China Policy Banks Test New Bond Issuance Program, Spelling Bad News for Middlemen
China’s top two policy banks have issued interbank bonds in a pilot program that removes the role of the underwriter and allows investors to bid directly for the debt, the latest step in government efforts to attract more foreign capital and promote financial opening-up.
China Development Bank (CDB) issued a 5-year 12 billion yuan ($1.9 billion) bond with a coupon rate of 3.28%, and the Agricultural Development Bank of China (ADBC) sold a 1-year 6 billion yuan bond with a coupon rate of 2.49%. Bidding was completed on Wednesday, according to announcements made by the two lenders.
If the pilot is a success and is rolled out across the interbank bond market, it will mark a significant revamp of how bond issuance is carried out in China. Overseas institutional investors currently purchase bonds issued by China’s three policy lenders through the underwriters of the sale.
The change is mainly aimed at meeting demand from overseas investors to directly participate in the world’s second-largest bond market, improve the efficiency of bond issuance and align more with international practice, several sources told Caixin. China’s interbank bond market, known as the CIBM, is the dominant market where around 90% of all trading is done and where government bonds, policy bank bonds and other financial bonds issued by financial institutions are issued.
Foreign investors have piled into the CIBM over the past two years as regulators further opened up the market and made it easier for them to trade. Higher yields on Chinese government bonds (CGBs), expectations of continued yuan appreciation, and the strong recovery in the world’s second-largest economy from the Covid-19 pandemic have also attracted international investors. Foreign holdings of Chinese bonds, mostly in the form of government debt, have tripled since the end of 2017 when they stood at just 1.15 trillion yuan.
Of the 103 (link in Chinese) institutional investors who submitted bids for the ADBC bond, 10 were foreign-owned and four were Hong Kong-based units of Chinese banks, according to a Wednesday statement (link in Chinese) by the ADBC. Forty bids were accepted and of those, three were Hong Kong arms of Chinese banks and six were other overseas institutions including Standard Chartered Bank (China) Ltd., HSBC Bank (China) Co. Ltd., Fubon Bank (China) Co. Ltd., and Crédit Agricole Corporate and Investment Bank’s Hong Kong branch. The nine took combined 10% of the 6 billion yuan bond.
The direct bidding model can help overseas investors purchase ADBC bonds in a more direct, convenient, and efficient manner, encourage them to participate in the primary market, improve the efficiency of bond issuance, and deepen opening-up and connectivity, ADBC Vice President Zhang Wencai said in the statement.
Overseas investors who bid for the CDB bond were mainly from Hong Kong, Macao, and Taiwan as well as countries in Southeast Asia, West Asia, the Middle East, Europe and Oceania, according to a Thursday statement (link in Chinese) released by the CDB. The bank has yet to disclose the names of the bidders or who was successful.
CDB also hailed the trial, saying in a statement (link in Chinese) that it helped fulfill overseas institutions’ demand for yuan-denominated assets, facilitate the two-way flow of capital and help promote the internationalization of the yuan.
The pilot took place as foreign holdings of bonds traded in China’s interbank market dropped in March for the first time since February 2019, as the rising yields on U.S. Treasuries and expectations of a stronger U.S. dollar lured yield-hungry global investors away.
Outstanding overseas holdings of Chinese interbank bonds stood at 3.56 trillion yuan at the end of March, a decrease of 9 billion yuan from a month earlier and representing 3.4% of the total market, according to data (link in Chinese) from Bond Connect Co. Ltd. and the People’s Bank of China (PBOC).
The yield gap between 10-year CGBs and U.S. Treasuries of the same maturity narrowed from 225 basis points at the beginning of this year to 145 basis points at the end of March. As of March 31, the U.S. dollar index, which measures the value of the dollar against a basket of currencies of the U.S.’s most significant trading partners, had rebounded around 4.2% from its lowest point in nearly three years at the beginning of 2021.
Policy bank bonds rank second among all overseas-held interbank bonds and accounted for nearly 30% of the total at the end of March, standing at 1 trillion yuan, 7.6 billion more than the previous month, central bank data (link in Chinese) showed. CGBs accounted for the biggest portion, amounting to 57.4% of the total.
Regulators also hope to use direct bidding to rectify violations they have uncovered in bond underwriting, sources with knowledge of the matter told Caixin. For example, underwriters of policy bank bonds often pass on the income they earn from underwriting the bonds to investors, which leads to vicious competition and a large gap in bond prices between the primary and secondary markets.
“Before bonds are bought and sold in the secondary market, bond underwriters resell bonds they purchase from issuers to other investors,” Sun Tianqi, head of the PBOC’s Financial Stability Bureau, wrote (link in Chinese) in an article published in March in a magazine overseen by the central bank. “This gives rise to the practice of illegal rebates, which can distort market pricing, reduce the efficiency of resource allocation and breed shadowy practices,” Sun wrote.
In January, China’s securities regulator summoned 12 brokerages suspected of waging a bond underwriting price war. This followed a ban on Shenzhen-listed Bank of Ningbo Co. Ltd. (002142.SZ) conducting interbank bond-related business for two months for underwriting several bond issues with coupon rates well below reasonable valuations.
For now, the direct bidding model is not mandatory, a source close to the central bank said. The two policy lenders can choose to use underwriters or direct bidding based on market conditions, the source said.
As the effect of the bond issuance revamp is controversial for bond issuers, it remains to be seen whether the pilot will be rolled out further, multiple sources told Caixin.
While the direct bidding model will save issuers money as they won’t have to pay underwriting fees, they will have to devote more time and effort to working with many institutional investors during the issuance process, rather than a handful of underwriters, a senior bond market insider said.
Contact reporter Luo Meihan (email@example.com) and editor Nerys Avery (firstname.lastname@example.org)
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