Bonds naturally make up a large part of international financial markets. This is no different in China. But the Chinese bond market is divided into three parts. On the one hand, there is an open, international offshore market in both US dollars and renminbi. On the other hand, there is a long, closed onshore market. Today, these markets are converging. The Chinese government is opening the market for Chinese bonds. Since 2017, Chinese onshore bonds can also be traded abroad without the previous restrictions.
The Long Road to China Bonds
Up until 2002, the Chinese capital market was practically inaccessible to international investors. This lack of access benefited the Chinese government in several ways. It satisfied their strong desire for control dating back to imperial times. This stems from the Confucian state philosophy, which strives for consistency in its own sphere. Moreover, it protected China from unexpected capital imports and thus from what economists call the “Dutch disease”: trade imbalances due to cheap imports and increasingly expensive exports.
The Chinese government followed a two-pronged approach in opening up the capital markets. Starting in 2002, selected banks were allowed to participate in the Chinese capital markets to a very limited extent. Thus, the so-called ‘offshore market’ initially gained importance. Under the watchful eye of the Chinese authorities, individual banks, companies and corporations were allowed to issue bonds on international markets: hence the term ‘offshore’. The first offshore issue took place in Hong Kong in 2007. Since then, Singapore, Taipei, London, Frankfurt, Paris and Luxembourg have been added as trading centres.
China Bonds: About Dim Sum and Pandas
Offshore bonds from Chinese issuers can be divided into two groups: bonds denominated in Chinese currency and other currencies. These can be local currencies. However, only the US dollar actually plays a role. Bonds with a nominal value in the Chinese currency renminbi are called ‘dim sum bonds’. Dim sum are actually small snacks offered in Chinese tea houses. The term alludes to the small volume of this market, but also perhaps to the possibility of securing business within China with them. ‘Panda bonds’, on the other hand, are international bonds issued in renminbi.
There are reasons for the greater success of the offshore market. The laws and regulations of the respective countries naturally apply to offshore bonds. For investors, little will change. They are not required to submit to the Chinese authorities. At best, China will influence which issuers it allows to enter the market. And of course, it can influence the renminbi, which in turn impacts the dim sum bonds. But it also benefits as a market for model companies that were able to obtain cheap capital from large, well-developed capital markets. At the same time, the government did not have to relax its control over the onshore market. But there was one problem: too many buyers for too few issues.
China Bonds: Dim Sum Coming Home
From a western perspective, the offshore market is the larger, more accessible one. The market for Chinese bonds in US dollars is estimated at USD 316 billion, while the ‘dim sum’ market is only valued at USD 82 billion. From a Chinese perspective, it is the other way around. The onshore market is worth around USD 12 trillion, about 30 times the combined weight of the other two markets. It is more liquid, more diverse, and more profitable because the markets were decoupled from each other. But the Chinese government is gradually opening up the onshore market.
The current high point – with likely more to come – a is called Bond Connect, a programme that has been linking the Chinese and international bond markets since 2017. The bonds remain in China, but entitlement to the respective security can be traded on the international markets. The Chinese government is thus giving up some of its control options and making large parts of the USD 12 trillion market accessible. For Western investors, this opens up brand new opportunities to invest in bonds in China.