The International Monetary Fund announced recently that Chinese yuan (Renminbi or RMB) will be added to the basket of currencies that constitute Special Drawing Rights with effect from 1 October 2016. The RMB will be given a weighting of 10.92% behind only the US dollar and Euro.
This recognition is to be considered against the backdrop of several significant developments in China during 2015, all of which point to the further relaxation of China’s strict control of cross-border capital flows. The expanding role of RMB in cross-border trade settlement is a key driver for the internationalisation of RMB.
KWM has written extensively about these developments includingthe cross-border (ie between the Mainland and Hong Kong) sale of shares and funds, the increasing access for foreign institutions to invest directly into China and the participation by foreign central bodies, sovereign wealth funds and international financial institutions in China’s interbank bond and foreign exchange market. Please see KWM Connect “A Roadmap to Cross-Border Finance II – An Update September 2014”; and KWM Connect “China Stock Connect and Mutual Recognition of Funds Latest developments in cross-border investment June 2015”.
The most recent relaxation is to permit foreign corporates, financial institutions and sovereign entities to issue RMB-denominated (so called “Panda”) bonds in China.
KWM has advised foreign issuers of bonds in China since 2005 when the International Finance Corporation issued the inaugural issue of onshore RMB bonds. KWM has acted on the two most recent approvals for issuance of onshore RMB bonds by the Republic of Korea and the Province of British Columbia, Canada. KWM’s role in the transactions points to the growing need for a “one stop shop” because these transactions involve complex PRC and offshore legal issues.
China’s bond market is the third largest in the world (behind the United States and Japan). China’s market comprises: the Inter-bank Bond Market (Interbank Market), which is regulated by the People’s Bank of China but administered by National Association Financial Markets Institutional Investors (NAFMII) and the stock exchange bond market which is regulated by the China Securities Regulatory Commission. The Interbank Market comprises more than 95%of total trading volume. Market participants primarily include domestic commercial banks (by far the largest participants), asset managers, insurance companies and securities firms. Foreign investors can access the market through programmes (such as through “QFII” and “RQFII”) that require a local license or approval (and grant of a trading quota).
A handful of onshore RMB bonds were issued by IFC and Asian Development Bank during 2005, 2006 and 2009.
Daimler issued bonds to professional investors in the Interbank Market in 2014 and 2015.
So, what’s new?
HSBC, BOC (Hong Kong) and Standard Chartered (Hong Kong) were each recently approved by the PBOC to issue up to RMB one billion (in the case of HSBC and Standard Chartered) and RMB ten billion (in the case of BOC) in the Interbank Market. China Merchants Group (Hong Kong) also issued 366-day commercial paper on the Interbank Market in November.
NAFMII recently announced on its website that it has approved for registration onshore RMB bond issues by the Republic of Korea and the Province of British Columbia, Canada.
The significance of the recent issues is:
- offshore issuers’ access to the Interbank Market;
- relaxation of, and clarity about, how the PRC rules apply to offshore issuers;
- China's willingness to accept a number of offshore debt issuance techniques,
all at a time when the gap between onshore and offshore interest rates are converging and the PRC government is reported to intend to avoid further lowering the value of the yuan against the US dollar.
Is the Interbank Market different to offshore markets?
Yes and no!
The aim of any offshore issuer is to replicate what it does in other markets so as to minimise the effort required to issue bonds and update investors about recent developments and financial information. To a large extent, the recent onshore RMB bond issues facilitate that approach.
- China generally requires financial information to be prepared in accordance with Chinese generally accepted accounting principles and for these accounts to be audited by a Chinese qualified auditor. The recent onshore RMB bonds indicate a willingness by the PRC authorities to recognise overseas accounting principles and audit procedures.
- Generally speaking, standards of disclosure in leading offshore markets are acceptable in the PRC although an assessment needs to be made as to whether names that are not as well known in the PRC require a more fulsome disclosure.
