T-bonds hot among foreign banks
(China Business Weekly)
Updated: 2004-06-02 09:21

Stimulated by China's booming economic growth and the wide expectation of renminbi revaluation, foreign banks are flooding into China's treasury bond markets.

International investors with long-term visions and willingness to accept risks are tempted by the country's bond market.

Last year, the China Securities Regulatory Commission (CSRC) licensed a dozen qualified foreign institutional investors (QFIIs) within several months.

The approval enabled foreign institutions to trade yuan-denominated A shares and bonds including treasury, corporate and convertible bonds via special accounts opened at designated custodian banks.

The appetite of foreign institutions for Chinese securities seems insatiable.

In 2003, the foreign banks, which set up branches on the mainland and had the QFII licences, have purchased treasury bonds worth a total of US$21.1 billion Treasury, up 11.6 times more than last year.

The trend has continued, with the Hongkong and Shanghai Banking Corp (HSBC) being especially active. Last year, the bank ranked first in terms of trading volume among all foreign financial institutions in the interbank bond market, buying treasury products valued at 9.1 billion yuan (US$1.1 billion).

The banking group continued to buy 2.1 billion yuan (US$253 million) worth of treasury goods in January.

In addition, HSBC also won an underwriting licence in the treasury market from the Ministry of Finance. This means that HSBC can subscribe the new offerings in both primary and secondary markets.

This year, Credit Suisse First Boston (CSFB) purchased US$7.31 billion in bonds.

The US financial giant Citibank also followed the heat wave, buying US$2.8 billion worth of treasury bonds.

Japanese Nikko Assets Management Company will launch the "Nikko Bond Market Fund," targetting China's treasury market.

The voracious desire shown by these institutional investors to take greater risks in search of higher returns was encouraged by an unprecedented set of special circumstances.

At the same time, the treasury indices started to drop, which triggered the buying spree from foreign financial institutions, while domestic investors remained prudent.

On May 27, the treasury market index closed at 93.8, down 4.05 per cent since 97.6 on April 1 this year. The developments over these last few months have proved that the once-running bull market for bond markets is finally over.

In mid-April, the Chinese central bank raised the reserve requirement for banks by half a percentage point to 7.5 per cent in order to pull out the liquidity from the credit market. Consequently, a wave of sell-offs followed. In the near future, uncertainty about another tightening measure including rate hikes will likely exacerbate the market's worries.

What's more, experts noted that the nominal yield rates of bond markets are not based on taxation, so they cannot actually reflect investment rates. If the taxation factor is taken into consideration, the yield curve shall be put downward further.

However, foreign banks seem to be ignoring the market turmoil. When fear and panic grip financial markets, it is usually a good time for smart investors with strong stomachs to buy, according to strategists and fund managers.

Most foreign banks believe that the trend of renminbi revaluation is irrevocable.

According to a report recently released by CSFB, the yuan will remain stable in the short term, but before 2006 or 2008, the currency's exchange rate may increase to 5 from 8.28 now against the US dollar.

Goldman Sachs (Asia) suggested the timing of adjusting the exchange rate is amateur. Solomon Smith Barney and UBS group also believe China should widen the floating range of renminbi against other currencies. These institutions all have QFII quotas.

"Overseas fund managers are enthusiastic about the market, now that the revaluation expectation lift their confidence in China's capital market, especially in the bond market," said Nicole Yuen, head of China equities at UBS, a Swiss bank. "The overseas investors were once cautious about currency risks, but currently they are talking about the potential returns on currency appreciation."

"Because China's treasury rate is higher than deposit interests of US dollar and other currencies, the foreign banks' drastic actions do not surprise me greatly," said Lu Yungang, head of CFSB's research department in China.

Akihiro Nakae, chief representative of Nikko securities in Beijing said: "A bearish market does not mean no profit. It is absolutely a good opportunity to enter the market."

He further pointed out that in general conditions, they will hold the securities to maturity rather than dealing in the market frequently.

Foreign financial institutions also profit from buying derivatives for hedging the treasury position at the same time. In fact, foreign banks with QFII licences can use overseas renminbi forward contracts to hedge potential risks derived from the China capital market.

"Recently, the treasury bond market has presented an unfavorable performance," said Charles Feng, a senior fixed income analyst at Deutsche Bank (Asia). "So through renminbi forward contracts, investors can hedge against both the exchange risk and bond risk, preventing the position effectively."

The strategy is named as "carrying trade," which means people can borrow at cheap rates in the United States and pump the proceeds into China.

The gains on the appreciation of the yuan can still compensate for the losses on the low rate. When asked about the negative impact caused by possible rate hikes, he said that returns from revaluation will surely cover the market losses triggered by the rate hike.

But the CSRC does not endorse the speculation. The industry's regulator hopes that QFIIs can dig out the investing value rather than speculating on revaluation.

A lingering concern is the entry of international hot money into the domestic market on speculation of a renminbi appreciation and chances of profit-taking.

"Compared to bonds, QFIIs buy more stocks, and their major interest is still focused on stock market," said an official of an investment bank with a QFII licence. The official declined to be identified.

After all, the capital value of the share market is far larger than that of the bond market.

The author Mo Fan is an independent contributor to China Business Weekly.

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