Dim Sum Bonds

What are 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 institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more, and government.

How it Came into Existence?

Chinese authorities have actively promoted the development of the offshore bond market. 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 bond. However, Hong Kong is still considered to be the largest issuer for dim sum bonds.

Characteristics of Dim Sum Bonds

Some of the characteristics 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 applies 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 marketSecondary MarketA secondary market is where securities are offered to the general public after being offered in the primary market. Such securities are usually listed on the stock exchange. A significant portion of trading happens in such a market and are of two types – equities and debt markets.read more is still in the developing phase with weak liquidity.
• The tenor of these 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 capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)"read more.
• Covenant is relaxed for high yield issuers, but there are 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 SPVSPVA Special Purpose Vehicle (SPV) is a separate legal entity created by a company for a single, well-defined, and specific lawful purpose. It also serves as the main parent company's bankruptcy-remote and has its own assets and liabilities.read more to raise Chinese yuan in the offshore market.

Factors Affecting Demand of Dim Sum Bonds

The following are factors affecting the demand for these bonds.

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• Yield Differential: Strong demand for dim sum bonds suppressed corporate bond yield to unusually lower levels with credit spreadCredit SpreadCredit Spread is the yield gap between similar bonds but with different credit quality. If a 5-year Treasury bond yields 5% and a 5-year Corporate Bond yields 6.5 percent, the gap over Treasury is 150 basis points (1.5 percent ).read more 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 issuersBond IssuersBond Issuers are the entities that raise and borrow money from the people who purchase bonds (Bondholders), with the promise of paying periodic interest and repaying the principal amount when the bond matures.read more 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.

Advantages

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 curveYield CurveA yield curve is a plot of bond yields of a particular issuer on the vertical axis (Y-axis) against various tenors/maturities on the horizontal axis (X-axis). The slope of the yield curve provides an estimate of expected interest rate fluctuations in the future and the level of economic activity. read more 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 company. 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 market 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.

Disadvantages

The different disadvantages are as follows:

• Two major factors that lead 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 was 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 currencyDepreciation Of The CurrencyCurrency depreciation is the fall in a country’s currency exchange value compared to other currencies in a floating rate system based on trade imports and exports. For example, an increase in demand for foreign products results in more imports, resulting in foreign currency investing, resulting in domestic currency depreciation.read more means that the expected return on many bonds is low to negative.
• The gross issuance in these bonds has drastically 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 controlCapital ControlCapital Controls are measures taken by the central bank, government, or other relevant bodies that limit the inflow or outflow from the domestic capital markets. These controls are specific to an industry or sector or even economy-wide.read more by China.

Conclusion

Dim Sum Bonds has played a very important role by increasing the participation of international issuers to capture offshore renminbi funds to support their business and investment activities.

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