Fitch: Panda Bonds - Crawling Through Regulatory and Liquidity Issues, Low Yields

Fitch Ratings says in a new report that it does not expect growth in Panda Bonds to accelerate significantly in the short term, despite low onshore yields which may make them attractive from an issuer perspective. This is due to stringent regulatory requirements, local investors being largely unfamiliar with international names, and shallow secondary market liquidity. These factors are likely to limit both issuer and investor interest for the time being.

Panda Bonds refer to the nascent market for bonds issued by foreign institutions on the onshore market in China. The market is very much in its formative stages with a total outstanding amount of only USD2.57bn by just 11 issuers, but most of the issuance has occurred since 2H15 when the Chinese regulators opened up the market to allow a wider variety of foreign entities to issue Panda Bonds.

The case of Daimler AG, as the sole international non-financial corporate to issue Panda Bonds so far, suggests that potential foreign corporate issuers of Panda Bonds are limited to multi-national corporations with significant operations in China, and a genuine need for yuan to fund their local operations.

Other short-term restraining factors on the potential growth of the market include the requirement for entities not based in Hong Kong or the EU to reproduce their accounts in line with local standards; poor visibility on the nature and timing of the regulatory approval process; and uncertainty over whether the proceeds can be transferred offshore.

The report illustrates how yields on Panda Bonds are around 200bp lower than Dim Sum Bonds, and hence an attractive option for foreign entities - at least on the surface. At the moment, expectations for further depreciation of the yuan have raised the yields on Dim Sum Bonds to abnormally high levels, but we expect investor appetite for Dim Sum Bonds to return once the market perceives the yuan to have stabilised.

Importantly, we expect Panda Bonds to erode some market share from that portion of the offshore Dim Sum Bond market issued by foreigners which have a need to use the proceeds onshore. Foreign entities with a requirement for offshore yuan will continue to use the Dim Sum Bond market.

The report details the key advantages and disadvantages of issuing Panda Bonds versus Dim Sum Bonds; examines the rationale of Panda Bond issuers which have to date included Daimler, the major UK banks and the Chinese property developers; lists the key regulatory hurdles holding back potential growth; and from the local Chinese investors' perspective, explains why secondary market illiquidity will make them think twice before rushing into Panda Bonds.