Nicknamed “dim sum bonds” after Hong Kong’s favorite dining pastime, the securities are the hottest financial innovation in town.
“It’s probably the fastest-growing market I’ve seen in my career,” says Tee Choon Hong, a banking veteran now at Standard Chartered.
Dim-sum bonds have come into their own this year. The first dim-sum bond was sold by China Development Bank in July 2007. That maiden sale was a solid indication of China’s interest in promoting its currency in global trade and investment via yuan-denominated bonds: CDB is one of three banks in China responsible for raising funds for infrastructure projects such as the Three Gorges Dam and Shanghai Pudong International Airport.
Until July 2010, only Chinese and Hong Kong banks were allowed to issue bonds denominated in yuan, the basic unit of the renminbi. Now all banks can.
The surge in Hong Kong this year has been electrifying, says William Liu, a Hong Kong-based partner at Linklaters, an international law firm.
“The changes are so rapid that I have to amend my slides every time I give a presentation,” Liu says.
The appetite for dim-sum debt is one of the few bright spots in the Hong Kong economy. Gross domestic product edged up 0.1 percent in the third quarter from the previous months, compared with a 0.4 percent contraction in the second quarter, as Europe’s crisis created a drag on overseas sales.
Exports declined in September for the first time in two years. The Hong Kong stock market fell 21 percent in the third quarter, its worst run in a decade.
Donald Tsang, the city’s chief executive, said Nov. 12 that Hong Kong’s economy faces “some shocks” in coming quarters. The government lowered its estimate for the full-year expansion to 5 percent from a range of 5 percent to 6 percent in an August estimate.
Against this backdrop, the dim-sum bond boom has cheered bankers in Hong Kong, one of two former colonies designated as special administrative regions by Beijing. (The other is Macau.)
“The offshore yuan business offers one of the most exciting new opportunities for Hong Kong,” says Gina Tang, head of debt capital markets for Hong Kong and China at HSBC Holdings. “Banks are actively recruiting to build up their teams.”
Sales of dim-sum bonds rose from the third quarter of 2010 onward following a decision by the Hong Kong Monetary Authority to give companies greater freedom to sell yuan bonds.
At the same time, China made it easier for corporations to settle trades in the Chinese currency.
With Hong Kong’s currency — the dollar — pegged to the U.S. greenback and its near-zero interest rates set by the U.S. Federal Reserve, the former colony offers bargains for mainland Chinese visitors as well as borrowing costs that are lower than China’s, which were set at 6.56 percent in July.
That makes it advantageous for foreign companies with China operations to raise yuan in Hong Kong, says Augusto King, co-head of debt capital markets for Asia at Royal Bank of Scotland Group in Hong Kong.
Hedging dollar bets
Reflecting a trend, McDonald’s issued 200 million yuan of debt in August 2010, marking the first dim-sum deal by an overseas nonfinancial company.
Bond sales by Caterpillar, Volkswagen and Tesco, leading a charge of more than 80 issuers, could bring total sales to $36 billion this year, a sixfold jump from last year, according to HSBC. The lender forecasts dim-sum bond sales could total as much as 310 billion yuan in 2012.
Dim-sum bonds are a way for China to hedge its dollar bets. The world’s second-largest economy is promoting the use of yuan in global trade and finance because the weakness of the U.S. dollar may hurt its record $3.2 trillion in foreign-exchange reserves.
Dim-sum bonds also provide investment channels for yuan holders outside of China, paving the way for the yuan to be fully convertible and held by central banks as reserve currency, says Frank Song, an economics professor at the University of Hong Kong.
The dollar, held in large quantities by most governments in the world as part of their foreign-exchange reserves, is the world’s major reserve currency. If the yuan goes global, it’s less necessary for China to hold huge reserves, Song says.
As for Hong Kong, dim-sum debt helps it diversify its equities-focused financial market. The bond sales also bolster Hong Kong’s ambitions to become China’s main offshore yuan-trading center while fending off threats from rival financial centers in Asia.
Since Hong Kong returned to Chinese rule in 1997, the former British colony has steadily lost ground to regional competitors Shanghai and Singapore in terms of GDP.
In 2009, Shanghai’s economy exceeded the size of Hong Kong’s for the first time in at least three decades. In coming months, Singapore’s GDP is expected to reach $254 billion compared with Hong Kong’s $245 billion in inflation-adjusted terms, according to International Monetary Fund estimates.
Speculation by investors betting that the yuan will appreciate against the dollar is fueling demand for dim-sum bonds from those unable to access mainland markets.
Yuan deposits in Hong Kong totaled 622 billion yuan in September, up 98 percent from December. That provided a ready pool of funds for investment. By comparison, savings in Hong Kong dollars fell 0.2 percent in the same period.
