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HONG KONG: The gap between China onshore and offshore bond rates is converging to the delight of fund managers, and probably the government, as it signals a deepening of markets for Chinese assets and the yuan.
More alignment between the two markets shows that the offshore market is not just being driven by FX speculation and will help toward internationalisation of the Chinese currency.
Money managers at the annual auction of China's ministry of finance bond sale on Wednesday found that the gap between the two debt markets that had existed for years had at last begun to shrink, and in some parts of the yield curve, even disappear.
Investors have long complained about the structural deficiencies in the offshore yuan bond market, which have always forced them to buy Chinese debt outside the mainland at costlier prices compared with onshore.
China's debt market is the third largest in the world after the United States and Japan and is poised to expand along with demand for Chinese assets as the country opens its financial markets.
While that gap narrowed to some extent in recent months as China gradually allowed access to foreign investors to its interbank bond market via quotas, the small size of these channels and a near-decade long currency rally meant yields on offshore debt were usually below onshore bonds.
This year's unexpected weakness and volatility in the Chinese currency, which has fallen 3 percent against the dollar so far this year and is among the leading losers in the emerging market universe, has accelerated this convergence trend.
Still, the renminbi's volatility and weakness failed to deter investors at China's ministry of finance bond sale where it sold the first of a 28 billion yuan ($4.5 billion) dual-tranche bond.
The first tranche was a 14 billion yuan six-part transaction sold to institutions on Wednesday with seven central banks and monetary authorities among the investors.
The 7 billion yuan 3-year tranche was priced to yield 2.53 percent, the 4 billion yuan 5-year tranche 3.25 percent, and the 1 billion yuan 7-year tranche 3.8 percent.
On longer tenors, the one billion yuan 10-year tranche was priced to yield 4 percent, the 500 million yuan 15-year tranche 4.29 percent and the 500 million yuan 20-year tranche 4.5 percent.
Demand was robust with the 2.99 times overall coverage ratio for the transaction higher than the 2.59 times ratio for the ministry's offering last November.
This was despite being the ministry's biggest debt offering in the last five years and some houses such as HSBC are predicting a record supply of dim sum debt this year.
Paula Chan, senior portfolio manager at Manulife Asset Management in Asia, said the currency's weakness has raised the awareness among investors to view offshore yuan bonds as a credit class rather than a vehicle for betting on the currency.
"Many of our institutional clients are looking to do more on the offshore yuan bond as an investment option and the recent trend in more issuance of rated paper is a healthy sign," she said at an RMB conference hosted by the Hong Kong Stock Exchange.
The demand for more ratings has led to investors allocating credit risk premium in line with the mainland bond markets, driving this convergence between the offshore and onshore debt.
Wednesday's auction cut-off in the longer tenors was broadly in line with the secondary market yields on the mainland while shorter-dated debt was still bought at a premium, indicating that convergence had still some way to go.
That lack of convergence on the shorter tenors exist because investors cannot freely access both the offshore and the onshore bond markets and shorter-dated instruments are still typically used as a bet on currency gains by many investors.
For example, the gap between the cut-off yields on the 10- year and the 15-year sector was an average five basis points compared with a whopping 94 basis point average gap on the two- and three-year tranche, according to Thomson Reuters data.
WEEK IN REVIEW:
Deutsche Asset & Wealth Management and Harvest Global Management have teamed up to sell a first small cap investment product to be launched under China's renminbi qualified institutional investment programme. The product will track the performance of an index of Chinese companies, each with a market cap averaging $1.2 billion.
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