five-year USD bond issued by China South City on the same day.
 
“Synthetic RMB bonds have enjoyed strong demand from Asian and global players invested in US dollars and betting on the appreciation of the RMB,” notes Moody’s. “These bonds transfer from the issuer to foreign investors the financial return of a presumed appreciation in China’s currency in return for an assured, lower cost of funding. As a result, the bond yields or coupons are lower on synthetic RMB bonds than on their plain-vanilla, USD-denominated equivalent.”
 
The risk for the issuer is that the renminbi will have depreciated, not appreciated, against the US dollar when the bond matures (and the Chinese currency becomes fully convertible), and so it would have needlessly locked itself into a much higher exchange rate. Then again, provided the offering was appropriately structured, the issuer would have enjoyed the benefits of a lower cost of funding in the interim and reaped profits on the investments made.
 
If market conditions allow it, some issuers may be able to do a dim sum bond and convert the proceeds into foreign currencies, using the money for investments outside of China instead of onshore.
 
What may those ideal market conditions be? Says Moody’s: “If coupons remain comparatively low on dim sum bonds, if a buy-side consensus of an appreciating currencies RMB currency continues, and if conditions for swapping currencies prove favourable, more issuers without RMB-funding requirements may raise money via dim sum bonds – not to use the proceeds onshore in China, but merely to swap their dim sum proceeds into US dollars at an overall, lower funding cost.”
 
Window of Opportunity
Should your company partake of Hong Kong’s dim sum feast? As always, the answer depends on the enterprise’s particular circumstances and objectives. Given their generally short tenures, dim sums may not be palatable to CFOs with long-term funding needs, for example.
 
If dim sum or synthetic RMB bonds fit into the CFO’s corporate financing agenda, however, it is probably best to do an issue sooner rather than later. New avenues for renminbi funds may appear, such as renminbi-denominated initial public offerings (IPOs), which can divert interest from fixed-income instruments.
 
The current expectation of a hefty appreciation in the exchange rate can also be turned on its head if China stubbornly holds the line against US pressure. There is no shortage of warnings from experts against such an appreciation.
 
It is “a no-no for China, the worst possible thing,” Columbia University economics professor Robert Mundell, who won the Nobel Prize for Economics in 1999, told participants at the Asian Financial Forum 2011. “A big appreciation would create deflation, aggravate poverty in the western part of the country and in the rural areas. It would be something that would in the long run come back to haunt China.”
 
All these issues should be on the table when the CFO meets with investment bankers and other corporate finance specialists, perhaps over char siu bao and chicken feet in black bean sauce.
 
About the Author
Cesar Bacani is Editor-in-Chief of CFO Innovation.
 

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