Investors warn of RMB bond market concerns

Despite recent moves by China’s central bank to slow renminbi appreciation, and the emergence of the first ever default in the country’s bond market, investors seem to be queuing up to buy mainland debt.

Fixed income experts outlined some of their concerns, while recognising the market’s potential, at the Investors and Borrowers Forum last week hosted by AsianInvestor and FinanceAsia in Hong Kong.

For one thing, the trend of RMB appreciation has reversed recently as the People’s Bank of China has sought to curb capital inflows and normalise its currency.

“At the end of the day, it’s most likely a policy engineering move to introduce a little bit of two-way volatility,” says MK Tang, senior China economist at Goldman Sachs. A one-way bet is not a healthy trend for any currency, he adds, so it's likely the Chinese government will allow more RMB volatility.

Nevertheless, investors are eager to access the Chinese onshore market via the country’s qualified foreign institutional investor (QFII) scheme and its RMB-denominated equivalent (RQFII), note panelists.

China opened the interbank market, which accounts for 95% of mainland bond trading, to QFII quota holders in March last year. But only a few have so far been allowed to enter – some put the number at five institutions – with most forced buy their bonds on-exchange.

But the lack of liquidity in listed Chinese bonds relative to their interbank equivalents remains a major obstacle, says Stephen Chang, head of fixed income at JP Morgan Asset Management. “The exchange market is really not functioning; the liquidity is awful,” he adds.

RQFII holders, on the other hand, can invest both on-exchange and via the interbank market. That said, doing so means they are likely to need investment professionals on the mainland. 

Certain central banks are said to be considering investing in the onshore bond market, but some panelists raised concerns. Sean Chang, head of Asian debt investment at Baring Asset Management, says different legal systems among jurisdictions may be a problem when investors enter China’s onshore market. 

Meanwhile, JP Morgan’s Chang says some central banks may look to external managers for help, as they are relatively new to onshore bond investment. But “probably most of they will do it in-house if they can”, he adds. 

Another issue with regard to China’s onshore bond market is the spectre of default risk, after it reportedly suffered its first ever default on March 4. Shanghai Chaori Solar Energy Science & Technology reportedly had insufficient funds to pay off the Rmb89.8 million due in interest on a Rmb1 billion issue.

Some argue this is a positive development, as it may teach investors a lesson that China’s bond market is not risk-free, as many have tended to believe.

Mainland investors do not pay much attention to the credit rating of onshore bonds, as there is an “implicit guarantee”, notes Goldman’s Tang, but he says he is not too worried. “After all, [Goldman Sachs has a] very strong balance sheet in Beijing; we do not rely on external funding.”

Meanwhile, the panel highlighted the potential for exchange-traded funds to access mainland bonds. There are already such products listed in Hong Kong, the first of which is CSOP’s ETF tracking China’s five-year treasury bond.

David Quah, vice president for issuer and clients service in the global markets division of Hong Kong Exchanges & Clearing, expects to see more fixed income ETFs with different yield curves listed in Hong Kong, such as two- or seven-year treasury or corporate bond products.