More panda bonds than ever are being issued, but problems surrounding them mean their range of appeal outside red-chip companies is limited.
In 2005 the Chinese government introduced panda bonds to liberalise its capital market, offer foreign investors an opportunity to invest in China and help local Chinese to diversify their investments.
There are in general two main Panda bonds markets in China: the interbank market, which is an over-the-counter market regulated by the National Association of Financial Market Institutional Investors (NAMFII); and the exchange market (the Shanghai and Shenzhen stock exchanges), which is regulated by the China Securities Regulatory Commission (CSRC). Panda bonds are debt instruments denominated in RMB and issued by foreign institutions in China for domestic consumption.
Panda bonds can be either a public or private offering. With more stringent controls imposed by the exchange, it is now becoming more popular to seek trading of panda bonds on the interbank bond market targeting institutional investors. The period of the bonds varies from one year (commercial paper) to 3-5 years (medium-term note). The coupon rate is around 5 per cent, which is lower than the bank borrowing rate and is attractive to companies in need of RMB financing.
Unlike high-yield US dollar or 'dim sum' bonds, panda bonds are generally unsecured. The credibility of the issuers is supported by personal undertakings from directors and senior management of the issuers.
Increasing interest
Reception to the panda bonds market has been lukewarm over the years. To attract further interest, more flexible and relaxed regulations were introduced to widen the scope of qualified foreign issuers, although there remain some uncertainties in the repatriation of the RMB proceeds out of China.
Since the third quarter of 2015, more 'red-chip' companies (ie Chinese companies operating in China and listed on the Stock Exchange of Hong Kong through Bermuda and Cayman Islands special-purpose companies) have been using this platform as an alternative channel for financing their business and operational requirements. In particular, Chinese property developers whose main source of income is RMB but borrow in US dollars are queuing to issue panda bonds.
Historically, these companies raised debt through the issue of high-yield dim sum and US dollar bonds with high coupon rates depending on their credit ratings. Given the dynamics of panda bonds, where the cost of borrowing is at more attractive rates, anecdotal evidence suggests that these companies are now retiring their high-yield dim sum and US dollar bonds to streamline their debt profile and to protect against foreign currency translation risks.
Notwithstanding the above, panda bonds are not without issues. Regulations are still unclear and deal-flow to completion has been slow. Each transaction is dealt with on a case-by-case basis and documentation may be different for even similar transactions. Financial disclosures are also required to be in accordance with Chinese accounting standards. In addition, there is a potential liability issue where the issuer's directors and senior management will have to give personal undertakings on the correctness and completeness of the disclosures in the offering circular.
Fake pandas
The anticipation of further depreciation of the RMB, the relaxation of regulatory requirements and the low RMB coupon rate create an incentive for Chinese property developers to restructure their existing high-yield US dollar and dim sum bonds.
On balance, it is anticipated that panda bonds will still be the bond of choice in 2016 for red-chip companies or 'fake pandas' due to its much lower cost of borrowing. However, on the whole, there appears to be doubt over the future success of the panda bonds market.
Unless the regulatory and accounting issues currently faced are clarified, personal undertakings are removed and the documentation is set in a more standard form or package, it is unlikely the panda bond market will be successfully liberalised.
Going forward, high-yield US dollar and dim sum bonds in an established and mature market will continue to be in demand. This is because the current trend of raising RMB debt is unique to Chinese property developers taking advantage of the lower cost of borrowing to restructure their existing US-dollar denominated debt.
This article was first published in The Lawyer, June 2016
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