International Investors Wary of Onshore RMB Bonds

Shanny Basar

Many international investors are still hesitant of buying Chinese onshore bonds, according to index provider FTSE RusselL, despite regulators making it easier to access the third largest bond market in the world.

International investors can now trade onshore bonds directly through banks with a Type A licence, held by 13 Chinese banks and four foreign banks – BNP Paribas, Deutsche Bank, HSBC, Standard Chartered – in addition to the existing quotas.

FTSE Russell said in a China bond research report that many international market participants are still wary of buying onshore renminbi bonds due to China’s slowing economic growth, a depreciating renminbi, and unresolved questions about the Chinese government’s role in managing how market forces develop via its ambitious financial reform program. In addition there are also many  questions about the transparency of China’s regulatory regime and the methodologies of its credit ratings agencies.

Michael Chow, head of international business at Fullgoal Asset Management (HK), said in the report: “From the investment structure perspective, the majority of allocations are driven by sovereign bonds, followed by interest rate bonds – together totalling to over 90% – while participation in corporate bonds and medium term notes remains insignificant.”

Chow added the credit spread in the current onshore market is very narrow while the appeal of corporate bonds is limited and the quality of domestic enterprises is hard for foreign investors to appraise.

This month the renminbi became included in the IMF’s Special Drawing Rights reserve currency basket, the first emerging markets currency to gain global reserve currency status.

Jan Dehn, head of research at Ashmore Investment Management which specialises in emerging markets, said in a report: “In years to come it will also be seen as the day the RMB embarked on its long journey to become the world’s pre-eminent global reserve currency.”

Standard Chartered Bank (Hong Kong) became the first commercial issuer of SDR bonds in China after pricing one-year bonds denominated in SDR this week. In August the World Bank became the inaugural issuer in the Chinese domestic market of SDR bonds.

Jim Yong Kim, president of the World Bank Group, said in a statement: “This is a landmark development for China’s bond market and for the SDR as an international reserve asset. It will also increase Chinese investors’ access to foreign currencies in the domestic bond market, while opening up new opportunities for international investors seeking high-quality investment products in the country.”

Ben Yuen, head of fixed income at BOCHK Asset Management Limited, the investment arm of the Bank of China, said in the FTSE Russell report that the SDR bond issuance is a further step in opening China’s capital markets to international investors.

Chow said in the FTSE Russell report that SDR bonds are still in their initial stages.

“Their advantage lies in possessing sovereign credit while reducing the foreign exchange fluctuation risks in a single currency by having a US dollar asset allocation,” added Chow. “The main problem remains that the current issuance scale is small, with poor product type liquidity anticipated. In addition, some domestic institutions do not have many foreign currency asset positions and face technical issues such as long-term valuation.”

Dehn said RMB’s inclusion in the SDR is particularly important for central banks, which now have access to a reserve currency, whose integrity is not undermined by quantitative easing and where the government in question pays positive nominal and real yields on its bonds.

He continued that financial markets prefer to benchmark themselves against the largest and most liquid markets, which is why the US replaced the UK as the global benchmarks for fixed income and currencies in the interwar years, where the US economy dramatically outpaced the UK economy.

“As China continues to gain clout her government bond and currency markets will catch and then overtake US markets eventually to emerge as the most dominant reference markets for global investors,” Dehn added .

He argued that Global investors are not paying enough attention to, and perhaps not fully understanding, the seriousness and profundity of China’s economic reform efforts.

Dehn said: “While reforms create a great deal of uncertainty, which in turn results in postponement of consumption and investment decisions – and hence slows the rate of economic growth – it is critical to bear in mind that the reforms also hold the key to high sustained growth in China for decades to come, especially when the full ramifications of myopic policies in the West become evident.”

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