201503 － Hsbc－中国债券市场手册

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This brings us back to the broader issue of growth vs risk. China’s debt levels have been climbing faster

than GDP for more than a decade, especially since 2009 when Beijing launched its economic stimulus

package to counter the effects of the global financial crisis. If we use total bank loans and bonds to

measure debt, it comes out at around 193% of GDP as of 2014, up from 130% in 2001.

As we argued in The easing dilemma: Volatility and leverage up, yield yet to fall (10 February 2015),

China’s central bank faces a policy challenge. Easing, including two rate cuts and one reserve

requirement ratio (RRR) cut, has yet to significantly bring down borrowing costs in the real economy.

The disruption of fund flows – due to potential lower onshore RMB yields and a weaker exchange rate –

also reduces the effectiveness of policy easing.

This means the government has to weigh the effectiveness of injecting more liquidity as it tries to drivedown yields. Liquidity remains tight despite several rounds of monetary easing, as seen in the persistently

elevated 7-day interbank repo rate. China’s Treasury curve now looks similar to the US in January 2008:

flat at c3-4% and inverted at the short end, reflecting the difficult financing outlook, especially for banks.

Moreover, default stress should remain an overhang as repayment pressure increases in a market that has

yet be tested by the default of a publicly-issued bond. Besides, it remains to be seen how cutting the ties

between struggling LGFVs and local governments will play out. Despite the challenges, we think the

pace of change will continue this year, with the focus on:

Simplifying rules as the regulators of different credit platforms compete for market share (although

there is a risk that this may intensify segmentation).

More savings will be channelled into the bond market via wealth management products, which will

help the bond market to expand.

The bond market is becoming a competitor to traditional lenders, which may force them to balance

their desire for growth by focusing on efficiency and profitability. This is evident by the rapid growth

in the issuance of asset-backed securities in 2014.

In summary, given that the economy is in need of more funding, we expect the onshore and offshore bond

market to continue to grow in size and sophistication.

This report is the fourth of a series being published for HSBC’s RMB, Reform and China’s Global

Future forum on 26 March 2015.

Gross and net supply of onshore bonds Gross and net supply of CNH bonds and CDs

Source: Wind, HSBC Source: Bloomberg, HSBC

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

R M B b n

Gross issuance Net issuance

0

100

200

300

400

500

600

2007 2008 2009 2010 2011 2012 2013 2014

RMBbn

Bond CD Net bond Net CD

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=pxqLkQHWbM&n=446849.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=pxqLkQHWbM&n=446849.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=pxqLkQHWbM&n=446849.PDF

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Summary: A time of progressand problems 1

Onshore bond market: Bigger,broader, but… 4

Growth accelerates in 2014 4

Market dynamics 6

Trading platforms 20

Investors 21

Recent developments 24

Conclusion 25

Changing dynamics of offshoreRMB bonds… 26

…They will come back 28

Disclosure appendix 50

Disclaimer 52

Contents

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Growth accelerates in 2014

China is now the third largest issuer of bonds in the

world, behind the US and Japan, as shown in Fig 1,

based on the total amount of bonds outstanding. This

is largely because of activity in the onshore market,

where growth of bonds outstanding has averaged

20% since 20011 (Fig 2) and around 93% of China’s

bonds are issued. Fundraising on the domestic bond

market rose to a new level last year: gross issuance

reached RMB12trn, up 35%, and net issuance rose

to RMB6trn, up 60% (Figs 3 and 4).

However, when adjusted for GDP, China’s bondmarket is still much smaller than those in developed

countries (Fig 1). The majority of financing still

comes from the banking system, whose share in

total social financing (TSF), a measure of total

funds raised by corporates in the financial system,

though in long-term decline, has stayed at around

60% in the past five years. So, while great progress

has been made, the era of direct debt financing in

China is still at an early stage.

______________________________________1 Compound annual growth rate (CAGR) between 2000 and 2014.

1. China is now the third largest bond market in the world

Source: World Bank, Bloomberg, HSBC

Note: Total bonds outstanding refer to all bonds issued by the country’s government

and corporates in both domestic and offshore market. For China, domestic bonds

account for 93% of the total. Debt data is as of 28 Feb 2015. GDP is as of 2013

Onshore bond market:Bigger, broader, but…

China’s onshore bond market is breaking new ground in terms of

size, issuance and the contribution it makes to fund raising

Its investor base and the range of products continue to expand

But structural challenges in the areas of default, ratings and

regulation need to be addressed

Zhi Ming ZhangHead of China ResearchThe Hongkong and ShanghaiBanking Corporation Limited

+852 2822 [email protected]

Helen Huang AnalystThe Hongkong and ShanghaiBanking Corporation Limited+852 2996 [email protected]

- 0.5 1.0 1.5 2.0

2.5 3.0 3.5

-

5,000

10,000 15,000

20,000

25,000

U n i t e d S t a t e s

J a p a n

C h i n a

G e r m a n y

F r a n c e

U n i t e d K i n g d o m

I t a l y

C a n a d a

S p a i n

S o u t h K o r e a

N e t h e r l a n d s

U S D b

n

Total bonds outstanding

Total bonds outstanding / GDP (RHS)

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2. Bonds outstanding breakdown, 2000-2014

Source: Wind, HSBC

Note: Certificate and deposit, collateral debt obligation and securities firm commercial paper are included in financial corp; asset-backed securities backed by non-credit underlying assets is

included in non-financial corp.

3. Gross issuance breakdown, 2000-2014

Source: Wind, HSBC

Note: Certificate and deposit, collateral debt obligation and securities firm commercial paper are included in financial corp; asset-backed securities backed by non-credit underlying assets is

included in non-financial corp.

4. Net issuance breakdown, 2000-2014

Source: Wind, HSBC

Note: net issuance is calculated as gross issuance minus principal repayment. Certificate and deposit, collateral debt obligation and securities fir m commercial paper are included in f inancial

corp; asset-backed securities backed by non-credit underlying assets is included in non-financial corp.

0%

5%

10%

15%

20%

25%

30%

35%

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

R M B b n

Central gov Local gov Quasi-gov Financial corp Non-financial corp Growth rate YoY, RHS

-40%

-20%

0%

20%

40%

60%

80%

100%

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

R M

B b n

Central gov Local gov Quasi-gov (PBoC, policy bank)

Financial institution Non-financial corp Growth rate YoY, RHS

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%140%

(1,000)

-

1,000

2,000

3,000

4,000

5,000

6,000 7,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

R M B b n

Central gov Local gov Quasi-gov (PBoC, policy bank)

Financial institution Non-financial corp Growth rate YoY, RHS

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Opening up to the world

Offshore investors have access to the onshore

bond market through several channels (Table 5).

Foreign investors’ bond holdings increased 68%

y-o-y in 2014, much greater than the rise in their

investments in equities, loans and deposits (Fig 6).

More doors may be open soon. In early February

2015, the South China Morning Post reported that

talks were taking place about a “bond-connect”

scheme that would mimic the Shanghai-Hong

Kong Stock Connect scheme launched in 2014.

Despite its rapid growth, the bond market is still

dominated by onshore investors. As of December

2014, foreign investors’ holdings totalled

RMB672bn, equivalent to only 1.9% of total

onshore bonds outstanding. This is due to

several factors:

Quota controls: Foreign investors need access

to one of the schemes listed in Table 5 and the

investment amount is subject to a quota.

