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Are Dim Sum Bonds The Next Chinese Reverse Merger Fraud?
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Are Dim Sum Bonds The Next Chinese Reverse Merger Fraud?

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Are Dim Sum Bonds The Next Chinese Reverse Merger Fraud?

While Draghi somewhat shut the door on the ECB being the lender of last resort today, there appears to be a sucker-of-last-resort where Dim Sum bonds (offshore/HK Yuan-denominated bonds) have seen issuance almost triple in the first 11 months of the year. The WSJ is reporting that 76 entities issued CNY99.1bn YTD, according to the Hong Kong Monetary Authority. Interestingly, the biggest growth in the second half of the year has been from European firms who are unable to raise funds economically due to the crisis of confidence at home. Bloomberg notes BMW and Lloyds as two recent issuers with the latter managing to price CNY-denominated 3Y debt at 3.6% yield against comparable EUR-denominated debt at 5.3% - quite a saving if you're willing to take the currency risk (or looking for non-Euro, non-USD diversification) as a corporate Treasurer (or desperate for the money). But for the bulk of Chinese issuers it would seem evident that the Dim Sum investors are perhaps a little too eager to be lending their Yuan, and therefore not being appropriately compensated for credit risk concerns (even with the implicit FX revaluation bet).

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This fear is even more prescient when, according to Bloomberg, one considers that 60% of Asia's fastest growing bond market lack any of the standard leverage covenant restrictions (protection) that Western bondholders are used to. And just to add some more fuel to the rising yield fire of these bonds, Bloomberg just reported that eager bondholders are more than willing (and blind to the risks) to accept one-off payments from issuers in order to accept significant covenant concessions (completely disregarding the credit risks through time). Our Dim Sum index has seen average yields jump a significant 70bps to 3.31% since mid-September leading us to raise concerns that this market, on which ETFs are now being created, is worryingly exposed to both a systemic Chinese credit crunch and idiosyncratic releveraging even if managers view Dim Sum as more of a currency play.

Dim Sum Investors Lack Protection on 60% of Bonds: China Credit

Asia’s fastest-growing bond market lacks restrictions that stop companies from borrowing to the brink of default. These debt-to-equity limits are typically required for junk bonds.

“We want comparable protection to what we get in other markets, regardless of the currency, and to date we’re not always seeing that,” said Bryan Collins, a fixed income portfolio manager at FIL Ltd., known as Fidelity Worldwide Investment. “We’re making it very clear that’s what we expect on new issues,” Collins said during an interview at his offices in Hong Kong. Fidelity manages $207.9 billion of assets globally.

Speculation the yuan will strengthen has fueled demand for the Chinese-currency assets in Hong Kong, where international bondholders can buy and sell debt.

Fees Blind Investors to Returns on Bond Changes, Fidelity Says

Bondholders are rushing to accept one-off fees from Asian companies asking to amend their notes rather than considering total returns, according to FIL Ltd.

It’s the medium-term approach to total return when looking at covenant changes that sometimes gets missed,” said Bryan Collins, a fixed income portfolio manager, at FIL Ltd., known as Fidelity Worldwide Investment. If companies take on more debt, “that’s going to deteriorate their credit profile which is going to see their bond price potentially fall,” he said during a media briefing yesterday.

Asian companies are more likely than European or U.S. borrowers to alter terms on their debt to increase the amount they can borrow as these amendments are often cheaper than buying the bond back and reissuing the bond, Collins said. Issuers typically offer bondholders a fee to accept changes, which have to be approved by a specified percentage of investors, usually a simple majority, he said.

Dollar bonds typically restrict debt incurrence when sold, but Hong Kong sales of yuan bonds do not, according to Sabita Prakash, head of Asian fixed income at Fidelity. “Covenants need to be strong and need to be made stronger and I would say that even more emphatically, even more strongly, and even more assertively for the offshore renminbi or Dim Sum bonds,” she said at the briefing.

Sixty percent of non-financial corporate securities listed on HSBC Holding Plc’s Offshore Renminbi Bond Index contain no leverage limits, according to marketing materials.

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PowerShares has a Chinese Yuan Dim Sum Bond Fund ETF (active since late September), which while not super liquid, trades at a modest 1.08% premium to NAV (vs average 1.2%). We have not checked borrow, but we note it has been lagging since mid November.

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