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This sponsored article first appeared in Asia Legal Business, issue 8.8, 2011.
K&L Gates
The Rise of the High Yield “Dim Sum” Bond Market
T
he international capital markets have
witnessed a spectacular phenomenon
in the past year – namely, the meteoric
rise of the “dim sum” bond market.
“Dim sum” bonds are debt securities which
are predominantly issued out of Hong Kong
and denominated and settled in “CNH”, i.e.
offshore Chinese Renminbi (“RMB” ), which is
effectively a currency different from onshore
RMB (or “CNY”) and primarily traded and
cleared in Hong Kong. The amazing growth of
the dim sum bond market reflects a number of
trends in the global economy and international
markets, including the growing importance
of the PRC as a global economic power, the
gradual loosening of Chinese foreign exchange
controls and the increasing importance of the
RMB in cross-border trade settlement.
Legal and Regulatory Underpinnings
Over the past few years, China has been
gradually deregulating its foreign exchange
controls over the RMB in an effort to
“internationalize” its currency. In June 2010,
the PRC government expanded a 2009
trial program allowing RMB settlement of
payments for cross-border trade by selected
Chinese cities and ASEAN countries to trade of
goods with all countries. A month later, most
restrictions on the offshore conversion, transfer
and offer of RMB and RMB-denominated
financial products in Hong Kong were lifted,
which led to a steady increase of RMB outflows
and a consequential surge in offshore RMB
deposits in Hong Kong banks. In addition, since
February 2010, virtually any corporate entity
can issue RMB-denominated bonds in the
Hong Kong capital markets. These significant
regulatory changes formed the legal basis for
the rapid increase in the issuance, trading and
settlement of dim sum bonds.
Changing Nature of Dim Sum Bond
Issuers
Prior to mid-2010, almost all dim sum bond
issuers were PRC sovereign bodies and financial
institutions. Briefly in mid-2010, this market’s
issuers were predominantely supranational
institutions and private investment grade
corporations. However, beginning with a
December 2010 issuance by Macau gaming
operator Galaxy Entertainment, an increasing
number of high yield (“HY”) issuers,
predominantly companies with sizeable PRCbased operations in non-property industries,
have increasingly accessed this bond market.
Large, well-known multinational corporations,
such as McDonalds and Caterpillar, have
likewise raised funding for their PRC-based
operations in the dim sum bond market — a
trend that is expected to continue to grow.
Typical Offering Structures and
Covenant Packages for Dim Sum Bonds
Unlike CNY-linked synthetic bonds 1 or other
Asian HY US$-denominated bonds, HY
dim sum bonds 2 issued to date have been
unsecured and have been characterized by
terms with little to no covenants and are
generally considered “loose” in terms of the
ability of bondholders to take enforcement
action against the issuer in a meltdown
situation. In the HY dim sum bond market,
U.S.-style HY bond covenants, such as
covenants limiting debt incurrence, “restricted
payments” and significant asset sales, are
conspicuously absent. Effective structural
subordination of the bondholders’ rights
to the rights of the creditors of the issuer’s
operating subsidiaries is not always addressed
by the appropriate upstream subsidiary
guarantees. HY dim sum bond issuances that
contain “true” HY offering structures are few
and far between; seen only where there is
a concurrent offering of US$-denominated
bonds by the same issuer or the issuer is
relatively unknown to the market. A typical
dim sum bond covenant package will only
include a negative pledge clause and few, if
any, maintenance financial covenants 3. Despite
the perceived higher level of bondholder
risk, coupons on HY dim sum bonds remain
relatively low compared to US$-denominated
and CNY-synthetic bonds.
Like offering structures for other debt
securities, dim sum bond tenors and covenant
packages are market-driven. As demand
currently outpaces supply, the existing dim
sum market is essentially an “issuer’s market”
– where the balance of power is generally in
favor of the issuer during negotiations with
the offering’s investment banks regarding
the proposed terms of the bonds. Hong
Kong banks and investment funds, faced
with burgeoning CNH deposit accumulation
and limited matching currency fixed-income
investment options available, are the main
dim sum bonds investors. As of May 2011,
over CNH500 billion was deposited in Hong
Kong, while only CNH131 billion (est.) in dim
sum bonds was outstanding as of June 2011.
Participation from other investors has been
fuelled by, among other factors, expectations
of RMB appreciation and the desire to gain
exposure to non-property PRC industries.
What Does the Future Hold for the
Dim Sum Bond Market?
Investment banks negotiating for tighter
covenant packages in HY dim sum bond
offerings will find existing “market practice” to
be their toughest hurdle. In a nascent market,
where competition for mandates is fierce and
investor interest remains strong in “covenantlite” bonds, there may be little reason for
investment banks to push for tougher terms
and higher yields for bondholders: in other
words, “if [the market] ain’t broke, don’t fix it.”
This view, however, appears to be changing
as creditors learn valuable lessons from the
publicity surrounding the alleged inaccuracy of
disclosure in some recent securities offerings by
PRC-related issuers and the difficulties creditors
are currently facing in taking enforcement
actions against defaulting or near-defaulting
issuers and borrowers within China. The
weaker market performance of HY dim sum
bonds towards the end of the first half of 2011
reflects, in part, a more discerning investor
base that prefers higher rated bonds. Market
requirements may further tighten for issuers
as alternative CNH-denominated investment
products become available. Finally, European
and U.S. investors entering the dim sum bond
market will likely expect to see bondholder
protections similar to those contained in other
Asian HY bonds. As a result, one can expect
that, as the dim sum bond market continues
to mature, offering structures and covenant
packages in HY dim sum bond issues will more
closely resemble their Asian US$-denominated
HY bond comparables – in other words,
they will be rated by reputable international
rating agencies, contain
covenants typically seen
in U.S.-style HY bond
offerings and offer
higher yields which are
commensurate with the
higher risks they carry.
Brian J. Wesol, Partner
Karen Phang, Associate
Brian J. Wesol
1 These bonds are typically offered by PRC-related issuers to a broader range of potential international investors, including U.S. investors under the Rule 144A offering exemption, and usually contain more traditional U.S.-style HY bond covenant
packages which include a “restricted group” concept, upstream subsidiary guarantees, a security package covering most of the unencumbered properties and assets of the restricted group and typical U.S.-style HY bond covenants.
2 Dim sum bonds generally have shorter tenors (i.e., up to five years but more typically three years) and relatively smaller issuance sizes than other types of bond offerings in the international capital markets. This is due, in part, because issuers
generally do not want to raise CNH financing in amounts much in excess of the RMB that they would be permitted by the authorities (determined on a case-by-case basis) to remit onshore.
3 In addition, frequently the financial ratios in these covenants are set at levels that offer little bondholder protection.
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