It’s a lot harder for David Yim to rack up the airline miles these days. The bond underwriter at Standard Chartered Plc used to fly across the Pacific from Hong Kong to the U.S. four or five times a year to arrange dollar-debt deals, but he’s not sure he’ll make it even once in 2017.
Such is the gravitational pull China is having on the market for dollar bonds issued by Asian companies and banks. Borrowers used to tap U.S.-based investors when they sold dollar securities. Now, there’s a big enough pool of greenbacks in Asia and predominantly Chinese buyers are able to take up the vast majority of bonds sold in dollars.
Within three years, this market may reach $1 trillion, composed mostly of Chinese dollar bonds, according to projections from Australia & New Zealand Banking Group Ltd. Big Chinese demand may be changing the risk dynamics of the dollar bond market in Asia, according to market watchers.
“Having a Chinese buyer means there’s a different risk profile — it’s not like Western money managers investing in Thailand before the Asian crisis,” said Nigel Pridmore, a long-time capital-markets attorney and partner at Hong Kong-based law firm Ashurst.
Evidence of the impact of the change was on display this month, when financial markets round the world were roiled by escalating tensions between the U.S. and North Korea. Among the harder hit markets was U.S. high yield — also known as junk-rated — dollar bonds. But premiums on junk-rated Asian dollar bonds by comparison barely moved:
“We’ve witnessed Asia’s offshore bond markets become the less-volatile part of global credit — on this firmer local demand,” said Owen Gallimore, head of credit strategy at ANZ in Singapore. That in turn is pulling in some global asset managers to the market, he said.
But with locals now dominant, there’s a welter of new dangers to consider, starting with Chinese financial regulations.
China’s move to contain leverage in its domestic financial system has made it more expensive to sell debt onshore, something that’s helped fuel the boom in Chinese dollar-bond issuance. Private-sector property developers that might find it tough to get loans from state-owned banks have been among the biggest sellers.
These dynamics can shift abruptly if Chinese regulators change policy. And this summer’s surprise crackdown on big private conglomerates’ overseas acquisitions is just one example of how quickly the picture can change. Any move by officials to rein in Chinese funds’ purchases of dollar debt — or companies’ and banks’ ability to sell it — could have a dramatic effect.
“The weakness to the ‘China bid’ is its homogeneous nature and strong but unpredictable regulatory oversight,” said Gallimore. “We have intra-Asia capital flight risks now rather than U.S. and European capital flight risks.”
As the market expands, it one day may pose contagion risks to assets outside the region, much the way a surge in European bond yields can have a global impact. For now, foreign concerns center on a less-disciplined approach towards best practices. Market participants from non-Asian institutions sometimes complain privately about “crowding out” from Chinese buyers, who have in some cases brought looser standards from the onshore bond market.
In China, almost two-fifths of corporate debt is improbably graded AAA, by domestic ratings companies, and bond desks lack the kind of extensive back offices to check deals or research teams to do due diligence that are found at fixed-income operations in developed nations.
The surging Asian market is a new chapter for the offshore dollar-bond market, which was created by the Europeans more than half a century ago. Spurred by the desire to tap a broad, international pool of capital, the manager of Italy’s highways sold the first so-called Eurobond in 1963.
It also reflects a long-held aim of Asian policy makers to encourage money to stay within the region, ever since the 1997-98 financial crisis that saw economies and corporate empires collapse after excess borrowing in dollars when local exchange rates were overvalued.
Nations across the region have made great efforts to build local-currency bond markets, and encouraging retention of dollars in Asia — much of which come from trade surpluses — is another aspect of their approach.
Here are some of the changing contours of the Asian dollar-bond market, and its outlook, according to ANZ:
- Issuance in the first half of 2017 reached a record $155 billion
- Investment-grade debt made up 62% of the total, with 23% being high-yield and 16% non-rated
- Almost all the debt was corporate and financial, with sovereigns making up just 6%
- China made up 66% of total issuance, with corporate debt 38% of the total
- Some 79% of the total was bought by Asian buyers
- Chinese buyers are taking up about 65% of the debt sold by Chinese issuers
- About 26% of Chinese issuance was property, with financial firms making up 42%
- Bonds sold according to Securities Act Rule 144A, which is required for issuance in the U.S., have tumbled to 16% of issuance, from 37% just three years ago. Bonds sold outside the U.S. are known as Regulation S, or Reg-S, securities, and are subject to much laxer accounting guidelines.
- China made up about 47% of the $730 billion market outstanding as of June, and is projected to surpass 60% of the market by 2020, when the total reaches a forecast $1 trillion.
For Yim, the head of debt capital markets at Standard Chartered for greater China, the market’s change has meant spending more time in his home base Hong Kong, not just because of less business travel.
Years ago, August was a quiet month when Asian bankers could go on Western-style summer holidays. Nowadays, issuance continues apace through the month. It’s Chinese New Year, in January or February, that’s become the dead-zone for sales.
“Back in 2010, 2011 if you wanted to sell even $200 to $300 million for say a PRC property issuer, you had to go to the U.S.,” Yim said in an interview last month, using the acronym for the People’s Republic of China. “Now you can do Reg-S issues at $2 billion and there’s not much difference in pricing.”
China Evergrande Group, a junk-rated company that’s China’s biggest developer, set a new bar for the size of deals that can be done in Asia with a $6.6 billion Reg-S sale in June.
The ultimate test of resilience to an outside shock might still be looming, however, as the Federal Reserve keeps up its campaign of normalizing monetary policy.
Robert McCauley, an adviser to the Bank for International Settlements with decades of experience analyzing global debt markets, concludes that “it was the stock of dollar bonds issued by non-financial borrowers outside the United States that proved most responsive” to policy makers’ drive to reduce longer-term borrowing costs.
Over the longer haul, events outside Asia will prove less important, observers in the region say.
“Asian capital markets, with China at the center of it, are going to be transformational,” and the dollar-bond market is part of that, said Luke Spajic, head of portfolio management for emerging Asia at Pacific Investment Management Co. in Singapore.
There are “so many more companies that need to come to market in Asia” for dollar bonds, Spajic said in an interview while on a visit to Beijing. “Asia has a big savings pool – this is their natural stomping ground. There is enough demand in this region to scoop up all the securities.”
The Reference Shelf
— With assistance by Denise Wee, Lianting Tu, Carrie Hong, Finbarr Flynn, and Emma O’Brien