China's Financial Crackdown Boosts Lure of Borrowing Offshore

Onshore pain is offshore gain.

A man monitors stock movements on his mobile phone at a securities brokerage in Beijing, China, on Monday, Jan. 18, 2016. China's economy slowed in December, capping the weakest quarter of growth since the 2009 global recession, as the Communist leadership struggles to manage a transition to consumer-led expansion.

Photographer: Qilai Shen/Bloomberg

China’s crackdown on leverage may be having the unintended consequence of boosting the allure of selling debt overseas -- potentially escalating currency risks, in particular for high-yield issuers. 

While Chinese sub-investment grade borrowers have long faced higher yields when selling in dollars, the gap is narrowing rapidly as rates surge onshore. For example, yields on junk-rated onshore yuan bonds reached just 18 basis points less than those on dollar bonds issued by Chinese property developers, one of the biggest source of junk sales in dollars, according to Bank of America Merrill Lynch.

While back in 2015, Chinese companies were focused on paying down dollar obligations thanks to prospects for a sinking yuan, they're now ramping up issuance. Some $67 billion has been sold so far this year, with high-yield issuers accounting for $12.7 billion, according to data compiled by Bloomberg.

Credit: Bank of America Merrill Lynch

“More high-yield bonds will come offshore due to these dynamics," said Arthur Lau, the Hong Kong-based head of Asia ex-Japan fixed income at PineBridge Investments. He added one proviso: local government financing vehicles may not see so much of a pick-up, given authorities' focus on reducing municipalities' leverage.

The yield spread is also shrinking thanks to demand for high-yield Chinese dollar debt -- read more about that here.

President Xi Jinping's focus on reducing risks in the domestic financial market were highlighted by his chairing of a meeting the Communist Party's Politburo had April 25 with the country's chief regulators. Steps taken by policy makers have included boosting money-market rates and increasing their scrutiny of banks' off-balance-sheet assets -- vehicles that have been used to pour money into riskier assets such as high-yield bonds.

``The tighter regulatory supervision on shadow-banking activities has induced a reduction in bond holdings at the banks,'' Hao Hong, Bocom International Holdings Co.’s chief strategist in Hong Kong, said in an interview. There are "a lot of off-balance sheet bond holdings that are likely not to be compliant under the new regulation” to be applied to so-called entrusted holdings off the balance sheet, he said. Entrusted assets aren't directly managed by the banks.

There are already signs that the sell-off is affecting the new issuance pipeline onshore. There was a total of 1.38 trillion yuan ($200 billion) of corporate bond issuance in January through March, the lowest quarterly volume in three years, according to data compiled by Bloomberg. 

“The regulatory crackdown has given people a hard time,” said Hua Xu, head of research at Shanghai-based Colight Asset Management, whose fund manages more than 30 billion yuan in assets. ``Corporate-bond issuance will shrink compared with the previous years.''

--With assistance from Ling Zeng.

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