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Foreign issuers keep clear of panda bond market despite lower costs

* Foreign issuers dominate dim sum market

* Barriers to sell cheaper panda bonds remain

* Dim sum bond issuance seen to fall for 2nd year

HONG KONG, March 18 (Reuters) - Red tape and difficulties in getting funds out of China have kept foreign issuers from tapping the mainland’s onshore yuan bond market, opting instead for the more expensive offshore “dim sum” market.

While China’s central bank is seeking to deepen the onshore bond market’s connection with global markets, the deal flow so far this year shows foreign issuers are still wary of the mainland “panda” bond market.

China launched the market for pandas - yuan-denominated bonds sold by overseas entities on the mainland - in 2005 but only a handful of foreign entities have raised debt in that market. HSBC and Bank of China Hong Kong did so late last year.

And while the dim sum market has been subdued this year with just 5 billion yuan ($770 million) of deals done in January and February, foreign issuers account for all of that issuance, compared with just 46 percent for all of 2015, according to statistics from HSBC, the top underwriter of dim sum deals.

The onshore bond market is the cheapest way for foreign companies to borrow in yuan and swap the proceeds back into dollars, due to the market’s high currency swap rates. However, this process comes with a few snags, bankers say.

“It makes sense for foreign entities to sell dim sum bonds as most of them convert yuan proceeds to other currencies such as U.S. dollar to lower the funding cost,” said a debt capital market banker at a European bank in Hong Kong.

“Though the onshore panda bond market is also open to foreign issuers, they will not flock to it as procedures and documentation of panda bonds are much more complicated,” said the banker.

Major drawbacks in the panda market are China’s deal-by-deal approval process and different accounting standards. Issuers also worry about getting the proceeds out of China with regulators clamping down on capital outflows.

Issuers such as Commonwealth Bank of Australia, Royal Bank of Canada, Export-Import Bank of Korea have this year opted for the offshore market over the onshore counterpart.

Fitch Ratings said on Thursday that it does not expect growth in panda bonds to accelerate significantly in the short-term due to regulatory and liquidity issues, despite the low yields that should make them attractive to issuers.

In tapping the yuan market offshore, borrowers are paying more than they would onshore. A three-year government bond on the mainland was trading at 2.40/2.34 percent on Thursday, much lower than 4.08/3.68 percent for the same tenor in Hong Kong.

Bankers estimate top tier Chinese banks may need to pay more than 5 percent for three-year dim sum bonds, but only about 3 percent in the onshore market.

However, raising money offshore still makes sense for some issuers wanting to convert proceeds into dollars thanks to high dollar-yuan cross currency swap rates in Hong Kong that help them reduce costs. The higher the swap rates, the more they can save.

The three-year yuan-dollar cross currency swap rate surged to a record high of 4.55 percent in mid-January and has stayed elevated. It was quoted at 3.55/3.65 percent on Thursday.

Despite the foreign preference for the dim sum market, offshore yuan issuance is likely to post its second consecutive year of decline amid a wider aversion to yuan assets on weakness in China’s economy and currency.

At the same time, mainland companies are unlikely to return the dim sum bond market any time soon unless they urgently need to refinance their offshore debt and cannot bring onshore funds abroad, analysts say.

“For this year, we expect issuance from Chinese issuers to decline faster than foreign issuers because the cost in the onshore market is significantly lower than the dim sum market,” said Helen Huang, an analyst at HSBC.

Deal sizes have shrunk along with the number of deals. HSBC has helped sell 13 offshore yuan bonds in the past two months, all of which were private placements that needed as few as one or two investors. Bond sizes were quite small at 100-150 million yuan ($23.11 million).

Dim sum bond sales are expected to fall to 260-300 billion yuan this year from 392 billion in 2015, the bank estimates.

$1 = 6.4954 Chinese yuan Reporting by Michelle Chen; Editing by Sam Holmes

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