Except for foreign central banks, few offshore

investors have much appetite for long-dated

onshore bonds.

Many offshore investors are still not familiar

with onshore dynamics.

5. Eligible offshore investors in interbank market

Investors Quota

Qualified Foreign InstitutionalInvestors (QFII)

USD66.9bn, all securities

RMB-denominated QFII (RQFII) RMB299.7bn, all securitiesForeign central banks, monetaryauthorities, SWFs and Supras

N/A

RMB clearing banks in Hong KongSAR and Macau SAR

N/A

Offshore RMB cross-border tradesettlement banks

N/A

Offshore insurance companies N/A

Source: CEIC, HSBC. Data as of December 2014

6. Offshore investors’ holdings in onshore financial assets

Source: PBoC, HSBC

Market dynamics

The onshore bond market differs from the

offshore market in many areas, including product

classification, trading platforms, regulations and

rating schemes. Not much has been done in the

way of converging the two markets as

participation by foreign investors is still quite low.

But at the same time these differences also makeit more difficult for foreign investors to

participate. In this section, we address the key

dynamics one by one.

Products

There are mainly five types of issuers in the

onshore bond market: the central government, local

governments, quasi-government entities (including

the PBoC, China’s central bank and policy banks),

financial institutions and non-financial corporates.

Back in 2000, the central government and quasi-

government entities accounted for 98% of bonds

outstanding (Fig 7). This declined to 55% in 2014

as more corporate issuers tapped the bond market

(Fig 8). We now take a more detailed look at the

main categories of bonds.

40%

50%

60%

70%

80%

-

500

1,000

1,500

2,000

2,500

3,000

Equities Bonds Loans Deposits

R M B b n

2013 2014 Growth

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Treasuries

Treasuries, also referred to as onshore Chinese

government bonds (CGBs), are issued by the

Ministry of Finance (MoF). This was China’s

largest bond class until 2014, when bonds issued

by policy banks took over.

Among Chinese bonds, Treasuries have the most

diversified tenors (Fig 10). They are also the mostimportant guide to the pricing of other bonds as

they have the best credit quality, strong issuance

volumes and ample liquidity. Back in 2000 they

represented 72% of total bond issuance. The

percentage declined in the next six years as more

corporates issued bonds and since 2008,

Treasuries accounted for 12-20% of total bond

issuance per year (Fig 11).

9. Yield on Treasuries: a key indicator

Source: Wind, HSBC

Note: Data as of February 2015

10. Breakdown of Treasuries outstanding by tenor

Source: Wind, HSBC

Note: Data as of 31 December 2014. Maturity refers to issuance tenor.

11. Treasury issuance and as % of total bond issuance

Source: Wind, HSBC

0.0%

1.0%

2.0%

3.0%

4.0%

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6.0%

J a n - 2

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M a y - 2

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S e p - 2

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1 yr 3 yr 5 yr

10 yr 30 yr

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Local government bonds (muni-bonds)

Muni-bonds are issued by local governments. This

young market started in 2009 when the MoF issued

muni-bonds on behalf of local governments for the

first time. Growth has been quite slow as the

issuance quota is strictly controlled. As of 2014

muni-bonds outstanding totaled RMB1.16trn, only 3%

of total bonds outstanding in the onshore market. In

2014 muni-bonds accounted for 3% of total bond

issuance (Fig 12).

The slow growth is quite deliberate as Beijing wants

to keep tight control of the amount of bonds issued

in order to prevent local governments borrowing too

much. Strict quotas and eligibility criteria are in

place, even for local governments deemed to be on a

strong financial footing. But relaxation has been

gradually introduced. When the scheme started, the

MoF was in charge of issuing and repaying all muni-

bonds on behalf of local governments. This has been

relaxed to allow all provincial governments and afew selected cities to issue their own muni-bonds

(Table 13), but the MoF is still the dominant force in

this market (Fig 14).

12. Muni-bond issuance and as % of total bond issuance

Source: Wind, HSBC

14. Breakdown of muni-bonds outstanding by issuer, 2014

Source: Wind, HSBC

Note: Data as of 31 December 2014.

The muni-bond market is important because it is

seen as a way of solving the local government

debt problem. But, first, a bit of background.

Beijing’s huge stimulus package of 2008-09

encouraged local governments to build a wide

range of infrastructure projects. According to the

Budget Law at that time, local governments were

not allowed to borrow. To get the necessary

financing local governments created alternative

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

-

50

100

150

200

250

300

350

400

450

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

R M B b n

Gross issuance As % of total bond issuance

MoF81.5%

Guangdong3.4%

Zhejiang3.2%

Shanghai3.1%

Jiangsu2.8%

Shandong2.1%

Jiangxi1.2%

Shenzhen1.0%

Beijing0.9%

Ningxia0.5%

Qingdao0.2%

13. Major changes in regulation for muni-bonds since 2009

Date Rules

Feb 2009 MoF issued and repaid muni-bonds on behalf of local governmentsOct 2010 Shanghai, Zhejiang, Guangdong and Shenzhen allowed to issue muni-bonds on their own, but issuance is subject to a quota and

the MoF still handled repayments

Jun 2013 Jiangsu and Shandong were added to the test programMay 2014 10 local governments permitted to issue and repay muni-bonds on their own, including the six local governments already in the testprogramme, plus Beijing, Jiangxi, Ningxia and Qingdao, subject to quota

Oct 2014 All provincial level governments permitted to issue and repay muni-bonds on their own, subject to a quota

Source: MoF, State Council, HSBC

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channels called local government funding vehicles

(LGFVs). The LGFVs were technically state-

owned enterprises (SOEs) and so could tap into

funding channels open to companies, neatly

sidestepping restrictions on local government

borrowing.

But there was a big problem. The LGFVs created

huge amounts of debt and local governments are

now faced with so many liabilities that Beijing is

taking steps to shut down this funding channel inorder to lower the chances of systemic risk.

Since October 2014, local governments have been

working to update the amount of their three types

of debts, as requested by Beijing:

Type 1: debts for which local governments

have repayment liability.


have guarantee liability.


have contingent liability.

In future, Type 2 and Type 3 will no longer enjoy

explicit or implicit government guarantees. These

debtors will be required to make repayments or

refinance the debt using their own resources. Type

1 debt is further classified into government

general debt and government project debt tied to

specific projects (Table 15). They will be funded

by a combination of muni-bonds, project revenue

and government support.

As a result, the issuance of muni-bonds will

accelerate to meet the funding gap previously filled

by LGFVs, which issued as much as RMB1.8trn

onshore bond in 2014 and have about RMB640bn

due every year from 2015 to 2019 (Fig 16). In 2015,

local governments were given a RMB600bn muni-

bond issuance quota (RMB500bn general-

obligation muni-bonds and RMB100bn revenuemuni-bonds tied to specific projects). In addition,

Beijing granted a RMB1trn quota for repaying or

refinancing existing Type 1 debt, accounting for

53.8% of Type 1 debt coming due in 2015. These

recent developments should drive rapid growth in

the muni-bond market in 2015.

15. Local government debt classification requirements

Debt type Underlying assets Repayment sources

Government generaldebt

Social welfare projectswith no commercial

return

General obligationmuni-bonds, fiscal

revenueGovernment projectdebt

Social welfare projectswith commercial return

Revenue muni-bondstied to specific

projects, governmentfund revenue, projectrevenue

Corporate debt Non social-welfareprojects

Corporate bonds andloans, corporate

revenue

Source: HSBC

16. LGFV bond gross issuance and repayment amount, 2006-2019

Source: Wind, HSBC

Note: Data include principal repayment only. Data as of 10 February 2015.