Clearly, PRC investors must be given the same disclosure, and at the same time, as offshore investors. This might involve satisfying on-going disclosure obligations by incorporating by reference to an onshore website and to making copies available at an address or website in China.
It is an expensive and time consuming process to translate a large quantum of financial data and so issuers will aim to translate only summaries of key financial information by way on on-going disclosure. Applications for approval must be accompanied by translated three year results together with management discussion and analysis or other data (including economic data) consistent with the issuer’s usual offshore disclosure.
Again, not one size fits all and a careful assessment needs to be made for each issuer.
- The onshore RMB bond market is largely a fixed rate, fixed term (three years is common), RMB-only market. Terms and conditions therefore provide less options than in offshore markets and reflect local issuance procedures. Issuers are free to adopt usual tax redemption, events of default and bondholder meetings provisions but PRC law must be used as the governing law and local arbitration will apply if there is any dispute. In our experience, offshore issuers are able to satisfy themselves as to the implications of undertaking PRC law-governed obligations.
- A key relaxation is an issuer’s ability to invest the onshore RMB bond proceeds with a local bank, the Interbank Market or to remit the RMB proceeds offshore. Whilst issuers are not able to convert the proceeds into a foreign currency onshore, they may do so offshore. Bond redemption and interest payment will need to be made in RMB (again, accessed from offshore).
So, what’s the complication?
The onshore RMB bond market is a domestic market and like any other domestic market has its own unique features such as:
- the local approval regime – all the recent onshore RMB bond issues have been conducted on a “pilot” basis meaning no PRC law expressly applies to offshore issuers (whether they are financial institutions, non-financial institutions or sovereign issuers). This means bespoke regulator approval although there is close reliance on the PRC law and practice that applies to onshore issuers;
- the issuance documents are in Chinese – this means issuers that do not read Chinese must have access to a pool of translators that are familiar with bond documentation;
- a rating by an onshore rating agency is required for onshore issuers and is generally required for offshore issuers – onshore ratings were obtained by BOC, HSBC, Standard Chartered and the Republic of Korea for their onshore RMB bonds. The Province of British Columbia is rated by international credit rating agencies as triple-A and was not required to obtain a local rating.
Onshore ratings might be required for all issuers (other than offshore sovereign issuers). Again, an assessment will need to be made for each issuer as to whether a local rating is an advantage in marketing to onshore investors;
- offshore issuers will need to become familiar with the way bonds are issued onshore. A bond is not actually “issued” (in either bearer or registered form) but rather the central depository electronically records the bond details from information fed to it by the issuer and bookrunner. The depository then issues a certificate reflecting the details on the register. The bond is only “issued” (in the sense of “goes live”) when the bond proceeds are paid to the issuer.
Again, in our experience, offshore issuers quickly become familiar with the process and how it differs from offshore practice.
Yes, liability for errors in, or omissions from, the offering circular.
Offshore issuers will be concerned as to the potential liability in the PRC for the issuer, its board or other governing body and its senior management for material inaccuracies in, or omissions from, what is disclosed in the offering circular – particularly when it is unclear how the standard of disclosure in the PRC, and the liability regime, applies to foreign issuers.
The key is a robust due diligence process so as to demonstrate the steps that were taken to compile the material to be disclosed, the scope of the disclosure and the verification of the disclosure.
The recent onshore RMB bond issues were undertaken in timeframes similar to those that apply offshore. The process followed was similar to that for an offshore bond issue (whether a one-off issue or a bond programme). A significant effort is required to understand the issues that are peculiar to the PRC market.
KWM is very well placed to assist you understand the key issues in the PRC and how they relate to an issuer’s offshore debt programmes.
Goldman Sachs Asset Management Global Liquidity Management “FAQ: China’s Bond Market First Half 2015”.
South China Morning Post Tuesday, September 29, 2015 “Yuan trades at strongest level since devaluation”.