Corporate Financing Analysis - Panda Bond Rise To Continue Albeit Off Records Pace - 14 AUG 2017

After a banner year for the issuance of yuan-denominated bonds by overseas firms in the Chinese Mainland last year, we believe that, while still extremely active, the sale of so-called 'panda bonds' in 2017 will fall short of last year's record tally. While overseas investor appetite to tap the deepening pool of debt capital market (dcm) liquidity in China is on a long-term upwards trajectory (a trend we expect to continue once the ongoing tightening at present plays out), we highlight that our view of a steady, rather than bumper haul of deals this year is heavily linked to the fortunes of the Chinese currency, which will draw issuers onshore as long as it remains weak.

Indeed, the weakness of the yuan over recent years has served as a boon for the panda bond market and its upwards growth trajectory, largely at the expense of the dim sum market for yuan-denominated bonds sold offshore (predominantly in Hong Kong) by overseas firms (see ' The Rise Of The Pandas Amid Dim Sum Bond Slump', September 7 2016). But in this regard, however, things are changing: we believe that the currency has passed its most recent trough and is showing signs of strengthening once more, a trend which should serve to create a drag on panda bond issuance across the remainder of H217. Indeed, following years of being bearish on the Chinese yuan, BMI's Global Team has finally turned towards downplaying such sentiment in regard to the currency in Q217. Instead, we now see the short-term outlook for the yuan as increasingly constructive amid a key technical break, cooling trade tensions between China and the US in the near-term, a stabilisation in foreign reserves, and a gradual normalisation in interest rates as the regulators seek to curb speculative activities. However, we continue to believe that a long-term strengthening path still remains unlikely, as the dominance of SOE (state-owned enterprises) and local government financing vehicles will still undermine the private sector. Thus, in terms of the panda bond market, this means that the near-term outlook is slightly less bullish than it was just a few months previously; for the medium to long-term outlook for the market, conversely, plenty of cause for optimism remains intact.

2016 A Hard Act To Follow
Annual Global Panda Bond Issuance By Deal Value, USD
Source: Bloomberg , BMI

IMF SDR Inclusion Key

A major boost to panda bond issuance over the past 18 months has been the move by the International Monetary Fund (IMF) to include yuan, alongside the US dollar, the pound sterling, and the euro in its special drawing rights (SDR) basket starting October 2016 ( see ' Panda Bonds To Benefit From Yuan ' s IMF SDR Inclusion ' , December 9 2015). Ever since the move to introduce the yuan as a global reserve currency was announced during the tail end of 2015, the prospects of the panda bond market have been significantly boosted by the rubber-stamping of Beijing's position as an emerging global economic power. Investor sentiment has, as expected, turned very much in favour of the market ever since. Fast-forward to the present day and, according to Bloomberg data correct to July 31, USD5,222.1mn worth of panda bond notes have been sold globally across the first seven months of this year. We highlight that this tally of deals puts the market well on course to record its second highest haul of deals on record, second only to the USD19,321.9mn in panda issuance recorded across the 2016 full-year period. Bloomberg data also show that Hong Kong has consistently been the market's most active destination in terms of where the panda bond deals have been originating from, with the offshore territory having been responsible for nearly half of all deals sold last year (USD8,680.3mn, equivalent to a 44.92% share of overall activity), and the lion's share of activity in the y-t-d period (USD2,992.5mn, equivalent to a 57.3% share of overall activity). After Hong Kong, Germany has consistently been home to the second highest volume of panda bond issues in China, contributing tallies worth USD1,1,016.9mn in the 2017 y-t-d period (a 19.47% share of global activity), and USD1,195.7mn across the 2016 full-year (a 6.19% share of global activity).

Big Names Are Key

The panda bond market, and its relatively short history, has a strong relationship with attracting high-profile issuers. It all started with German automaker Daimler's CNY500mn bond issued back in 2014 (a one-year deal priced to yield 5.2%), which set the real blueprint for the market - the onshore bond deal was the very first to be completed by an overseas company on the Chinese Mainland. We note that on a qualitative basis, the note sale signaled the beginning of a process of opening up China's dcm arena to the outside world, a process which has continued through to the present day, with the most recent development - dating from July 3 - being the People's Bank of China (PBoC)'s decision to launch trading on the China interbank bond market, CIBM, via a new specially designed platform called 'Bond Connect'. The new gateway for international investors into China sees the linking of bond markets on the Mainland and offshore in Hong Kong for the first time, allowing investors to trade local bonds - on top of the equities provided by 'Stock Connect' - without first needing approval to operate and invest in China ( see ' Chinese Bond Markets Opening Up Via Hong Kong ' , July 5 2017). More broadly, Bond Connect marks another step towards financial market liberalisation in Mainland China and, furthermore, will make the dim sum bond market, which has previously served as a window for foreigners into China, redundant - another positive development for panda bonds in terms of the competition for investors (see ' The Slow Death Of Dim Sum Bonds ' , July 1 2017).

Recent Deals Add Value

In terms of both near-term activity, in enticing other deals to market, and for the long-term growth of the market among global investors, recent deals from reputable issuers has, in our view, served as a positive for the market. The biggest potential deal which has caught the eye has been from Russia's leading aluminum producer, Rusal. The Hong Kong-listed firm has made no secret of its plans to potentially place a new tranche of its panda bond before the 2017 year-end, a USD1.0bn deal which would follow-on from the issue of its debut tranche, completed on the Shanghai Stock Exchange back in Q117 when it raised CNY1bn from three-year non-call two notes carry a coupon rate at 5.5%. Another deal of some significant has been the return of Daimler to the panda bond arena on two separate occasions this year - the first deal came back in March and saw the firm raise CNY3.0bn with a one-year deal that carries a 5.18% coupon, while the more recent deal completed in late July has seen the firm tap investors for CNY4.0bn, with a three-year deal that carries a 5.3% coupon.

Beyond the world of corporate finance, there haS been a flurry of panda bond deals from sovereign issuers over the past eighteen months. The Republic of Korea, the National Bank of Canada, the Republic of Hungary, and the Republic of Poland have all tapped issuance in the panda bond arena with deals which have raised CNY3.5bn, CNY3.5bn, CNY2.0bn, and CNY3.0bn, respectively. Market chatter is alive with the Philippines bringing a deal to market over the coming quarters too. BMI acknowledges that while such deals do not directly impact the performance of the corporate panda bond market, they do hope to raise the market's profile on the international stage - a factor which is hard to quantify in terms of its capacity to bring further deals to market.

Headwinds Too Big To Ignore

While the march of the panda bond market has gone almost uninterrupted over the past 18 months, we caution that, for the first time since the yuan's SDR basket inclusion, the headwinds are building against future issuance. As well as a projected appreciation of the local currency in the near-term, we point to Beijing's move to deleverage its financial system (as well as the subsequent liquidity crunch it has created) as creating a potential drag on panda activity. In sum, however, while we expect the record clip of deals from 2016 to slow this year, we do not expect the building headwinds to blow out the positive momentum in the panda bond arena altogether.