The hard work has just started. We think more

reforms are needed before the market, rather than policy support, plays a decisive role in muni-

bonds. For example:

Local governments should have to disclose

more detailed information about their

financial status and improve their risk

management capabilities. Otherwise investors

buying muni-bonds will continue to rely on

the implicit guarantee from the central

government, something that Beijing does not

want to bear. Unlike in the US, local

authorities in China do not yet have

-

500

1,000

1,500

2,000

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2 0 1 0

2 0 1 1

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2 0 1 5

2 0 1 6

2 0 1 7

2 0 1 8

2 0 1 9

R M B b n

Gross issuance Repayment

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standalone balance sheets. If they are in

danger of defaulting, then the central

government would be forced to bail them out.

While muni-bonds will help, a stronger

mechanism than an issuance quota is needed

to prevent local governments from borrowing

excessively. Beijing’s implicit guarantee

gives local officials an incentive to borrow,

since they are unlikely to be allowed to go

bankrupt. They also have incentives to borrow long term as the debt will fall due

after their term of government service comes

to an end.

17. Yield of muni-bonds

Source: Wind, HSBC


18. Breakdown of muni-bonds outstanding by tenor

Source: Wind, HSBC


Policy bank bonds

The three policy banks – China Development Bank

(CDB), Agricultural Development Bank of China

and Export-Import Bank of China – are now

collectively the largest bond issuers in terms of

amount outstanding: RMB9.7trn, or 27% of total

bond outstanding onshore as of 2014. CDB is the

biggest contributor; accounting for 62% of policy

bank bonds outstanding (Fig 19).

19. Breakdown of policy bank bonds outstanding by issuer

Source: Wind, HSBC

Policy banks rely heavily on the bond market for

funding. According to CDB’s annual report, the

amount of bonds issued (RMB5.84trn) were

equivalent to 71% of total assets (RMB8.19trn) as

of 2013. This is because: 1) policy banks cannot

take deposits like commercial banks; and 2) they

provide funding for many projects that help the

economy – such as public housing and

infrastructure in poor areas – but do not generate

much return.

Beijing helps policy banks raise funds at a low

cost, for example setting the risk weight of policy

bank bonds at zero to attract purchases from

commercial banks, who are the biggest investors

in the onshore bond market. Policy bank bonds

are also exempt from rating requirements. Simply

put, policy banks enjoy sovereign credit status,

like CGBs and PBoC bills.

Thanks to this government support, policy bank

bonds have become the biggest bond class in

terms of amount outstanding as well as trading

volume. In 2014, these three banks issuedRMB2.3trn of bonds, accounting for 19% of total

bond issuance (Fig 20). Like Treasuries, policy

0

1

2

3

4

5

6

A u g - 1

0

N o v - 1

0

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1

M a y - 1

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F e b - 1

5

%

3 yr 5 yr 7 yr 10 yr

3 yr 31%

5 yr 54%

7 yr 12%

10 yr 3%

ChinaDevelopment

Bank

62%

AgriculturalDevelopment

Bank ofChina22%

Export-Import Bank

of China16%

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bank bonds offer tenor diversification. A yield

spread of 89bp to 97bp (2014 average) over

Treasuries further enhances their attractiveness to

investors. The risk is that, should this policy

support ever be withdrawn, the benefits associated

with these bonds would be discounted.

20. Policy bank bonds issuance and as % of total bondissuance

Source: Wind, HSBC

21. Yield of China Development Bank bonds

Source: Wind, HSBC


22. Breakdown of policy bank bonds outstanding by tenor

Source: Wind, HSBC


PBoC bills

PBoC bills are bonds issued by the central bank.

Between 2004 and 2010 this was the largest bond

class, accounting for up to 63% of total onshore

issuance per year (Fig 23) as the central bank tried to

offset the growth in the money supply created by

foreign exchange inflows. As the main purpose is to

offset capital inflows, maturity is quite short, with

tenors of 3 months, 6 months, 1 year and 3 years.

Issuance has slowed down significantly since 2011as capital inflows have declined. As of 2014, only

RMB422bn of 3-year PBoC bills remain traded as

all the others have matured.

23. PBoC bill issuance and as % of total bond issuance

Source: Wind, HSBC

Financial bonds

Financial bonds refer to bonds issued by financial

institutions, mainly policy banks, commercial banks,

securities firms and insurance companies. We

exclude policy bank bonds (see above) because they

are quasi-government bonds supported by the central

government, while other types of financial bonds are

backed by the issuers’ credit quality.

Bonds are an important source of capital for

commercial banks. One reason for enlarging the

financial bond market in 2004 was to help

commercial banks to improve their capital

adequacy ratios before their IPOs. That is why

commercial banks’ subordinated bonds, which arecounted as tier-2 capital, have always been the

biggest component of financial bonds (Fig 24). As

0%

5%

10%

15%

20%

25%30%

35%

40%

-

500

1,000

1,500

2,000

2,500

2 0 0 0

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2 0 0 8

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R M B b n


1%

2%

3%

4%

5%

6%

J a n - 2

0 0 9

J u l - 2 0 0 9

J a n - 2

0 1 0

J u l - 2 0 1 0

J a n - 2

0 1 1

J u l - 2 0 1 1

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0 1 2

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0 1 3

J u l - 2 0 1 3

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0 1 4

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0 1 5

1 yr 3 yr 5 yr

10 yr 15 yr

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the main purpose of commercial banks’

subordinated bonds is to support capital adequacy,

tenors are quite long: the breakdown as of 31

December 2014 was 10-year (36%), 15-year

(61%) and 20-year (3%), as shown in Fig 25.

24. Breakdown of financial bonds outstanding by bond type

Source: Wind, HSBC

Note: Data as of 31 December 2014.

25. Breakdown of commercial banks’ subordinated bondsoutstanding by tenor

Source: Wind, HSBC


26. Yield of commercial banks’ subordinated bonds

Source: Wind, HSBC

Note: Data as of February 2015.

Enterprise bonds

Enterprise bonds, introduced in 1985, were the

first bond class opened to non-financial

companies. In the first 20 years growth was rather

slow as a result of various administrative

restrictions put in place to control risks. For

example, issuers were required to get the bond

guaranteed by third parties and the approval

process was long and complicated. A lot of these

restrictions were relaxed in 2008 and the

enterprise bond market today is over eight times

bigger than it was in 2007, making it the second

largest bond class for credit issuers in terms of

amount outstanding. Since 2012, enterprise bonds

have accounted for 5-8% of onshore bond

issuance (Fig 27).

27. Enterprise bond issuance and as % of total bondissuance

Source: Wind, HSBC

LGFVs are key contributors to the growth of

enterprise bonds. Around half of LGFV bonds

issued between 2005 and 2012 were through

enterprise bonds, although the percentage fell to

39% in 2013 and 35% in 2014 (Fig 28) as Beijing

started to tighten its control over local government

borrowing that forced LGFVs to tap into more

diversified borrowing sources.

