Confusion as China rushes out Bond Connect deals

HONG KONG (REUTERS) - Two Chinese policy banks are racing to issue bonds through a new trading link with Hong Kong even though bankers say the framework is not fully ready.

Agricultural Development Bank of China and China Development Bank, both rated A1/AA- by Moody's Investor's Service and S&P Global Ratings, will sell renminbi notes of a combined 36 billion yuan (S$7.31 billion) to onshore and offshore investors under the new "Bond Connect" scheme.

The two offerings start on Monday (July 3), although the CDB deal will run for two days, and are intended to coincide with the 20th anniversary of Britain's handover of Hong Kong to China on July 1.

Bankers and investors, however, are still not clear how the offshore element of the deals will work, given that the landmark Bond Connect trading link is not yet up and running.

"We still have lots of questions on the operation and lots of logistics need to be cleared," said one banker involved in the two deals.

Bond Connect promises to give offshore investors direct access to China's interbank bond market without the need to open custody and bank accounts on the mainland. Hong Kong and Chinese regulators did not set an official start date when they approved the link in May, but market participants have been working towards a launch on July 3, the first working day after the anniversary celebrations.

Guidelines for the initiative arrived in early June, giving traders just a month to prepare for the launch.

Late last week, underwriters were still trying to figure out their roles and investors were scrambling to check their eligibility under the scheme.

One offshore investor, who had been asked to support the two pilot deals, told IFR the application had been unexpectedly rejected last week because the institution had already opened an onshore account.

When asked last Thursday in Hong Kong if the path had been cleared for offshore investors to participate in onshore primary issues, Jimmy Jim, co-head of global markets department at ICBC (Asia), said the changes involved made Bond Connect a"revolution".

"There are certain rules yet to be announced, so I don't have any inside information on that."

ICBC (Asia) is one of eight cross-border coordinators on the ABDC deal and one of 10 on the CDB offering.

In the first phase, Bond Connect will allow foreign and Hong Kong investors to buy onshore bonds in the primary or secondary markets, under the so-called northbound trading link.

Only new issues sold with a prospectus in both Chinese and English will be available to offshore investors.

The first batch of primary issuers will be well-known Chinese borrowers already with international ratings, according to market sources.

Beside the two policy banks, state-owned enterprises China Three Gorges and Aluminum Corporation of China are also among the first batch of issuers. One or two Panda bond offerings may also be included, sources have said.

ADBC, which tapped the Dim Sum bond market in its previous offshore bond deal in 2014, is planning two rounds of tenders for the new offering, the first for both offshore and onshore investors on Monday morning and the second for offshore investors only on Monday afternoon. ADBC aims to raise up to 16 billion yuan from one-year, three-year and five-year notes.

CDB, a frequent issuer in both renminbi and US dollars, at first did not make any special arrangements for offshore investors, but last Friday said it would add a day of marketing for offshore investors on Monday.

The CDB issue will be split into 5 billion yuan one-year, 5 billion yuan three-year and 10 billion yuan 10-year tranches, to be priced on Tuesday.

Both issuers will auction the notes through a public tender on the People's Bank of China's onshore issuance system.

ADBC and CDB have each employed a large group of cross-border coordinators for their issues, in addition to onshore syndicate groups of 82 and 38 members, respectively.

However, cross-border coordinators involved are not so sure about their jobs.

"I think our role is to introduce offshore investors to the second round of the tender for ADBC in the afternoon," said one of the cross-border advisers.

The banker said the pricing for ADBC's notes should be decided after the first-round auction on Monday morning, but she did not know when the allocations would be confirmed.

Another banker involved in the two deals said he was still waiting for clarification over his bank's role.

Despite the fanfare around the launch of Bond Connect, overseas appetite for renminbi bonds is likely to be limited.

Foreign investors have been slow to take advantage of new rules allowing direct access to the onshore Chinese market, given expectations of further renminbi weakness and rising domestic yields.

Market participants say recent signs of currency stabilisation, as well as higher yields and much better liquidity in the onshore market than in the offshore Dim Sum arena, will help rekindle international interest in onshore renminbi bonds.

"In general we see strong value in the onshore renminbi- denominated Chinese government bonds and policy bank bonds as we see their bonds yields are too high relative to the benign inflation in China," said Ken Hu, CIO for Asia Pacific fixed income at Invesco.

He cautioned, however, that the scheme may cause some"teething problems" for the international custodian banks as the operational details were only recently released.

Analysts say it will take more time for foreign investors to get comfortable with the new framework.

"I suppose the offshore demand (for the policy bank notes) will be primarily from offshore Chinese investors," said a credit analyst at a foreign bank, one of the 20 onshore market makers under the Bond Connect scheme. "The schedule is so tight, but applications take time. So, why should foreign investors rush? Why not wait until everything is sorted out?"

International investors still have questions about mutual supervision, withholding tax, beneficial ownership and the treatment of the scheme under European UCITS (Undertakings for Collective Investment in Transferable Securities) regulations, analysts say. It is also not yet clear whether entities that already have access to Chinese bonds through QFII quotas or onshore accounts are eligible under Bond Connect.

"The background for the Bond Connect is very much to diversify the investor base (for onshore bonds). In that sense, it is an issue for Bond Connect to look at how to avoid the duplication of the investor base," said Jim of ICBC (Asia).

The rush to market, however, underlines China's determination to attract global investment into its domestic bond market.

"Every reform here starts with a pilot programme," said a DCM banker.