'Dim Sum Bonds' on the Menu for Foreign Investors

'Dim Sum Bonds' on the Menu for Foreign Investors

By PETER STEIN
Financial experimentation in Hong Kong is providing investors with a new way to bet on Chinese currency appreciation: the "dim sum bond."
These bonds, denominated in Chinese yuan and issued in Hong Kong (thus the unofficial name), represent a tiny portion of China's total local-currency debt. The amount raised so far this year is a mere $1.46 billion, versus the $144.7 billion worth of yuan debt issued inside mainland China, according to Dealogic.

But there's a key difference: Foreign investors, who are prevented from buying China's domestic yuan debt by strict capital controls, face no such obstacles when it comes to dim sum bonds.

The latest offering came courtesy of the Asian Development Bank, which recently sold 1.2 billion yuan ($180 million) of yuan-denominated, 10-year bonds in Hong Kong, the longest maturity so far for the fledgling market. Most issuers are from mainland China or Hong Kong, but even burger giant McDonald's Corp. has experimented with dim sum, raising 200 million yuan in bonds sold in Hong Kong to finance its expansion in China.

The buyers of these bonds can thank Beijing's decision to encourage the growth of a so-called offshore yuan market in Hong Kong, an in-house laboratory where China is allowing bankers to create new products and services to make use of yuan piling up in the city's bank accounts.

On Friday, Hong Kong exceeded its full-year quota of yuan available for settling trade deals in the territory, forcing the Hong Kong Monetary Authority to draw on a currency-swap arrangement with China's central bank in order to meet the demand. While the quota is aimed at promoting the use of yuan for trade purposes, some of the demand may in fact be driven by investors looking for ways to bet on yuan appreciation.

Investors in Hong Kong with yuan deposits find these bonds attractive given that they have few alternatives for where to park their cash. But a recent loosening of restrictions means investors from virtually anywhere, not just Hong Kong, are largely free to purchase from banks in Hong Kong the yuan they need to acquire these bonds, though they pay a slight premium to the rate they would get on the mainland.

For now, big fund firms are mostly watching from the sidelines. The market remains too small and illiquid for them, and uncertainties about how companies can use the funds they raise or repay them are still being worked out.

Still, since Beijing began allowing minor fluctuations in the yuan's trading range in June, interest has picked up in ways to play the currency's rise against the dollar. This is because despite Beijing's efforts to let the yuan zig-zag in its day-to-day movements, few believe the Chinese currency, also known as the renminbi, is going anywhere but up for the foreseeable future. That's at least in part because of political pressure on China to address its trade imbalance with the U.S.

With dim sum bonds, "you give access globally to investors who want exposure to the currency, who'd otherwise find it restrictive to access," says Daniel Mamadou, co-head of debt capital markets for Asia ex-Japan at Deutsche Bank.

So far, bonds issued in the local currrencies of China's emerging-market neighbors have been the easier way for fixed-income fans to play Chinese currency appreciation. As the yuan rises, these currencies are expected to follow suit.

But these currencies are more volatile than the yuan. And China has one of the best sovereign credit ratings in the region. In theory at least, that makes dim sum bonds sold by China Development Bank, Export-Import Bank of China and other local institutions that dominate the list of issuers a better credit risk than many of their regional counterparts.

Mr. Mamadou believes issuance is set to take off. The amount of money raised this year, while small, is nonetheless likely to double last year's issuance. At a 100% compounded annual growth, the market could be big enough within five years to eclipse all the dollar-based debt issuance in Asia, he figures.

The issuers to date all boast investment-grade credit ratings. "What's interesting is we're seeing quite a pipeline of issuers seeking to tap offshore renminbi," says Michael Petit, head of corporate and government ratings for Asia Pacific at Standard & Poor's Ratings Service. That includes issuers with lower credit ratings and higher yields that could attract investors with an appetite for risk as well as a conviction about the yuan's trajectory.

Until then, the more conservative investors are happy with the relatively low yields on the issues so far; the ADB bond offered an annual coupon of 2.85%, compared with the current yield of about 2.5% to 2.6% on U.S. 10-year Treasurys. "We see the interest from global investors just in currency exposure," says Mr. Petit. "If they see a good name and a renminbi-denominated instrument, it's an attraction to them."

Write to Peter Stein at peter.stein@wsj.com