Policy tightening intensified in December 2014,

when the China Securities Depository and

Clearing Corp (CSDC), the clearing agency forexchanges, disqualified bonds issued by higher

risk corporates from being used as collateral for

Commercialbank

subordinatedbond50%

Commercialbank bond

18%

Securitiesfirm CP

20%

Insurancecompany

bond7%

Otherfinancial

institutionbond5%

10 yr 36%

15 yr 61%

20 yr 3%

4

5

6

7

8

J a n - 0

9

J u n - 0

9

N o v - 0

9

A p r - 1 0

S e p - 1

0

F e b - 1

1

J u l - 1 1

D e c - 1

1

M a y - 1

2

O c t - 1 2

M a r - 1 3

A u g - 1

3

J a n - 1

4

J u n - 1

4

N o v - 1

4

%

Subordinated bond, AAA, 15 yr Subordinated bond, AA+, 15 yr

0%

1%

2%

3%

4%

5%

6%7%

8%

9%

-

100

200

300

400

500 600

700

800

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

R M B b n


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repo transactions. The aim is mainly to stop

LGFV bonds being used in leveraged borrowing.

28. Breakdown of LGFV bond issuance

Source: Wind, HSBC

29. Yield of 7-year enterprise bonds

Source: Wind, HSBC


30. Breakdown of enterprise bonds outstanding by tenor

Source: Wind, HSBC


Corporate and enterprise bonds

Both corporate and enterprise bonds are for non-

financial corporates. But they also differ in terms

of issuer, listing venue and regulation (Table 31).

31. Differences between corporate and enterprise bonds

Name Issuer Listing venue Regulator

Corporatebond

Originally opened tolisted non-financialcompanies only.Expanded to allcompanies with

shareholding structure(excl. LGFVs) from 16January 2015.

Exchange only CSRC

Enterprisebond

Mostly non-listed non-financial companies. Afew listed companiesalso issue enterprisesbonds.

72% were dual-traded in interbank

and exchange;28% were tradedin interbank only

as of 2014

NDRC

Source: HSBCNote: Listed commercial banks were allowed to issue corporate bonds after November 2013.CSRC: China Securities Regulatory Commission. NDRC: National Development and ReformCommission.

Corporate bonds were introduced in 2007, around

the same time as some other types of creditinstruments began to take off, such as mid-term

notes (MTNs), enterprise bonds and commercial

paper. But corporate bonds have been left behind,

accounting for only 2% of China’s bonds

outstanding as of 31 December 2014, compared

with 8% for enterprise bonds, 9% for MTNs and 5%

for commercial paper.

32. Corporate bond issuance and as % of total bondissuance

Source: Wind, HSBC

-

500

1,000

1,500

2,000

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

R M B b n

Enterprise bond PPN MTN CP Others

3.0

5.0

7.0

9.0

11.0

J a n - 0

9

J u l - 0 9

J a n - 1

0

J u l - 1 0

J a n - 1

1

J u l - 1 1

J a n - 1

2

J u l - 1 2

J a n - 1

3

J u l - 1 3

J a n - 1

4

J u l - 1 4

J a n - 1

5

%

AAA AA+ AA A+

3 yr 0.30%

4 yr 0.05%

5 yr 2.27%

6 yr 7.64%

7 yr 57.29%

8 yr 2.07%

10 yr 22.37%

11 yr 0.07%

13 yr 0.03%

15 yr 7.12%

18 yr 0.00%

20 yr 0.68%

30 yr 0.10%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

-

50

100

150

200

250

300

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

R M B b n


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CSRC simplified the approval process for

corporate bond issuance (although it still insists

on checking the information disclosed by issuers).

36. Yield of 5-year MTNs

Source: Wind, HSBC


37. Breakdown of MTN outstanding by tenor

Source: Wind, HSBC


Commercial paper (CP)

CP is the biggest bond class at the short end, withtypical tenors of 3 months, 6 months, 9 months

and 1 year (Fig 38). The approval process is the

same as for MTNs, which gives issuers more

flexibility than enterprise bonds and corporate

bonds. This instrument is specifically designed to

meet non-financial corporates’ short-term funding

needs2. Issuance as a percentage of the total

onshore bond market keeps increasing; CP

______________________________________2 Securities firms can also issue CP, but it is not under regulation of NAFMII. We classify securities firms’ commercial paper as financialbonds in this report.

accounted for 18% of annual bond issuance

between 2012 and 2014 (Fig 39).

38. Breakdown of CP outstanding by tenor

Source: Wind, HSBC


39. CP issuance and as % of total bond issuance

Source: Wind, HSBC

40. Yield of AAA-rated CP

Source: Wind, HSBC

Note: Data of February 2015.

Government-backed institutional bonds

There are only two issuers of this bond class –

China Railway Corp (CRC) and Central Huijin

3%

6%

9%

12%

15%

J a n - 0

9

A p r - 0 9

J u l - 0 9

O c t - 0 9

J a n - 1

0

A p r - 1 0

J u l - 1 0

O c t - 1 0

J a n - 1

1

A p r - 1 1

J u l - 1 1

O c t - 1 1

J a n - 1

2

A p r - 1 2

J u l - 1 2

O c t - 1 2

J a n - 1

3

A p r - 1 3

J u l - 1 3

O c t - 1 3

J a n - 1

4

A p r - 1 4

J u l - 1 4

O c t - 1 4

J a n - 1

5

AAA AAA- AA+ AA

AA- A+ A A-

2 yr 0.2%

3 yr

18.9%

4 yr 1.2%

5 yr 61.7%

6 yr 1.2%

7 yr 10.9%

8 yr 0.5%

10 yr 4.6%

12 yr 0.1%

15 yr 0.8%

=3 month,=6 month,

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Investment (Huijin), a state-owned investment

company that holds shares of state-owned

financial institutions. CRC bonds were used to

finance China’s massive railway infrastructure

construction and the Huijin bonds were issued in

2010 for subscribing to the ICBC, BOC and

CCB’s rights issues and injecting capital into the

Export-Import Bank of China and China Export &

Credit Insurance Corp.

These two issuers are not purely commercially-driven companies. They have significant public

welfare and state asset management responsibilities

and the government provides explicit support to help

them reduce funding costs.

41. Yield of China Railway Corp bonds

Source: Wind, HSBC


42. Breakdown of government-backed institutional bondsoutstanding by tenor

Source: Wind, HSBC


Asset-backed securities (ABS)

ABS are bonds backed by a pool of assets,

converted in shares which are sold to investors.

Table 43 shows the three types of ABS in China.

Of these three, Collateralised Debt Obligations

(CDO), which are backed by credit assets such as

corporate loans and mortgage, are the largest.

ABS were launched in 2005 but growth was very

slow until 2014 (the market was shut down over

2009-2011 following the global financial crisis).

As we argued in Our multi-asset view of the third

plenum China’s turning point? (15 October 2013),

the key challenges were: 1) banks were reluctant

to sell high quality assets; 2) ABS were much

more complex than a cash bond, increasing

transaction costs; and 3) ABS offered limited

yield spread for investors to compensate for low

liquidity and the due diligence cost.

