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China issues first-ever London offshore sovereign renminbi bond

By Cecily Liu ( Updated: 2016-06-02 17:36

China's Ministry of Finance issued its first sovereign offshore renminbi bond in London on Thursday, intended to reassure global investors of China's long term capital account liberalization commitment, as the renminbi embraces its new status as a global reserve currency.

The 3 billion yuan ($458 million) three year bond, is the first sovereign bond Ministry of Finance issued outside China. It is expected to act as a benchmark to aid future renminbi assets' pricing, hence encourage more issuance of renminbi investment products by commercial banks and grow London's renminbi liquidity.

The bond is to be listed on the London Stock Exchange from June 8. The listing creates transparency and liquidity, allowing investors to access how the bond trades. It will also expand the bond's potential investor base because some institutional investors in Europe would only consider buying bonds listed on public exchanges. Bank of China and HSBC are joint global coordinators of the bond.

So far demand for the bond is so high that it received interest of 8.5 billion yuan book value, meaning it is roughly 3 times oversubscribed, and investors who requested purchase of the bond can only invest a fraction of what they requested for.

Bonds issued by countries' finance ministries, known as sovereign bonds, are significant contributions to market confidence because they are liquid and safe. An additional attractive feature of the renminbi sovereign bond is the Bank of England's acceptance of it as an eligible collateral instrument, meaning holders of this bond can swap it with the BoE for sterling for short term liquidity purposes.

Andrew Carmichael, Capital Markets partner at the London-based law firm Linklaters, said the BoE's acceptance of the bond as eligible collateral helps to advance the renminbi's international use as mainstream currency.

"In addition, the bond supports the growing trend of using offshore renminbi for trade finance and investment, as it is a step in demonstrating the renminbi is part of the international banking system", Carmichael said.

Beng Hong Lee, head of Global Markets division at Deutsche Bank in China, said that the 3 billion yuan bond in London is small relative to London's capital market size, but it makes sense for the first such bond to be small in order to test market infrastructure and sentiment. He said in the future it is likely that renminbi sovereign bonds issued in London would be larger in size and thus enhance liquidity, as demonstrated by the average size of about 20 billion yuan for renminbi sovereign bonds issued in Hong Kong.

The first sovereign bond Ministry of Finance issued in Hong Kong was in 2011, and so far an aggregate of 136 billion yuan of sovereign bonds have been issued in Hong Kong.

Renminbi's internationalization process rides on the back of the Chinese economy's increasing integration into the global financial market. In recent years, as China became the largest foreign trading country and the second largest economy in the world, the renminbi has become the world's second-largest trading currency, and the fifth largest currency of payment. Liquidity in offshore renminbi markets in Hong Kong, Singapore, London, and Luxemburg, have also developed rapidly.

The renminbi's international use has broadened in trade, investment, and foreign reserves, and the International Monetary Fund's announcement to include it in its basket of special drawing rights currencies in October will further boost the renminbi's ambition to become a major global reserve currency.

One key outcome of the renminbi becoming a reserve currency is the growing appetite for global investors to tilt their investment portfolio towards renminbi assets, and the Ministry of Finance renminbi bond in London is good initiative to increase the availability of such assets for investors. China's $7 trillion bond market is currently the world's third largest, but international investors only hold about 2 percent, signifying the enormous potential for them to increase holdings in the future.

The bond's issuance came at a time of increasing renminbi exchange rate fluctuations, signified by renminbi's depreciation of 1.6 percent against the dollar in May, but investors say increasing volatility are signs of the renminbi's increasing market driven exchange rates, hence are no cause for concern.

"Volatility is normal for any closed capital market to become one that is flexible and open. The amount of increased communication with international markets that PBoC has done to assure them about its intention to further liberalize China's capital accounts is encouraging," said Deutsche Bank's Lee.

Sean Chang, Head of Asian Debt Investment at London-based Baring Asset Management, said the depreciation is mainly due to market's expectations of a strengthening dollar from the Federal Reserve rate hike cycle, which impacts all Asian currencies, and on a relative basis the renminbi experienced a smaller impact. In comparison, the Japanese Yen weakened against the dollar in May by 3 percent, the Singapore dollar by 2 percent, Malaysian Ringgit by 4 percent, and Korean Won by 3.5 percent.

Chang added that the renminbi depreciation against the dollar will have different impact on different investors looking to buy the Ministry of Finance bond, depending on which currency investor uses as their funding currency.

"If investors' funding currency weakens even more against the dollar, they would expect to gain from investing in renminbi bonds. Because London's investor base is so diverse, all investors' perspectives will be different," Chang said.

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