Deng's cats prefer synthetics to dim sum

I bumped into Morgan's ex-boss at the Asian Financial Forum (AFF) last week in Hong Kong.

Morgan, our family cat, is not a stranger to the readers of this column. His previous owner, an investment banker who left Dubai in the wake of the financial crisis is now based out of London.

Our meeting in Hong Kong was a matter of pure coincidence. I was in the city to cover the AFF. My friend was there on a road show to place a bond issue for a Chinese real estate company.

After a brief chat about the cat and our respective families, my friend took off on a long lecture about the emerging opportunities for fund raising through Hong Kong.

He spoke extensively about dim sums. Initially I wondered why he should be so excited about the bite-sized Chinese snack. Sensing my perplexity, he explained that dim sum is the nickname given to bonds denominated in yuan issued in Hong Kong and is settled in yuan.

As he continued he spoke about a new variety called synthetic bonds which is fast emerging as a rage among Chinese companies seeking to raise funds. These are bonds denominated in yuan but settled in other currencies such as the US dollar.

Dim sum bond was born out of the necessity to internationalise the Chinese currency as part of financial reform on the Mainland. Several foreign companies, including McDonald's Corp. and Caterpillar Inc., have already raised yuan through debt issues aimed at funding their China expansion.

But the soaring demand for the synthetic bonds which my friend hawks for Chinese companies underscores the surging global demand for ways to play appreciation of China's currency and the limits of China's efforts to create an international market for the yuan in Hong Kong.

To date, most offshore yuan-denominated bonds have been issued in Hong Kong, while several synthetic convertible bonds have been issued in Singapore and are likely to be issued in other international financial centres.

Evergrande Real Estate Group, a mainland based company's $1.4 billion bond issue in early January was Asia's biggest high-yield corporate debt deal ever. Investors love these hybrids amid widespread consensus that China's currency will continue to appreciate against the dollar. This gives investors a new way to bet on yuan while earning yields on the bonds that are much better than what they would get on dim sum bonds.

Settling in dollars makes synthetic yuan bonds accessible to a wider pool of investors, who also demand higher returns for the risk they take by investing in non-investment-grade securities.

I could not quite figure out why issuers should opt for high yield synthetics when they have the option of raising cheaper yuan through dim sum bonds. My friend clarified that China is keen to control companies using offshore yuan funds to invest in real estate. Ironically, there's no such taboo restriction on raising dollars abroad through synthetic yuan bonds, and then sending that money onshore.

Deng Xiaoping (1904 - 1997), the Chinese leader who led the country towards a market economy, is credited to have said that it didn't matter the colour of the cat, so long as it caught mice.

Clearly the capitalist cats did not disappoint Deng's China. Over the last three decades it has emerged a global economic power. But the crude cocktail of surging inflation and the artificially weak currency has opened several windows of opportunity for global speculators to bet on China's currency. The new rush for synthetic bonds could be just the beginning of a cat fight in currency markets over sharing the yuan's potential gains.

Going forward, it looks like China has no way but to let its currency and wages to rise to cool inflation and hot money inflows from bets on the yuan.

I bumped into Morgan's ex-boss at the Asian Financial Forum (AFF) last week in Hong Kong. Morgan, our family cat, is not a stranger to readers of this column. His previous owner, an investment banker who left Dubai in the wake of the financial crisis, is now based in London.

Our meeting in Hong Kong was a matter of pure coincidence. I was in the city to cover the AFF. My friend was there on a road show to place a bond issue for a Chinese real estate company.

After a brief chat about the cat and our respective families, my friend took off on a long lecture about the emerging opportunities for fund raising through Hong Kong.

He spoke extensively about dim sums. Initially, I wondered why he should be so excited about the bite-sized Chinese snack. Sensing my perplexity, he explained that dim sum is the nickname given to bonds denominated in yuan issued in Hong Kong and is settled in yuan.

As he continued he spoke about a new variety called synthetic bond, which is fast emerging as a rage among Chinese companies seeking to raise funds. These are bonds denominated in yuan but settled in other currencies such as the US dollar.

Dim sum bond was born out of the necessity to internationalise the Chinese currency as part of financial reform on the Mainland. Several foreign companies, including McDonald's and Caterpillar, have already raised yuan through debt issues aimed at funding their China expansion.

But the soaring demand for the synthetic bonds, which my friend hawks for Chinese companies, underscores the surging global demand for ways to play appreciation of China's currency and the limits of China's efforts to create an international market for the yuan in Hong Kong.

To date, most offshore yuan-denominated bonds have been issued in Hong Kong, while several synthetic convertible bonds have been issued in Singapore and are likely to be issued in other international financial centres.

Loved by investors

A $1.4 billion (Dh5.14 billion) bond issue by Evergrande Real Estate Group, a Mainland-based company, in early January was Asia's biggest high-yield corporate debt deal ever. Investors love these hybrids amid widespread consensus that China's currency will continue to appreciate against the dollar. This gives investors a new way to bet on yuan while earning yields on the bonds that are much better than what they would get on dim sum bonds.

Settling in dollars makes synthetic yuan bonds accessible to a wider pool of investors, who also demand higher returns for the risk they take by investing in non-investment-grade securities.

I could not quite figure out why issuers should opt for high yield synthetics when they have the option of raising cheaper yuan through dim sum bonds. My friend clarified that China is keen to control companies using offshore yuan funds to invest in real estate. Ironically, there's no such taboo on raising dollars abroad through synthetic yuan bonds, and then sending that money onshore.

Deng Xiaoping (1904 - 1997), the Chinese leader who led the country towards a market economy, is credited with having said that it didn't matter the colour of the cat, so long as it caught mice.

Clearly the capitalist cats did not disappoint Deng's China. Over the last three decades it has emerged a global economic power. But the crude cocktail of surging inflation and the artificially weak currency has opened several windows of opportunity for global speculators to bet on China's currency.

The new rush for synthetic bonds could be just the beginning of a cat fight in currency markets over a share of the yuan's potential gains.

Going forward, it looks like China has no way but to let its currency and wages rise to cool inflation and hot money inflows from bets on the yuan.