Hong Kong has long promoted itself as China’s route to international financial markets. Now the territory has become the international financial community’s means of getting exposure to China’s currency.
Largely due to Beijing’s efforts to keep idle money offshore – rather than have it contribute to already worrying levels of asset price inflation on the mainland – Hong Kong has become a popular location for renminbi-backed bond issues.
Caterpillar (CAT.NYSE) is the latest US blue-chip multinational to get involved, selling US$150 million in notes due in December 2012 with a 2% coupon. The machinery manufacturer is following in footsteps initially cast by McDonald’s (MCD.NYSE), which in September became the first foreign company to issue bonds in Hong Kong.
So far, about US$6.2 billion in renminbi bonds have been issued in Hong Kong, mostly by Chinese state-owned enterprises, according to Bloomberg. In comparison, the pool of renminbi deposits in Hong Kong more than doubled in the six months through September to US$22.4 billion.
There is clearly pent-up demand for renminbi-backed debt in Hong Kong – with investors looking for steady returns as much as opportunities to take advantage of currency appreciation. This demand will likely be amplified in the next few months following Beijing’s decision to halt preparations for a program that would allow brokers and fund managers to raise renminbi funds in Hong Kong and put it into mainland equities.
The “mini QFII” scheme – so called for its similarities to the Qualified Foreign Institutional Investor program, as yet the only official channel through which overseas investors can gain exposure to mainland-listed equities – had been scheduled to debut by the year end. Pausing it in favor of developing an offshore debt market for the Chinese currency speaks volumes for the government’s concerns about a massive influx of money to the mainland market.
For now, Beijing wants to gauge the foreign appetite for renminbi via bond issues in Hong Kong.
Just before Caterpillar’s debt sale, the Ministry of Finance said it would sell US$1.2 billion in notes at the end of November with mixed tenors of up to 10 years. This was essentially an attempt to establish a benchmark yield curve in Hong Kong. The ministry’s only previous bond issue in the territory was a US$902 million sale in October 2009.
All parties involved seemed happy with the arrangement for the time being.
For issuers, strong demand for the renminbi debt in Hong Kong helps lower borrowing costs. China Development Bank in December sold US$451 million in renminbi-denominated bonds at 2.7%, 38 basis points cheaper than a US$3 billion sale on the mainland in October.
For investors, the bonds are low risk and deliver steady returns. HSBC (HBC.NYSE, HSBA.LSE, HSB.Euronext, 0005.HK) now offers an annual interest rate of 0.71% on deposits of RMB500,000 [US$75,180] or less. According to Bloomberg calculations, an investor who bought China’s one-year offshore bond a year ago would have earned a return of 2.7%.
As for the governments involved, Beijing has secured a means of absorbing some of the speculative funds targeting the renminbi while Hong Kong has developed a new business line. However, some issues must be dealt with before the territory can consolidate its position as an offshore center for China’s currency.
Perhaps most important, there may be a demand glut for renminbi bonds, but there is shortage of supply. For all the fuss about McDonald’s and Caterpillar, only a few foreign firms have publicly shown their interest in the program. Wal-Mart (WMT.NYSE) said it March that it was considering selling renminbi-backed bonds and United Company Rusal (0486.HK) confirmed in September that company executives met with bankers to learn about the market.
Neither firm has followed up on these initial expressions of interest.
A key concern among corporations may be that Beijing will wield considerable influence over the use of the proceeds from any bond issue. Caterpillar reportedly has obtained government permission to transfer its newly raised renminbi funds to the mainland in order to support the creation of a leasing unit. Beijing would much rather see money enter the real economy than come onshore merely to chase property and equities.
Furthermore, the government is unlikely to condone converting any renminbi proceeds into to other currencies – so perhaps only those companies with immediate plans for mainland expansion will be interested.
The big question is whether Hong Kong can sustain its bright start in renminbi-backed bond issuance.
Liquidity is a problem, with many investors preferring to hold the debts – based on expectations of further renminbi appreciation – instead of trading them. There is also policy uncertainty, as no one knows when Beijing will resume the mini-QFII scheme, which would draw funds away from the debt market. A small-scale trial program in the first half of 2011 is the best bet.
Finally, Shanghai looms on the horizon. The city is gearing up to establish an international board and it has been lobbying the central authorities to approve the sale of renminbi-denominated shares by foreign firms as early as next year. The Shanghai Stock Exchange is also seeking government support for an exchange-based bond market. If the city gains regulatory approval, high valuations and ample liquidity may lure many foreign firms to stocks and bonds there rather than in Hong Kong.
It may be wrong to characterize this as a zero-sum game contested between Shanghai and Hong Kong. Having a strong financial center in both cities is key to facilitating China’s economic development.
And from, Beijing’s perspective, there can be no loser. The ultimate result of these capital market activities, wherever they take place, is a stronger, more internationalized renminbi. That is precisely the central government’s ambition.