Hong Kong’s income as a yuan offshore center will expand as Chinese currency deposits in the city increase to 2 trillion yuan by 2014, Deutsche Bank’s chief China economist Ma Jun estimates. Growth in yuan bond sales is expected to add 30,000 financial jobs in Hong Kong in five years, Ma says.
Chinese government policy promotes Hong Kong’s position as a yuan offshore center. “The central government will actively support the growth of the renminbi market and the innovation and development of offshore yuan financial products in Hong Kong,” Chinese Vice Premier Li Keqiang said in August.
Li pledged to allow more Chinese firms to sell yuan bonds and to encourage foreign direct investment in yuan.
As of Nov. 14, Standard Chartered’s Tee had concluded 45 dim-sum bond deals out of Hong Kong; that’s more than the total number of yen, dollar and euro transactions done by Standard Chartered in the entire Asia-Pacific region, excluding Japan.
Debt is not the only yuan-denominated security on offer in Hong Kong.
In April, the city’s richest man, business magnate Li Ka-shing, sold units of Hui Xian Real Estate Investment Trust, the city’s first stock denominated in yuan. He raised $1.6 billion.
Hong Kong Exchanges and Clearing, the stock exchange, says it’s targeting more initial public offerings by year’s end and will allow listed companies to sell shares in yuan. In October, Hong Kong’s Chinese Gold & Silver Exchange Society, a century-old bullion bourse, started trading gold quoted in yuan.
It’s natural that Beijing would pioneer yuan bonds in Hong Kong, given the former colony’s history.
In 1992, five years before the handover to China, Hai Hong Holdings was the first Hong Kong-incorporated Chinese enterprise, or red-chip firm, to list its shares on the city’s exchange through an IPO. A year later, Tsingtao Brewery, the country’s second-largest brewer, became the first China- incorporated company to trade on the exchange.
In 2005, Bank of Communications went public in Hong Kong, making it the first Chinese bank listed outside the country.
“Hong Kong is a unique place for the experiments and initiatives to promote yuan as a global currency because it’s much closer to the international financial community,” Tee says.
Yuan-based trade is a step toward a fully convertible Chinese currency, which is what the United States and Europe are demanding from Beijing as a condition for the renminbi to be part of the IMF basket of reserve currencies restricted to the dollar, euro, yen and pound.
People’s Bank of China Governor Zhou Xiao-chuan has said that while there’s no timetable for convertibility, the offshore yuan market is developing faster than the central bank anticipated.
About 9 percent of China’s trade in the first half of this year was settled in yuan, according to the Hong Kong Monetary Authority. Hong Kong now handles more than 80 percent of China’s trade settled in yuan.
Under China’s latest five-year plan, Hong Kong will continue to develop as the world’s most important yuan-trading hub. Chinese officials told European Union business executives that the yuan will be fully convertible by 2015, European Union Chamber of Commerce in China President Davide Cucino said Sept. 7.
The embrace of yuan-denominated debt in Hong Kong hasn’t gone entirely smoothly. Dim-sum bond sales slowed in July after Muddy Waters, a short-seller, said some Chinese companies, including the forestry company Sino-Forest, may have exaggerated assets and finances, which led to concern among investors about the ability of firms to repay loans.
Yuan bond sales revived in the following month, boosted by the Chinese Ministry of Finance’s sale of 20 billion yuan in bonds and by Beijing’s pledge to allow easier transfer of funds across the border.
Also, Hong Kong may have to contend with competition from Singapore, which is also looking to offer yuan products, according to King.
Singapore this year surpassed Tokyo as the busiest market for currency trading in Asia. Average trading volumes rose to $314.2 billion in April, higher than Tokyo’s $277.9 billion.
An international player
Shanghai aspires to be the nation’s international financial center by 2020, while London is eager to build up its own offshore yuan-trading capability.
Furthermore, dim-sum bonds haven’t been immune to the recent global market rout.
In these adverse conditions, investors are demanding additional protection for holding the securities. The average yield on yuan-denominated bonds has risen 57 basis points to percent since the beginning of September. It reached a record at on 3.837 on Nov. 3. (A basis point is 0.01 percentage point.)
None of this has diminished the prevailing optimism among bankers and investors in Hong Kong.
The number of banks arranging dim-sum bond sales in Hong Kong totaled 36 as of Nov. 14; for all of 2010, the number was 14. Underscoring the internationalization of the business, HSBC overtook Bank of China as the top underwriter of the securities this year.
“Yuan internationalization will be one of the most important episodes of Hong Kong’s history in the next 20 years,” Song says, inevitably serving up a culinary metaphor. “With more issuers tapping the market, dim-sum bonds will become big meals for many.”
The full version of this Bloomberg Markets article appears in the December issue.