Fast approvals, investor interest, ample liquidity attract foreign issuers of yuan-denominated debt to China market

Adorable giant pandas typically come in binary black-and-white color scheme but bonds named after them are more vibrant and adding depth to China's bond market, the world's third largest, industry insiders said.

Just as China gifts or loans pandas to friendly countries to deepen bilateral ties, panda bonds are helping fortify local financial markets' bonds with global counterparts, they said.

Panda bonds are yuan-denominated debt instruments issued by foreign entities, including governments, in China.

Funds raised from local investors in China are used by foreign bond-issuers to repay sovereign debt, augment national reserves, or finance large construction projects.

Typical buyers of panda bonds are mainly institutional investors, include companies, foreign banks, multilateral institutions, and sovereigns, who see them as reliable investment options that could generate steady returns, besides helping boost economic development worldwide through the Belt and Road Initiative, and maintaining global economic stability.

Issuances of such bonds have risen of late on the back of quicker approvals, competitive coupon rates, ample liquidity in the local markets, and growing confidence in China's economic strength among foreign entities.

In 2018, 41 foreign entities issued 87 panda bonds in the interbank market and raised 165.56 billion yuan ($23.96 billion), according to data from the National Association of Financial Market Institutional Investors.

That's impressive progress from their debut in 2005 when China allowed foreign banks, companies, multilateral institutions, and sovereign entities to issue renminbi-denominated bonds. In the first year, the International Finance Corporation and the Asian Development Bank issued panda bonds valued at 4 billion yuan.

Some analysts predict that China's panda bond market may see issuances in excess of 300 billion yuan next year.

"The panda bond market is still growing, and more foreign issuers are seeing Chinese bond market as a significant funding source to diversify their financing channels," said Ivan Chung, head of China credit research and analysis at Moody's Investors Services.

Portugal is the latest country to jump on "the panda bondwagon", a market insider said. On May 29, Portugal became the first eurozone country to issue renminbi-denominated bonds. Its first series, with a maturity of three years, totaled 2 billion yuan and was underwritten by Bank of China and HSBC.

Earlier, Hungary, Poland and South Korea issued panda bonds. According to Portugal's bond offer documents, it can issue as much as 3 billion yuan in panda bonds within two years.

Money raised will be transferred to Portugal in euro currency and used for repaying government debt issued domestically and for supporting the Belt and Road Initiative in the future.

Interest Portugal would pay on renminbi-denominated bonds would be higher than that on comparable debt in the eurozone, said Ricardo Mourinho Felix, Portugal's secretary of state for finance, at a recent conference.

A slightly higher return on the panda bond can make it more attractive for Chinese investors, market mavens said. Felix called the Chinese panda bond market "a big new market with high liquidity".

Austria could be the next sovereign issuer of panda bonds. Industrial and Commercial Bank of China, the largest Chinese State-owned commercial bank, and the Austrian government signed an agreement in late April to work together for issuing panda bonds. ICBC will be the lead underwriter of the issue.

According to a statement on ICBC's website, the issuance will attract more capital from the Chinese domestic market to invest in Austria. The European country is tipped to become the sovereign issuer with the highest rating for this type of bond.

The Philippines' three-year panda bonds carrying a coupon of 3.5 to 4.1 percent hit the market last month and raised 2.5 billion yuan, following China's pledge to lend as much as 6 billion yuan to the country through bonds.

That coupon rate was 0.5 to 1 percentage point higher than the three-year Chinese treasury bonds, and comparable bonds with risk-free interest rate.

The proceeds will be used to shore up Philippines' foreign exchange reserves and support the country's fiscal spending.

The fund could be also used for some projects related to the Belt and Road Initiative in the future, according to a document published on the Shanghai Clearing House.

Rules and regulations on panda bonds could significantly influence the future growth of the market. When the market took off in 2005, strict restrictions on issuers and usage of funds were in place.

As curbs eased over the years, issuances grew gradually and peaked in 2016 at 130 billion yuan, up from a paltry 13 billion yuan in 2015 and just 2 billion yuan in 2014, according to Wind Info, a Shanghai-based market data provider.

The surge in 2016 was mainly because of easing of restrictions to enable cross-border settlements and bond issuances. That year, lower financing cost in the onshore bond market as compared to the offshore market had attracted more foreign investors, said experts.

Chinese regulators are continuing to make it easy for foreign participants to thrive in China's panda bond market. This approach is helping both investors and issuers.

The easing marks fulfillment of the government's promise to embrace greater openness, especially through lowering of access barriers to China's financial market for foreign investors.

Pan Gongsheng, director of the country's foreign exchange regulator, the State Administration of Foreign Exchange, said earlier this year that capital raised through panda bonds can be freely transferred out of China, or kept in the domestic market for reinvestment.

In December, BNP Paribas became the third locally incorporated foreign bank in China to underwrite the panda bonds, following HSBC and Standard Chartered.

China also launched a bond connect program last year, which allowed foreign investors to buy panda bonds through brokers in Hong Kong. Chinese regulators have implemented fresh measures to streamline the approval process for panda bond issuances.

In September 2018, the Ministry of Finance and the People's Bank of China jointly issued a fresh set of rules for panda bonds, simplifying issuance procedure.

Foreign financial institutions that issue panda bonds should be approved by the PBOC. Other types of issuers only need to register on the National Association of Financial Market Institutional Investors.

"There were no unified management rules before. Foreign governments, financial institutions and non-financial enterprises can only follow some international procedures. They also need to wait long for the approval after handing over materials to the financial regulators," said Wang Qing, an analyst with Golden Credit Rating International Co Ltd.

Faster approvals will make the Chinese interbank market more attractive to foreign investors, he said.

Ba Shusong, chief economist of the China Banking Association, said the new regulatory rules, along with the internationalization of the Chinese renminbi, will encourage more foreign investors to hold panda bonds.

And the Chinese bond market can do with more diversified investors, he said.

According to central bank data, by the end of 2018, the Chinese bond market was valued at 86 trillion yuan, maintaining its third position in the world. The bonds held by foreign investors, however, accounted for only 2.3 percent, suggesting the potential for growth is humongous, said experts.