CNH Tracker-China's debt yields converge slowly, even amid FX volatility

By Saikat Chatterjee

HONG KONG, May 22 (Reuters) - The gap (NYSE: GPS - news) between China onshore

and offshore bond rates is converging to the delight of fund

managers, and probably the government, as it signals a deepening

of markets for Chinese assets and the yuan.

More alignment between the two markets shows that the

offshore market is not just being driven by FX speculation and

will help toward internationalisation of the Chinese currency.

Money managers at the annual auction of China's ministry of

finance bond sale on Wednesday found that the gap between the

two debt markets that had existed for years had at last begun to

shrink, and in some parts of the yield curve, even disappear.

Investors have long complained about the structural

deficiencies in the offshore yuan bond market, which have always

forced them to buy Chinese debt outside the mainland at costlier

prices compared with onshore.

China's debt market is the third largest in the world after

the United States and Japan and is poised to expand along with

demand for Chinese assets as the country opens its financial

markets.

While that gap narrowed to some extent in recent months as

China gradually allowed access to foreign investors to its

interbank bond market via quotas, the small size of these

channels and a near-decade long currency rally meant yields on

offshore debt were usually below onshore bonds.

This year's unexpected weakness and volatility in the

Chinese currency, which has fallen 3 percent against the dollar

so far this year and is among the leading losers in the emerging

market universe, has accelerated this convergence trend.

Still, the renminbi's volatility and weakness failed to

deter investors at China's ministry of finance bond sale where

it sold the first of a 28 billion yuan ($4.5 billion)

dual-tranche bond.

The first tranche was a 14 billion yuan six-part transaction

sold to institutions on Wednesday with seven central banks and

monetary authorities among the investors.

The 7 billion yuan 3-year tranche was priced to yield 2.53

percent, the 4 billion yuan 5-year tranche 3.25 percent, and the

1 billion yuan 7-year tranche 3.8 percent.

On longer tenors, the one billion yuan 10-year tranche was

priced to yield 4 percent, the 500 million yuan 15-year tranche

4.29 percent and the 500 million yuan 20-year tranche 4.5

percent.

Demand was robust with the 2.99 times overall coverage ratio

for the transaction higher than the 2.59 times ratio for the

ministry's offering last November.

This was despite being the ministry's biggest debt offering

in the last five years and some houses such as HSBC are

predicting a record supply of dim sum debt this year.

Paula Chan, senior portfolio manager at Manulife Asset

Management in Asia, said the currency's weakness has raised the

awareness among investors to view offshore yuan bonds as a

credit class rather than a vehicle for betting on the currency.

"Many of our institutional clients are looking to do more

on the offshore yuan bond as an investment option and the recent

trend in more issuance of rated paper is a healthy sign," she

said at an RMB conference hosted by the Hong Kong Stock

Exchange.

The demand for more ratings has led to investors allocating

credit risk premium in line with the mainland bond markets,

driving this convergence between the offshore and onshore debt.

Wednesday's auction cut-off in the longer tenors was broadly

in line with the secondary market yields on the mainland while

shorter-dated debt was still bought at a premium, indicating

that convergence had still some way to go.

That lack of convergence on the shorter tenors exist because

investors cannot freely access both the offshore and the onshore

bond markets and shorter-dated instruments are still typically

used as a bet on currency gains by many investors.

For example, the gap between the cut-off yields on the 10-

year and the 15-year sector was an average five basis points

compared with a whopping 94 basis point average gap on the two-

and three-year tranche, according to Thomson Reuters (Frankfurt: TOC.F - news) data.

WEEK IN REVIEW:

* Deutsche Asset & Wealth Management and Harvest Global

Management have teamed up to sell a first small cap investment

product to be launched under China's renminbi qualified

institutional investment programme. The product will track the

performance of an index of Chinese companies, each with a market

cap averaging $1.2 billion.

* Chinese asset management firm E Fund Management (Hong

Kong) said it has tied up with London-based ETF Securities to

launch an exchange traded fund (ETF) to list on three European

exchanges.

* Tracking the MSCI China A Index and with a quota of 2

billion yuan ($320.9 million), the ETF listed on the London

Stock Exchange, Deutsche Boerse (Xetra: 63DA.DE - news) and NYSE Euronext Amsterdam on

Monday. It is the first such fund to list in three European

stock exchanges simultaneously under the Renminbi Qualified

Foreign Institutional Investor scheme.

CHART OF THE WEEK: http://link.reuters.com/zyw39v

China's ministry of finance annual bond sale is a

much-awaited event in the offshore market as authorities usually

use the occasion to inject some new reform into the market. Past

years have seen longer tranches, portions set aside for foreign

central banks and even tranches aimed at retail investors.

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THOMSON REUTERS SPEED GUIDES

($1 = 6.2337 Chinese yuan)

(Additional reporting by Nethelie Wong at IFR; Editing by

Jacqueline Wong)