Dim Sum Bonds

Dim Sum Bonds are fixed debt instruments denominated in Chinese renminbi rather than local currency and quite popular in Hong kong. These are quite attractive to investors interested in holding the debt issues denominated in yuan but are unable to do so due to increasing Chinese domestic debt regulation.

These bonds can be sold by domestic as well as non-domestic entities, including corporations,, financial institutions, and government. Dim Sum Bonds have played a vital role by increasing the participation of international issuers to capture offshore renminbi funds to support their business and investment activities.

The Dim Sum Bonds are debt instruments that rae denominated in the Chinese currency and are issued outside China, typically inn HongKong.  HongKong is the main offshore trading center of these bonds. These bonds primarily cater to the foreign institutional investors in the international market and thus, allows them to freely invest in Chinese assets, which otherwise has a lot of restriction is invested directly.

Chinese authorities have actively promoted the development of the offshore bond market through a list of dim sum bonds. Due to no limitations imposed on capital inflow and outflow, many countries have raised funds by issuing these bonds.

As the renminbi entered into global markets, demand has drastically increased from countries like Taiwan, London, Singapore, and Frankfurt who have also permitted issuances of renminbi bonds. However, Hong Kong is still considered to be the largest issuer for dim sum bonds.

It can be issued by both the Chinese or non-Chinese institutions and can be of short or longer timeframe. So it is suitable for investors with different time horizons. Similar to other bonds, it is also influenced by market related factors like cuurecy, issuer’s creditworthiness, etc and has to abide by some rules and regulations of the financial market.

Thus, it is a unique option for investment in the Chinese market, where international investors can get a satisfactory return on their investment. But is it necessary to do good research on the issuer before putting money into such bonds to ensure that it is worth investing in them?

Some of the characteristics China dim sum bonds are as follows:

• Credit rating is often optional and market-driven for these bonds though the rating is an increasingly important factor on which investor decisions are based upon. The rating approach for this bond is generally similar to the other offshore bonds issued by Chinese corporates irrespective of currency.
• Onshore Regulatory approval for issuance for dim sum bonds is optional, depending on certain circumstances.
• The Hong Kong law that governs the issuance of these bonds.
• The investor for dim sum bonds is small and still evolving. it includes commercial banks, private banking clients, international investors as compared to the US bond market, which has a very large and diversified institutional investor base.
• The liquidity of these bonds is moderate and evolving, though the secondary market is still in the developing phase with weak liquidity.
• The tenor of these list of dim sum bonds mostly ranges to 3 years or below as most of the dim sum bond issuers raise renminbi funds to support ongoing investment projects or for meeting day to day working capital.
• Covenants are relaxed for high yield issuers, but there is strong demand and increasing market pressure for tighter covenants on high yield issuers.
• Investors’ protection mechanism (e.g., investor meeting, trustee responsibilities) is still evolving as compared to the US Bond market, which is quite efficient with a proven track record.
• To facilitate the issuance of a dim sum bond, china firms set up subsidiaries or SPV to raise Chinese yuan in the offshore market.

Let us understand the concept of China dim sum bonds with the help of a suitable example as given below:

We assume the XYZ Corporation is a Chinese MNC, based in China and they are planning to issue Dim Sum Bonds in the international market in order to raise capital for the company and diversify their investors.

Thus, the bond is issued at an interest rate of 5 % p.a annually and the company has aimed to raise 2 billion. The coupon payment will be done semi-annually. These bonds are denominated in Chinese Yuan and will be traded in the Hong Kong stock exchange. The global investors will invest in these bonds which will facilitate growth and expansion of the company. It has a maturity period of 10 years after which issuer has to pay back the investors the entire principal amount.

From the above example, it is possible to understand the type and nature of such bonds and how they work in the financial market.

The following are factors affecting the demand for these bonds.

