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Analysis: Offshore yuan market foreshadows China bond market
SHANGHAI (Reuters) - If you want to know how Chinese authorities will open up the closely-regulated $3 trillion onshore bond market, their actions in Hong Kong's offshore yuan market should give you a clue.
The success of what market players call the CNH market shows that foreign investors of all stripes are hungry for yuan-denominated fixed-income products and that a more hands-off policy in the bond market may really help to grow it.
The so-called dim sum bond market has about 100 billion yuan in outstanding paper, with more in the queue. The onshore market dwarfs this, but the dim sum market has grown from practically nil a year ago.
"If they don't let more people buy yuan bonds onshore, there will be even more yuan issuance offshore, which is now picking up quite quickly," said Wee-Khoon Chong, a fixed income strategist at Societe Generale in Hong Kong, referring to Chinese financial authorities.
Chinese regulators are expected to gradually shift their role to become facilitators, like in Hong Kong, rather than supervisors by introducing similar policies in the mainland that have helped boost the offshore market.
Sources say this could include adopting the shorter and less complicated registration system for corporate bond issuers as opposed to the mainland's approval system, which requires more details and involves special meetings with the regulators.
"The People's Bank of China appears to hope to make Hong Kong an experiment, where they can accumulate experience to help push the liberalisation of the domestic market," said a source, who did some research for the central bank on the issue.
The offshore yuan bond market in Hong Kong has grown rapidly since it was first launched in 2007, especially after Beijing amended its clearing arrangements with Hong Kong last July to allow the sale of a wider range of yuan-denominated products there.
By the end of 2010 some 30 dim sum bonds, named after the Hong Kong delicacy, had been issued worth a combined 62 billion yuan ($9.5 billion). The momentum has also carried over into this year. [ID:nTOE71M04H]
After conducting a slew of investigations on how to supervise Hong Kong's yuan market last year, the PBOC late in the year made a key decision to let the offshore market develop in a very loosely-regulated way, sources say.
This highlighted a trend among Chinese policymakers of moving toward redefining their relations with the onshore market in a more market-oriented way, including policies such as easing issuing rules and increasing the number of issuers and products, a second source said.
"A growing number of officials are now thinking of how to serve the market rather than to simply supervise it. Such an open-minded attitude will bring new opportunities for small firms and foreign participants in the future," he said.
Under the government's 11th five-year plan, annual bond issuance increased by two thirds to 10 trillion yuan in 2010, with much of it in the Shanghai-based interbank market.
The 12th five-year plan from 2011 to 2015 unveiled in March stated that China aimed to raise the ratio of corporate financing via the market, such as via stocks and bonds.
Currently, more than three-fourths of company funding comes from bank loans, a very high ratio in the standards of Western mature economies, but a marked difference from more than 90 percent just two or three years ago.
To support growth of the market, new products are already being introduced, although at a slow pace.
China's securities regulator introduced the "green channel" in late 2010 to shorten the approval process for issuers with net capital above ten billion yuan and an AAA rating. [ID:nL3E7F40OC]
Instruments similar to credit default swaps were launched in November to allow investors to hedge risks from investing in the debt issued, in particular, by smaller companies.
Regulators have also launched a so-called super short-term commercial paper facility of maturity up to 9 months.
China is also preparing to resume bond futures trading after a 16-year hiatus. [ID:nL3E7ET028] China currently has limited trading in bond forwards.
FOREIGN FIRMS, NON-FINANCIAL CORPS DO MORE
Only about 200 foreign institutions are permitted to trade bonds on a restricted basis, but the central bank recently pledged to open up the bond market further to foreign investors.
Foreign financial institutions can participate in the onshore market via limited repatriation of offshore yuan funds and through trust vehicles, in addition to quotas allocated through the qualified foreign institutional investor programs.
"What we expect to see is also a relatively big trust business onshore, where you create trust contracts that you can distribute to corporations and individuals," said Augusto King, co-head of Asia debt capital markets at RBS. ($1=6.5 Yuan)
(Editing by Kazunori Takada and Ramya Venugopal)
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