0

2

4

6

8

2 0 0 9

2 0 0 9

2 0 0 9

2 0 1 0

2 0 1 0

2 0 1 0

2 0 1 1

2 0 1 1

2 0 1 1

2 0 1 2

2 0 1 2

2 0 1 2

2 0 1 3

2 0 1 3

2 0 1 3

2 0 1 4

2 0 1 4

2 0 1 4

2 0 1 5

%

1 yr 3 yr 5 yr 10 yr 30 yr

5 yr 2.9%

7 yr 18.3%

10 yr 49.5%

15 yr 10.8%

18 yr 0.3%

20 yr 15.4%

30 yr 2.8%

43. Breakdown of ABS by products

Products Full name No. of bondsoutstanding

Amountoutstanding

(RMBbn)

As % of all ABSoutstanding

As % of all bondsoutstanding

Underlyingassets

Listingvenue

Regulator

CDO CollateralisedDebt Obligation

241 251 83% 0.70% Credit assets Interbank CBRC

ABS Asset-backedSecurities

120 33 11% 0.09% Non-financialcorporate

assets

Exchange CSRC

ABN Asset-backedNotes

50 17 6% 0.05% Non-financialcorporate

assets

Interbank NAFMII

Total 411 301 100% 0.84%

Source: Wind, HSBCNote: Data as of 31 December 2014. CBRC: China Banking Regulatory Commission; CSRC: China Securities Regulatory Commission; NAFMII: National Association of Financial MarketInstitutional Investors.

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=ekkrZAi0aX&n=390208.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=ekkrZAi0aX&n=390208.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=ekkrZAi0aX&n=390208.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=ekkrZAi0aX&n=390208.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=ekkrZAi0aX&n=390208.PDF

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These concerns eased in 2014 because: 1) the

increasing number of financial products available

to savers (e.g. wealth management products,

popular savings schemes that pay higher rates of

interest than bank deposits, and money market

funds) have made it more difficult for banks to get

new deposits; in order not to breach the loan-to-

deposit ratio, they have to sell existing loans to

release quotas for new loans; 2) as LGFV bonds

start to wind down, investors are searching for

alternative high yield bonds, which helps support

demand; 3) increased new issuance is improving

liquidity; and 4) regulators are helping too: in

November 2014 the CBRC and CSRC announced

simplified approval processes for ABS.

As a result, there was a big jump in ABS issuance

in 2014. Gross issuance reached RMB331bn, 11

times more than in 2013, and accounting for 3%

of total bond issuance in 2014 (Fig 44). There are

still issues that need to be addressed, such as tenordiversification (now the issuance tenor is quite

short – some 80% are below 3 years, Fig 45) and

liquidity improvement (a lot of investors still buy

and hold until maturity).

44. ABS issuance accelerated in 2014

Source: Wind, HSBC

45. Majority of ABS have tenors of less than three years

Source: Wind, HSBC


46. Yield of ABS

Source: Wind, HSBC


Privately placed notes (PPNs)

PPNs allow unlisted non-financial companies to

issue bonds privately to selected investors in the

interbank market. Similar to MTNs and CP, PPNs

are open to non-financial companies, the custody

agent is the Shanghai Clearing House (SCH) and

the regulator is NAFMII. Introduced in 2011, PPNs

have grown into a major bond class, raising nearly

RMB1trn in 2014, accounting for 8% of total bond

issuance (Fig 47), even more than MTNs.

As these bonds are privately placed, regulators

impose fewer restrictions, an approach welcomed by

issuers and investors. At the same time, PPNs may

carry a higher risk than publicly listed bonds and

liquidity is tighter. Maturity is also quite short –55% has a tenor of 3 years (Fig 47).

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

-

50

100

150

200

250

300

350

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

R M B b n


=6 month,

=1yr, =2yr, =3yr 20%

0

2

4

6

8

J a n

- 1 1

M a y

- 1 1

S e p

- 1 1

J a n

- 1 2

M a y

- 1 2

S e p

- 1 2

J a n

- 1 3

M a y

- 1 3

S e p

- 1 3

J a n

- 1 4

M a y

- 1 4

S e p

- 1 4

J a n

- 1 5

%

ABS, 1 yr ABS, 2 yr

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47. PPNs: Rapid growth since being launched in 2012

Source: Wind, HSBC

48. Breakdown of PPN outstanding by tenor

Source: Wind, HSBC


Among so many bond types, trading is

concentrated on five, namely Treasuries, policy

bank bonds, MTN, CP and enterprise bonds (Fig

49). We list the features of these key bond classes

in Table 50.

49. Trading volume is dominated by selected bond classes

Source: Wind, HSBC

Note: Trading volume refers to transaction amount (buy or sell) per year.

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

-

200

400

600

800

1,000

1,200

2011 2012 2013 2014

R M B b n


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50. China bond market overview

Treasuries Muni-bonds Policy bankbonds

PBoC bills Financialbonds

Enterprisebonds

Corporatebonds

Mid-term notes(MTN)

Commercialpaper (CP)

Government-backed

institutionalbonds

Asset-backedsecurities

(ABS)

Launch time Re-launched in

1981

2009 1994 2002 Mostly f rom2004

1985 2007 2008 Re-launched in2005

1995 2005

Amountoutstanding(RMBbn)

9,591 1,162 9,708 422 2,352 2,912 666

3,377 1,761 1,018 301

Turnover 1

(RMBtrn/week,interbank only)

108 2 345 2 13 84 NA 99 101 9 NA

Typical tenor(years, atissuance)

1, 2, 3, 5, 7,10, 15, 20,

30, 50

3, 5, 7, 10 1, 2, 3, 5, 7, 10,15, 20, 30, 50

0.25, 0.5, 1, 3 5, 10, 15 6, 7, 10, 15 3, 5, 7, 10 3, 5, 7, 10 0.25, 0.5, 0.75,1

7, 10, 15, 20 1-3

Issuer MoF Localgovernments2

3 policy banks3 PBoC Financialinstitutions

Mostly unlistednon-financialcompanies4

Mostly listedcompanies5

Non-financialcompanies

Non-financialcompanies

China RailwayCorporation,

Central HuijinInvestment

Banks for CDO,non-financial

companies for ABS and ABN

Approvalauthority

MoF State Council,MoF

PBoC PBoC PBoC, CBRC,CSRC

NDRC CSRC NAFMII NAFMII NDRC for CRC,State Council

for Huijin

CBRC for CDO,CSRC for ABS,

NAFMII for ABN

Bond rating No rating AAA 9%; no

rating 91%

No rating No rating AAA 59%; AA+

14%; AA 8%; AA- 3%; A+

1%; A-1 5%; Norating 11%%

AAA 37%; AA+

26%; AA 36%; AA- 1%

AAA 57%; AA+

21%; AA 20%; AA- 1%

AAA 65%; AA+

21%; AA 13%; AA- 1%

A-1 60%; no

rating 40%

AAA for CRC

bond 89%; norating for Huijin

bond 11%

AAA 73%; AA+

4%; AA 2%; AA- 2%; A+ 2%; A 1%; no rating

16%

Listing venue Interbank,exchange,

OTC

Interbank,exchange

Mostly ininterbank

Interbank Interbank Interbank,exchange

Exchange Interbank Interbank Mostly ininterbank, some

in exchangeand OTC

CDO and ABNin interbank,

ABS inexchange

Settlementagent6

CCDC,CSDC

CCDC, CSDC Mostly in CCDC CCDC CCDC CCDC, CSDC CSDC CCDC, SCH7 SCH8 Mostly in CCDC CDO and ABNin CCDC, ABS

in exchange

Note:1. Turnover refers to transaction volume (buy or sell) in interbank market. Data are calculated as average of weekly transaction volume in 2014. Source of data for policy bank bonds is CFET because Wind groups policy bank bondswith financial bonds and a breakdown is not available. Data for other types of bonds are from Wind.2. All provincial level government plus Shenzhen and Qingdao

3. Including China Development Bank, Agricultural Development Bank of China, The Export-Import Bank of China4. A few listed companies also issue enterprise bonds but the majority are unlisted companies.5. Eligible issuers were expanded to all companies with share-holding structure in 16 January 2015.6. CCDC: China Central Depository & Clearing Co.; CSDC: China Securities Depository and Clearing Co.; SCH: Shanghai Clearing House. All are settlement agents onshore.7. MTN issued after 17 June 2013 is under custodian of SCH.8. Custodian agent of commercial paper was changed from CCDC to SCH fr om September 2011 onwards.Source: Wind, CFET, HSBC. Data as of 31 December 2014.

