December 16,2007

Panda (Bonds)-Hugging

By Ma Wenluo
The conclusion of the third Sino-American Cabinet-level SED (Strategic Economic Dialogue) marks China's continued steps in developing and opening its financial markets and creating opportunities for U.S. investors and financial services firms. Among these steps was an agreement to allow incorporated foreign banks to issue RMB-denominated stocks and bonds, providing foreign companies with new opportunities for finance and expansion of sales in China.

In the first time that China has opened its bond market to foreign issuers, the International Finance Corporation (IFC) and Asian Development Bank (ADB) have been permitted to issue, respectively, 1.13billion and 1 billion yuan-denominated bonds, branded Panda Bonds.

Permission to underwrite domestic IPOs and a license to issue RMB-denominated debt securities indicates foreign banks are being granted national treatment by the government, same as Chinese banks, setting up real and inevitable competition at all levels. When the transformation to banks?incorporation is fully completed, foreign invested banks will realize "localization" and gain exactly the same business scope as their Chinese competitors, including financing modes and channels.
Before incorporation in China, foreign invested banks major financing source has been overseas inter-bank borrowing. Regulators feared that without proper scale control and necessary supervision, this may result in too great an influx of overseas capital, causing volatility in the RMB exchange rate. Therefore, the People’s Bank of China (PBoC), China’s central bank, has limited foreign banks?use of overseas financing to lend to Chinese clients. But after the overall opening-up of RMB-denominated transactions, the rapidly developing business of foreign banks will lead to the need for a larger purse, and with few local branches and limits to both size and ability to hoover up RMB deposits, it may be hard for them to meet their needs for finance merely via equity capital and domestic inter-bank borrowings.
Convenience in financing is crucial in measuring whether foreign banks are being given real national treatment. Especially at present, with China suffering a surplus cash flow, allowing foreign invested banks to list on the Chinese stock market and to issue designated amounts of RMB-denominated financial bonds will help them not only to raise operating funds but also to sop up domestic liquidity, lessening their dependence on overseas funding. 

The issuance of the Panda Bonds by international multilateral financial institutions was co-supervised by the central bank, the Treasury, the National Development and Reform Commission, and the China Securities Regulatory Commission. Yuan-dominated bonds issued by qualified foreign banks share the same issuing mode as their Chinese counterparts and will, upon approval, be treated the same way as inter-bank financial bonds. The issuer will decide the bonds?interest rate by referring to the rate of return of other financial bonds with the same term. The supervisory departments may be cut from four to two, namely the PBoC and the China Banking Regulatory Commission, which will accelerate approval of RMB-dominated bonds by overseas banks. Currently there are nearly 20 foreign banks whose systems transformations have been approved. The scale of Panda Bonds is set to super-size.

Allowing foreign banks to issue yuan-dominated bonds helps not only to diversify China’s bond market and accelerate its development and the process of internationalization. It also marks a crucial step on the road to loosening RMB capital controls, a mixed blessing. Panda Bonds tighten the tie between domestic and overseas financial markets, allowing overseas financial risks greater chance to infiltrate the Chinese market. Meanwhile, RMB will also flow into global markets. While the PBoC’s influence will be enhanced, it will also face the challenge to effectively manage that increased financial risk.
Credit rating of issuers and their bonds is an essential issuing procedure. Now most of the controlling stockholders of overseas bank corporations enjoy powerful competitiveness and strong management structures. With that support, Panda Bonds should receive a high rating, enabling issuers to obtain RMB funds at low cost.  

But according to PBoC regulations, credit ratings will be conducted by a domestically registered agency before any financial bond issuance. Credit rating any overseas bank will be a super challenge for China’s underdeveloped credit rating agencies, who have not yet gotten involved in international rating business, and their competence is going to be severely tested.

(Mr.Ma Wenluo is the deputy director of  the Institute of Dredit Research of Shanghai Academy of  Social Sciences and a senior executive of a credit rating company in Shanghai. He holds a Bachelor and a Master in economics.)

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