Shaken investors losing appetite for China's 'dim sum' bonds

HONG KONG -- Global market volatility is chipping away at investor appetite for Chinese yuan bonds issued here.

Investor demand for yuan-denominated debt issued outside mainland China — called dim sum bonds, after China's bite-size meals — is closely watched, as this debt is a cornerstone of the government's efforts to encourage wider use of the yuan.

In the past year, dim sum bonds have been popular with Chinese banks and foreign multinationals such as McDonald's, Caterpillar and Unilever, which have sold them as an inexpensive way to fund their operations in China.

Demand has largely outrun supply as investors bet that yuan appreciation will make up for these bonds' relatively low interest rates.

But that picture has changed as the Greek debt crisis and the U.S.' anemic growth led investors to seek safety in the U.S. dollar in late September. Asian currencies, including the yuan, weakened, damping investor appetite for dim sum bonds.

The yuan remains volatile, with tension between the U.S. and China over exports also pressuring the currency.

The dim sum bond market isn't "immune to the global weakness, although the volatility is still lower than in other markets," says Becky Liu, strategist for Asian credit research at HSBC.

September was the worst month for dim sum bonds since the market opened to foreign issuers last year.

Dim sum bonds have a total return of 1.3% so far this year, dragged down by a 3.1% loss in September, according to HSBC.

Selling pressure is continuing in October, according to Jonathan Cavenagh, senior currency strategist for Westpac Banking.

Even as the yuan appreciates, the dim sum bond market could remain volatile until the global economic outlook improves, he says.

The cooling of the dim sum market is leading some companies to rethink whether to issue dim sum bonds, and others to consider getting their bonds rated by credit agencies, says Ivan Chung, a vice president at Moody's Asia Pacific in Hong Kong.

When market demand for dim sum bonds exceeded supply, issuers often didn't bother spending the time or money to get a rating.

"The extremely difficult global conditions have increased the need for transparency," says Michael Petit, a managing director at Standard & Poor's in Hong Kong.

Investors are also paying more attention to issuers' creditworthiness as the growing dim sum bond market attracts high-yield issuers, who are at greater risk of defaulting than high-grade issuers.

For now, most analysts expect market volatility to deal a temporary setback to the young but growing dim sum bond market, which has seen more than $11.3 billion in debt issued so far this year.

That is more than double the amount in all of 2010 and puts total outstanding dim sum bonds at $17.5 billion, according to data provider Dealogic.

"We see an explosive growth in accumulation of yuan outside China, and this money needs to find a home," says Tee Choon-Hong, a regional head of capital markets for Standard Chartered Bank. "The bond market is usually the first place that investors look at given the lack of other investment alternatives currently."

HSBC is sticking to its June forecast that 180 billion to 230 billion yuan of dim sum bonds and yuan-denominated certificates of deposits will be issued in full-year 2011, bringing total outstanding debt to as much as 270 billion yuan — or more than $42 billion U.S. — due to its expectations that investors will still want high-quality debt.

HSBC estimates total outstanding dim sum bonds and CDs amount to 198 billion yuan.