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Trading platforms

Onshore bonds are traded on three platforms:

interbank, exchange (including Shanghai and

Shenzhen Stock Exchanges) and over-the-counter

(OTC), which is operated by commercial banks’

retail counters. Institutional investors can

participate in the interbank and exchange markets.

The exchange market also allows individual

investors to participate. As shown in Table 51, the

interbank market is the dominant platform.

The interbank market offers a much wider range of

products, as shown in Table 52. Most bonds can

only be traded on one of the three platforms. Of the

28 types of bond in the onshore bond market, only 6

can be traded on more than one platform (Table 53).

There are three custodian agents. China Securities

Depository and Clearing Co (CSDC) for bonds

traded in the exchange market, while China

Central Depository & Clearing Co (CCDC) and

Shanghai Clearing House (SCH) cover bonds in

the interbank market.

51. Interbank vs. exchange bond markets1

Interbank Exchange

Trading volume2 (RMBtrn, 2014) 38.9 1.4 Amount outstanding3 (RMBtrn, 2014) 34.3 2.6Investors Institutions Institutions and individualsTrading venue China Foreign Exchange Trade System &

National Interbank Funding Center (CFET4)Shanghai and Shenzhen Stock Exchange

Custodian and settlement agent5 CCDC and SCH CSDCTrading mechanism Private negotiation (majority), market making Public auction (majority), private negotiation for block

trade

Source: Wind, HSBC. Data as of 2014

Note:1. The table does not include OTC market because it is very small compared with interbank and exchange markets and is purely fo r individual investors.2. Data refer to one-side trading volume, i.e. buy side or sell side3. Interbank bond market size is calculated as sum of amount outstanding under custodian of CCDC and CSDC. Some bonds are t raded in both interbank and exchange markets. So sum of

amount outstanding in interbank and exchange markets is larger than total bond outstanding as there is double counting.4. Other than bonds, CFET has many other fixed income products, including bond derivatives, FX spot and derivatives, interbank lending, repo and interest rate swaps5. CCDC: China Central Depository & Clearing Co; CSDC: China Securities Depository and Clearing Co; SCH: Shanghai Clearing House.

52. Product offerings in the interbank and exchange bond markets

Interbank • From non-financial issuers: MTN, CP, super-short-term CP, PPN, ABN, collective MTN, government-backed institutionalbond, enterprise bond, collective enterprise bond, international institution bond

• From financial issuers: CD, commercial bank subordinated bond, commercial bank bond, securities firm bond, securities firmCP, insurance company bond, other financial institution bond, CDO

• From government/quasi government issuers: Treasuries, policy bank bond, municipal bond, PBoC bill

Exchange • From non-financial issuers: corporate bond, privately placed bond, CB, ABS, enterprise bond, collective enterprise bond,government-backed institutional bond (very little amount)

• From government/quasi government issuers: Treasuries, policy bank bond (very little amount), municipal bond,

Source: Wind, HSBC

53. Bonds that can be traded across markets, RMBbn, as of 31 December 2014

______________________________ Amount that can be traded in _______________________________

Bonds Amountoutstanding

Interbank only Exchange only OTC onlyInterbank+

Exchange+OTCInterbank+Exchange

Interbank+OTC

Treasuries 9,591 19% 0% 11% 54% 14% 2%

Policy bank bonds 9,708 99% 0.3% 0% 0% 0% 1%Municipal bond 1,162 0% 0% 0% 0% 100% 0%Govt-backed institutional bonds 1,018 97% 0% 0% 0% 1% 2%

Enterprise bonds 2,912 26% 0% 0% 1% 72% 1%Collective enterprise bond* 12 14% 0% 0% 0% 86% 0%

Source: Wind, HSBC

* Collective enterprise bond is a product for more than one borr ower to collectively issue one bond. This t ype of bond was introduced to help small companies to issue bond. Besides collectiveenterprise bond, there is also collective MTN that has similar structure.

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Interbank market

The interbank market was originally set up in

1994 for commercial banks to trade currencies.

From 1996, banks were required to conduct all

interbank lending in this market and the range of

products offered has since been expanded to

include bonds, repurchase agreements (repos),

interest rate swaps and derivatives. It is also a

much broader market in terms of who can trade –

participants now include a wide range of

institutions, financial and non-financial.

This market has gradually opened up to foreign

investors. As of 13 March 2015, of the 7,680

institutions allowed to invest in RMB products such

as bonds and repos on the interbank market, there

were 98 foreign banks (offshore), 88 foreign-owned

onshore banks, 11 foreign insurance companies, 77

R-QFIIs and 19 QFIIs (Fig 54).

54. Number of onshore RMB product participants

Source: CFET, HSBC

Note: data as of 13 March 2015

Exchange market

Until 1997 the exchange market was the dominant

trading platform for bonds and stocks. But bond

trading significantly shrank after banks exited this

market in 1997 and has remained lukewarm ever

since because banks are the biggest investors in

the bond market in China.

The CSRC has been trying to ease the ban on

commercial banks’ trading in the exchange

market: in 2009, listed banks were allowed to

trade bonds there; in November 2013, listed

commercial banks were allowed to issue bonds; in

December 2013 wealth management products

(WMPs) were permitted to invest in fixed income

products. However, the interbank market has now

achieved such dominance that it will be difficult

for the exchange market to catch up.

Investors

Many different types of institutional investors

have joined the bond market since 1998 when the

interbank market began to open to non-bank

institutional investors. Individual investors are

now the minority.

Domestic banks remain the dominant investors.

For the 78% of onshore bonds for which holding

information is available, national, city and rural

commercial banks collectively hold 60% (Fig 55).

Domestic banks are also the biggest trading

participants, contributing 54% of trading volume

in 2014 (Fig 56). The onshore branches of foreign

banks are becoming bigger players, representing

13% of trading volume in 2014. Other major

investors include securities firms, insurance

companies and investment funds. We now discuss

their different investment styles.

55. Commercial banks are the biggest holders of bonds

Source: Chinabond, Shanghai Clearing House, HSBC

Note: data above include RMB28trn domestic bonds that account for 78% of total bond

outstanding as of Dec 2014. Investor holding information for the rest of the bonds is not

available. “Others” including mainly credit unit, policy banks and stock exchange (as a

trading agent for investors). Data as of December 2014.

