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Dim Sum Bonds, European and U.S. Investors Demand Bondholder Protections.

20 January, 2012

 

Legal News & Analysis – Asia Pacific – China – Banking & Finance – Capital MarketsHong KongBanking & FinanceCapital Markets

 

 

Dim sum bonds emerged in 2007 when China began its experiment to internationalize the national currency by permitting foreign companies and certain Chinese financial institutions to issue debt denominated and settled in offshore Chinese renminbi (CNH) — a currency effectively different from onshore renminbi (CNY) and primarily traded and cleared in Hong Kong. Since then, more than 70 companies have issued offshore renminbi (RMB) bonds in Hong Kong. Dim sum bonds, like the popular bite-sized Chinese food from which their name originates, often have been doled out in relatively small sizes, with some deals raising as little as RMB 200 million (US$30 million). However, the market for these bonds has been growing rapidly, with the largest dim sum bond issuance to date being the RMB 3.6 billion (US$564 million) issuance by Baosteel Group in November 2011.
 
In the first six months of 2011, 22 issuers raised an aggregate of more than RMB19 billion (US$2.9 billion) through dim sum bond sales. The majority of these issuers were Hong Kong-based companies (including Chinese businesses owned by offshore companies whose shares are publicly traded on the Hong Kong Stock Exchange). International players (typically those with meaningful China operations) such as McDonald’s, Caterpillar, Unilever, Tesco and L’Air Liquide also are developing an appetite for this new debt class. A recent policy change by the People’s Bank of China allows Chinese state-owned companies to issue offshore RMB bonds, up to a quota of RMB 50 billion. The first issuance of such bonds by a Chinese state-owned company took place in November 2011, when Baosteel issued its debut dim sum bond.
 
Dim Sum Bond Terms and the Changing Nature of Dim Sum Bond Issuers
 
Prior to mid-2010, virtually all of the dim sum bond issuers were People’s Republic of China sovereign bodies and financial institutions. A slight change occurred in mid-2010 when a number of private investment-grade corporations and supranational institutions, such as the World Bank, International Financial Corporation and Caterpillar, came to the market. However, beginning with a December 2010 issuance by Macau gaming operator Galaxy Entertainment, an increasing number of high-yield issuers — including those that either previously had issued U.S. dollar high-yield bonds or had U.S. dollar high-yield bonds outstanding — have accessed this market.
 
Speculation that the RMB will strengthen, as well as the large deposit of RMB with banks based in Hong Kong, have fueled demand for dim sum bonds in Hong Kong and the region. The demand for dim sum bonds by investors has been so high that many of the deals that were done prior to early 2011 contained only limited bond covenants, even though the issuers were not investment-grade companies. In some cases, the bond terms do not contain covenants that restrict debt incurrence (such as a fixed-charge coverage test or a maximum debt-toequity ratio). According to Bloomberg, only four non-financial companies in the HSBC Offshore Renminbi Bond Index contain this level of protection. Investors bought these bonds with reliance on negative pledge provisions, which typically prevent the issuer from using its assets as security for new debt unless holders of the dim sum bonds will get to share such security or get alternative security of the same value. Other safeguards include relying on cross-default clauses in the bond instruments; if the issuer is in default of another bond or loan with a set minimum principal amount, it will trigger the dim sum bonds to be repayable immediately. Additional differences between typical dim sum bond terms and China-related U.S.-dollar high-yield bond terms include the following:
 
  • Secured vs. Unsecured. It is common for China-related U.S. dollar high-yield bonds to be secured by shares of the non-China subsidiaries. It is very rare for dim sum bonds to be secured.

 

  • Structural Subordination. It is common for China-related U.S. dollar high-yield bonds to be guaranteed by the issuer’s non-China subsidiaries. The advantage is that it reduces structural subordination, as investors are able to have direct causes of action against the guaranteeing subsidiaries. It is very rare for dim sum bonds to be guaranteed. 

 

  • High-Yield Covenants. China-related U.S. dollar high-yield bonds often contain a suite of typical high-yield covenants, including limitations on indebtedness, restricted payments, asset sales, transactions with shareholders and affiliates, dividend and payment restrictions affecting subsidiaries, and sale and leaseback transactions, among others. Except for a handful of recent deals, most dim sum bonds do not contain typical high-yield covenants. At times, the decision on whether to employ high-yield covenants may determine the success of a bond issuance. A tighter covenant package helped the automobile dealership ZhongSheng Group successfully issue its RMB 1.25 billion 4.75 percent dim sum bonds in early 2011. This issue’s bond terms included standard incurrence tests, as well as asset sale and payment restrictions. Recently, some real estate companies have failed to put through deals using light covenant packages.
 
As demand has outpaced supply, the dim sum market has, until very recently, been essentially an “issuer’s market” — where the balance of power regarding the proposed terms of the bonds is generally in favor of the issuer during negotiations with the offering’s investment banks. Hong Kong banks and investment funds, faced with burgeoning RMB deposit accumulation and limited same-currency, fixed-income investment options, are the main purchasers of dim sum bonds. Other investors include high-net-worth individuals in the Asia-Pacific region. As of May 2011, more than RMB 500 billion was deposited in Hong Kong, while only RMB 131 billion in dim sum bonds was outstanding as of June 2011. Participation from other investors has been fueled by, among other things, expectations that the RMB will appreciate.
 
A review of the more recently completed dim sum bond terms suggests that some issuers are now including selected high-yield covenants in their bond terms to facilitate marketing. For example, the RMB 1 billion dim sum bonds issued by Shougang Corporation in November 2011 include a leverage covenant and an asset sales covenant.
 
What Is the Future for the Dim Sum Bond Market?
 
The recent volatility in global currency and financial markets, along with the publicity surrounding the alleged inaccuracy of disclosure in some recent securities offerings by People’s Republic of China-related issuers, have made it more difficult for issuers and investment banks to market dim sum bonds. This has led to the repackaging of bond terms by tightening the covenants in a number of deals. Market requirements may further tighten for issuers as alternative RMBdenominated investment products become available.
 
With more than 70 dim sum bonds having been issued, investor demand in Asia for this type of product may gradually reduce. European and U.S. investors entering the dim sum bond market have in the past demanded, and likely will continue to demand, bondholder protections similar to those contained in typical Asia-based U.S. dollar high-yield bonds. Furthermore, as expectations for RMB appreciation decline, there may be less demand for dim sum bonds. As a result — and as this
market continues to mature — we expect offering structures and covenant packages in dim sum bond issues to correlate more closely with the credit quality of the issues.
 
 
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