Unleashing China’s inner panda

The wide gap between renminbi- and U.S. dollar-denominated bond yields has set off a mini-boom in China’s so-called “panda bond” market, designed for foreign companies seeking to fundraise from domestic investors. It marks another step forward in the increasing usage of the yuan for investment, trade and payments.  

But when the Fed moves to cut interest rates, the current spread between dollars and renminbi benchmarks will narrow, making the proposition less profitable. Now is an ideal time to implement reforms to sustain investor interest.   

Last year was a big year for pandas. A total of 94 such bonds were issued, raising 154 billion yuan (US$21 billion). The number of issuances and value of funds raised increased by around 80% from 2022, setting new records. The increase was partly driven by large number of new issuers, including Volkswagen and the government of Egypt. 

Corporations may issue panda bonds for a variety of reasons, but the simplest one is bread-and-butter operational finance. Multinational firms have accumulated a whopping US$3.8 trillion in direct investment stock in mainland China: factories, coffee chains, research labs, consultancies and so on. Maintaining and expanding these operations requires continued investment, but raising funds overseas then converting them into renminbi can entail foreign exchange risk and hedging costs. Selling local currency bonds to domestic investors takes currency volatility out of the equation and can be more efficient for balance sheets.  

On the demand side, panda bonds can offer domestic fixed-income traders a channel to diversify their portfolios and share the profits earned in China by top-performing foreign brands.  

At present it is particularly affordable to tap this market. The average yield on a 10-year U.S. Treasury bond is around 4.4%, 2 percentage points higher than comparable Chinese benchmark bonds of the same tenor. Accounting for differences in corporate credit ratings and exchange rate hedging, HSBC estimates the cost for multinational companies issuing panda bonds is about 2.2 percentage points lower than their comparable financing costs in US dollars.  

At the same time issuers have appreciated recent liberalisations, especially new policies in 2022 that make it easier to repatriate funds raised via panda bonds.  

Such a wide gap is naturally attractive, both for foreign companies seeking to raise funds to invest inside China and for corporate treasuries looking for arbitrage and hedging strategies. The question is how to keep the market attractive after the spread inevitably contracts. 

First, it is important to qualify the panda bond market’s success: it remains very small in comparison to the broader Chinese fixed-income market, which issued 71 trillion yuan (US$10 trillion) in 2023.  

Liquidity is an issue: tenors tend to be short, limited to within 3 years, and investors hold them to maturity.  

Representation is another. At present many issuers are offshore subsidiaries of Chinese companies which are well-known to domestic investors. Few North American or European multinationals participate.  

So there is a lot of room to grow, both in terms of size and depth. To unleash the next wave of expansion, I have three suggestions.  

First, harmonize regulations with international standards.  

At present, only certain national or regional accounting standards (such as the European Union's international standards EU-IFRS) are equivalent to Chinese accounting standards. The industry should work with regulators and the Ministry of Finance to provide flexibility in accounting standards and auditing agency qualifications for some bond types and specific issuers, and to give greater recognition to international accounting and auditing standards. In relevant disclosure documents, the use of internationally accepted information disclosure standards may be considered. 

In addition, it is particularly critical to further improve the panda bond issuance system and supervision system and integrate it with international standards, which will help better meet the diversified credit rating needs of international investors investing in the domestic financial market, and will also help the international development of China's rating industry. 

Second, optimize the market’s functioning, liquidity, and structure. 

The panda bond market would be more attractive to issuers if it had more trading volume. That means encouraging insurance companies, domestic funds, asset managers and other institutions to invest, and improving the market-making mechanisms of the secondary market, making repos more convenient and strengthening underwriters' obligations to conduct secondary market market-making and facilitate transactions. 

While liberalisations enacted in 2022 made it easier for foreign issuers to remit funds, the transparency of the review process and related standards leave much to be desired.  

Thirdly, we must also ensure any increase in the quantity of issuance is accompanied by an improvement in quality.   

The management model and the responsibilities of all parties following the issuance of bonds should be clarified, and investor protection strengthened. We must pay close attention to potential regulatory differences caused by cross-border capital flows. 

In conclusion, so long as domestic renminbi financing costs remain low and the exchange rate is relatively stable, panda bonds will remain popular. To keep them that way will require that we maintain the current reform momentum.