Commercialbank, 1,322

, 17%

Policy bank,3 , 0.04%

Investmentinstitutions,2,563 , 33%

Insurancecompany,139 , 2%

Securitiescompany,118 , 2%

QFII, 19 ,0.2%

RQFII, 77 ,1%

Otherfinancial

institution,169 , 2%

Non-financialinstitution,148 , 2%

Non-legalentities, suchas pension,

WMP,investment

product,3,122 , 41%

Nationalcommercial

bank50%

Foreignbank1%

Citycommercial

bank7%

Ruralcommercial

bank4%

Securitiesfirm1%

Insurancecompanies

7%

Fund11%

Others19%

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56. Commercial banks, especially the smaller ones, are themain contributors to bond trading volumes

Source: Wind, HSBC

Note: Data refers to transaction volume, both buy and sell, in interbank market in 2014.

Commercial banks

Banks are the most conservative investors. Around

80% of their holdings are Treasuries and policy bank

bonds that do not have default risk (Fig 57).

57. Bond holdings of commercial banks

Source: Chinabond, Shanghai Clearing House, HSBC

Note: Holing information is available for only 78% total bonds outstanding. Data as of

31 December 2014.

Securities firms

Securities firms are the most aggressive investors.

The majority of their holdings are in enterprise

bonds, MTNs and CPs (Fig 58), with less than

20% in products such as Treasuries and policy

bank bonds. This is because funding costs for

securities firms are comparatively high, so they

have to chase higher yields from credit bonds in

order to gain a decent spread.

Insurance companies

Similar to commercial banks, insurance companies

are also very conservative. They prefer Treasuries,

policy bank bonds and financial bonds. They are the

second largest investors in financial bonds as they

have an appetite for long-term products (Fig 59).

59. Bond holdings of insurance companies

Source: Wind, HSBC

Note: Holding information is available for only 78% total bonds outstanding. Data as of

31 December 2014.

Funds

Investment funds are the second largest investors

in MTNs and enterprise bonds after commercial

banks. In other bond classes, they like policy bank

bonds because their yields are higher than

Treasuries (Fig 60).

Others(mainly

securitiesfirms and

funds)33%

Citycommercial

banks27%

Joint-stockcommercial

banks14%

State-owned

nationalcommercial

banks3%

Foreigninstitutions

(incl.domesticbranch)

13%

Ruralcommercial

banks10%

Treasuries34.4%

Policy bankbonds45.0%

Enterprisebonds3.9%

Financialbonds

3.4% MTNs8.6%

CP4.3%

Others0.3%

Treasuries14.6%

Policy bankbonds29.9%

Enterprisebonds15.3%

Financialbonds27.6%

MTNs10.5%

CP1.8% Others0.2%

58. Bond holdings of securities firms

Source: Wind, HSBC

Note: Holing information is available for only 78% total bonds outstanding. Data as of31 Dec 2014.

Treasuries7%

Policy bankbonds10%

Enterprisebonds37%

Financialbonds

1%

MTNs31%

CP13%

Others1%

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Regulatory regime

China’s bond market is overseen by several

regulators. Each has its own territory and rules that

artificially split the market and hurt liquidity. For

example, the interbank market is largely regulated

by the PBoC, NAFMII and CBRC while the

exchange market is the CSRC’s territory (Table 61).

Competition between regulators is one of the

reasons why the consolidation of the two trading

platforms has been slow. Moreover, some areas

are regulated by more than one regulator, creating

extra administrative work for issuers and

investors. For example, both the CBRC and PBoC

have a say in banks’ issuance of financial bonds.

61. Bonds need approval from different regulators before

issuance and are listed in different venues

Product Approval requiredbefore issuance

Listing venue

Treasuries Ministry of Finance Interbank, exchangeMunicipal bonds State Council,

Ministry of FinanceInterbank, exchange

Policy bank bonds PBoC InterbankFinancial bonds PBoC, CBRC, CSRC InterbankEnterprise bonds NDRC Interbank, exchangeCorporate bonds CSRC ExchangeMTN, CP, PPN NAFMII Interbank

Note: PBoC refers to People’s Bank of China, China’s central bank; NDRC refers to NationalDevelopment and Reform Commission, a regulator responsible f or reforms and industrialpolicies; CSRC refers to China Securities Regulatory Commission, regulator of China’ssecurities market and NAFMII refers to National Association of Financial Market Institutional

Investors, an association set up by PBoC to regulate issuance of several types of bondsincluding MTNs and commercial papers.

Source: HSBC

Rating system

Rating agencies were set up in the 1990s and their

opinions have become more important as the

market has grown. The market is dominated by

domestic rating agencies, including:

Dagong Global (大公国际, a local firm)

China Chengxin International (中诚信国际, a

joint venture with Moody’s)

China Lianhe Credit Rating (联合资信, a joint venture with Fitch)

Shanghai Brilliance Credit Rating & Investors

Service (上海新世纪资信)

Pengyuan Credit Rating (鹏元资信评估有限

公司)

Golden Credit Rating International (东方金诚)

Shanghai Far East Credit Rating (上海远东资

信)

China Chengxin Security Rating (中诚信证

券评估)

United Ratings (联合信用评级)

But ratings do not necessarily accurately reflect an

issuer’s credit quality. Bonds rated AAA account

for 55% of all credit bonds outstanding. Only 18%

of credit bonds are rated below AA+ (Fig 62).

Also only 32% of onshore bond have a rating

because many big bond classes are exempted from

rating requirements, such as Treasuries, policy

bank bonds, municipal bonds that the MoF issues

on behalf of local government, PBoC bills and

Huijin bonds.

60. Bond holdings of funds

Source: Wind, HSBC

Note: Holding information is available for only 78% total bonds outstanding. Data as of

31 December 2014.

Treasuries3%

Policy bankbonds33%

Enterprisebonds21%

Financialbonds16%

MTNs27%

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62. Over half of credit bonds are rated AAA

Source: Wind, HSBC

Note: Data as of 31 December 2014. A-1 is rating specifically for CP. Around 32% of

onshore bonds have a rating. Credit bonds refer to those issued by financial institutions

and non-financial corporates, i.e. exclude Treasuries, muni-bonds, policy bank bonds

and PBoC bills.

Recent developments

The onshore bond market has changed rapidly in

the past few years. In addition to increasing in

size, the market is growing in complexity, a trend

that is likely to continue as the financial needs of

the economy become more sophisticated. Thechallenge now is how to achieve a balance

between growth and risk.

Default stress

Onshore bond issuance took off in 2009. By 2014

repayment and refinancing was becoming a major

concern as more bonds came due (Fig 63) at a

time when corporate earnings were deteriorating.

As shown in Table 64, the number of bond issuers

that have recorded consecutive losses has been

increasing rapidly.

63. Gross issuance and repayment (principal and coupon)schedule of non-financial corporate bonds

Source: Wind, HSBC

Note: both issuance and repayment data exclude CP because it comes due within 1

year and thus distorts growth trend in future years compared with historical years.

64. Bond issuers that have three consecutive years of losses

As of 3Q 2014 As of 2013 As of 2012

No. of issuers 54 28 14 Amount ofbondsoutstanding(RMBbn)

405 155 73

As % of totalcredit bonds

outstanding

2.8% 1.3% 0.8%

Source: Wind, HSBC

There has yet to be a default for a publicly issued

debt instrument. All the near defaults on principal

have resulted in bail-outs by either regulators or

third parties. While this may protect investors in the

short term, it is increasingly detrimental to the long-

term development of China’s bond market because:

Investors go for products that offer higher

yield without doing sufficient due diligence

on the issuer. This disadvantages high quality

issuers that deserve lower yields.