• Yield Differential: Strong demand for dim sum bonds suppressed corporate bond yield to unusually lower levels with credit spread narrowed down from being positive in the year 2013-14 to negative in the year 2015-2016.
• Use of Funds: One of the main motives behind issuing renminbi funds was to finance direct investment overseas. To overcome the currency mismatch problem, some dim sum bond issuers may swap renminbi to US dollars in the offshore market.
• Exchange Rate Fluctuation: The appreciation of china yuan has supported external financing using dim sum bonds, while depreciation has led to a decline in issuance activities.
• Hedging Costs: also influence the issuance of dim sum bonds and affect overall funding costs.

The different advantages are as follows:

• Due to its high accessibility, the dim sum bond market has become an alternative renminbi fundraising platform for international issuers, which helps in promoting external use of currency by global firms.
• The continuous issuance of offshore renminbi bonds by the ministry of finance has established a benchmark yield curve called dim sum bonds to measure its performance.
• Due to the absence of restrictions on the type of issuers in the dim sum bond market, the issuer profile is quite diverse, ranging from small issuers to multinationals companies. Non-bank financial companies and real estate developers are also active issuers in offshore renminbi bond markets. Developers often take the support of the dim sum bond index when liquidity dries up in the onshore markets. Hong Kong developers often use these funds to finance their construction projects in the on-shore market.
• The demand for this bond mostly includes the need for foreign companies to support business in the onshore market and from firms to support outward direct investment. This market has played an important role in price discovery and acting as an intermediary for renminbi funds between onshore and offshore markets.
• Large multinationals such as McDonald’s, Unilever participated as an issuer in dim sum bonds raising capital to fund their equipment, expanding, setting up production plants. Due to strong credit quality and huge demand for renminbi bonds, the coupon rate is quite lower as compared to AAA bonds with a similar maturity.

The different disadvantages are as follows:

• Two major factors that led to the downfall of dim sum bonds was that investors expected the renminbi to continuously appreciate against the dollar and China is in the developing phase of economic growth. They expected the current yield to continuously rise, resulting in huge profits, and hence the demand for these bonds has widely increased.
• However, in 2014 renminbi’s performance worsened as compared to the dollar resulting in many investors incurred huge losses as the currency yield became negative, reducing the attractiveness of renminbi bonds. The corresponding decline in offshore renminbi deposits has also meant that there are fewer sources of renminbi to be invested in offshore bonds. As the Chinese economy has recorded a slowdown in economic growth, interest rates have drastically decreased for all the bonds. The reduced yield combined with the depreciation of the currency means that the expected return on many bonds is low to negative.
• The gross issuance in these bonds has dramatically decreased in recent years due to factors such as increased volatility, slow economic growth of China.
• There was a huge yield difference between onshore and offshore markets due to different demand and supply conditions prevailing, market liquidity, and monetary conditions while at the same time, risk-free arbitrage opportunity was limited due to excessive capital control by China.

Therefore it is necessary to identify and understand the advantages and disadvantages of any financial instrument clearly so that investors can take wise and informed decisions with their money and are able to earn maximum return as per their own financial goal, investment horizon and risk profile.

The above are types of debt instruments that related to the financial market of China. But there rae some points of differences between them, which are as follows:

• The most prominent difference is that the former is issued outside the Mainland China and the latter is issued within China by foreign institutions, even though both are denominated in Yuan, which is the Chinese currency.
• The main offshore centre is HongKong dim sum bond index for the former apart from other financial international centers. But this is not the case with the latter.
• In case of the former, the foreign investors can access the bond market of China without undergoing a lot of stringent rules and regulations, but for the latter, the investors have to enter the bond market of China and thus, has to follow may rules and laws, which makes the process complex and difficult.
• Another important difference between the two is that the investors need to convert their own currency into Chinese Yuan if they wish to invest in the former. But in case of the latter the inevstors need to convert their own currency into Yuan and them invest in those bonds since these bonds are issued in the Chinese financial market.

Thus, we see that the basic differences between them lie in the fact that their location of issue and the type of investors whom they are intended for. However, both of them, in their own way, encourage investment in the Chinese bond market and help in their internationalization.