Issuers tend to borrow excessively because

they believe regulators will bail them out if

they have trouble making repayments. This

has become one of the obstacles to

deleveraging.

China’s debt levels have been climbing faster than

GDP for more than a decade, especially since

2009 when Beijing launched its massive

economic stimulus package to counter the effects

AAA55%

AA+17%

AA16%

AA-1%

A-110%

Others1%

-

500

1,000

1,500

2,000

2,500

3,000

3,500

2 0 0 0

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2 0 0 7

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2 0 1 6

2 0 1 7

R M B b n

Gross issuance To tal repayment

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of the global financial crisis. If we use total bank

loans and bonds to measure debt, it comes out at

around 193% of GDP as of 2014, up from 130%

in 2001 (Fig 65).

65. China bonds and loans as % of GDP

Source: CEIC, Wind, HSBC

Tight liquidity

As we argued in The easing dilemma

(10 February 2015), liquidity remains tight despite

several rounds of monetary easing. This is evident

by a persistently high 7-day repo rate (Fig 66).

66. 7-day repo rate: persistently high

Source: Bloomberg, HSBC

China’s Treasury curve now looks strikingly

similar to the US in January 2008: flat at c3% to

4% and inverted at the short end (Fig 67),

reflecting the challenging financing outlook,

especially for banks.

67. China and US Treasury yield curve comparison, 2015 vs.2008

Source: CEIC, HSBC

Conclusion

In 2014, the onshore bond market made great

progress in many areas such as issuance, new

product launches and the simplification of

regulations. We think the pace of change will

continue to increase this year, with the focus on:

Simplifying rules as the regulators of different

credit platforms compete for market share

(although there is a risk that this may

intensify segmentation).

More savings will be channelled into the bond

market through wealth management products,

which will help the bond market to expand.

The bond market is becoming a competitor to

traditional lenders, which may force them to

balance their desire for growth by focusing onefficiency and profitability. This is evident by

the rapid growth in the issuance of asset-

backed securities in 2014.

In the long term some structural issues need to be

addressed, including the lack of a default

mechanism, an unsatisfactory rating system and

the fragmented regulatory landscape. However, as

the economy is in need of more funding, we

expect the onshore bond market to continue to

grow in size and sophistication.

100%

125%

150%

175%

200%

-

20,000 40,000

60,000

80,000

100,000

120,000

140,000

2 0 0 0

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2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

Debt: bond Debt: loan Total debt / GDP (RHS)

R M B b n

2

3

4

5

6

7

3 N o v 1 4

1 0 N o v 1 4

1 7 N o v 1 4

2 4 N o v 1 4

1 D e c 1 4

8 D e c 1 4

1 5 D e c 1 4

2 2 D e c 1 4

2 9 D e c 1 4

5 J a n 1 5

1 2 J a n 1 5

1 9 J a n 1 5

2 6 J a n 1 5

2 F e b 1 5

9 F e b 1 5

1 6 F e b 1 5

2 3 F e b 1 5

2 M

a r 1 5

9 M

a r 1 5

1 6 M

a r 1 5

%

Rate cut Rate cutRRR cut

0

1

2

3

4

5

1 M

6 M 2

Y 4 Y

6 Y

8 Y

1 0 Y

1 5 Y

2 0 Y

China, 11 Mar 15 US, 14 Jan 08

%

https://www.research.hsbc.com/R/20/mVab4Dahttps://www.research.hsbc.com/R/20/mVab4Dahttps://www.research.hsbc.com/R/20/mVab4Da

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The offshore RMB (CNH) bond market

underwent several major changes last year.

Offshore yields, which used to trade as much as

200bp below onshore levels, have now converged

to similar or even higher than onshore peers. The

main driver has been the further liberalisation of

cross-border flows.

The CNH bond market has continued to grow

despite the RMB weakening against the USD.

With nearly 15 offshore RMB centres already

established, we expect the pool of CNH liquidity

to increase further, although the rate of expansion

will be affected by currency sentiment.

In this report, we provide an update to ‘CNH bond

primer: Hot dim sum’ in The redback primer: An

essential guide to renminbi asset classes (20

March 2014), addressing the top 10 questions

regarding the market in the past 12 months:

1) How important is the CNH market in terms of

offshore financing for Chinese companies?

2) How fast have cross-border RMB flows

expanded?

3) What caused the accelerated convergence of

onshore and offshore yields?

4) In an environment of currency uncertainty, are

there any new drivers to support the offshore

RMB pool?

5) How has the primary market evolved in the

past 12 months?

6) Have any new structures emerged in recent

bond offerings?

7) What type of new investors may find CNH

bonds attractive?

Changing dynamics ofoffshore RMB bonds…

The CNH bond market has become an increasingly important

channel for Chinese companies to source offshore financing, in

the context of the central government’s ‘go abroad’ strategy

Offshore yields have converged to onshore levels in early 2015 on

the back of broadening channels of cross-border flows and

changing expectations about the RMB FX rate

The growth of the offshore pool and demand for CNH bonds are

likely to resume once currency sentiment stabilises, helped by the

rising number of offshore RMB centres around the globe

Crystal Zhao AnalystThe Hongkong and ShanghaiBanking Corporation Limited+852 2996 [email protected]

Zhi Ming ZhangHead of China ResearchThe Hongkong and ShanghaiBanking Corporation Limited


https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=Qfhjm9I7V0&n=409050.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=Qfhjm9I7V0&n=409050.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=Qfhjm9I7V0&n=409050.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=Qfhjm9I7V0&n=409050.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=Qfhjm9I7V0&n=409050.PDF

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Q1: How important is the CNH market

in terms of offshore financing for

Chinese companies?China has become the centre of emerging market

borrowing since quantitative easing was launched

in the US. Driven by cheaper offshore financing

costs, Chinese borrowers have accumulated

USD1.5trn debt from international lenders as at end

of September 2014 (USD1.1trn bank loans and

USD0.4trn bonds), up from a mere USD200bn five

years ago, according to BIS data (Fig.1 and Fig.2).

Offshore bonds are an increasingly important

channel for Chinese entities to raise fund. They have

raised a total of USD500bn bonds in G3 currenciessince 2007 and have been expediting CNH issuance

since the market took off five years ago (Fig.3). In

2014, for every RMB raised overseas by Chinese

issuers, 25% came from CNH bonds (including

bank certificates of deposit).

We think CNH bonds will continue to play an

essential role in the offshore financing of Chinese

companies, especially at a time when the RMB is

…They will come back

CNH bonds have proved less popular in the last few months due to

expectations of RMB weakness and tighter offshore liquidity

Attractive carries on RMB would lure back investors once

sentiment stabilises; Formosa bonds are adding to issuer diversity

We remain positive on the CNH market, given policy support for

domestic companies going abroad and the increasing global use

of the RMB

Crystal Zhao AnalystThe Hongkong and ShanghaiBanking Corporation Limited


Zhi Ming ZhangHead of China ResearchThe Hongkong and ShanghaiBanking Corporation Limited+852 2822 [email protected]

Fig.1 Onshore funding costs have been much higher thanoffshore levels post the financial crisis

Fig.2 Total cross-border claims on China reached USD1.5trn asof end of September 2014

Source : Bloomberg, HSBC Source: BIS, HSBC

Note: All BIS reporting banks’ cross-border claims include banks’ positions vis-à-vis

their own offices.

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