China's Dollar Bond Is a Puppet Show for Markets

(Bloomberg Gadfly) -- Beijing likes to do things its own way. If socialism can have Chinese characteristics, so can international debt markets.

China's first dollar bond issue since 2004 wasn't graded by the major rating companies. After all, why pay U.S.-based agencies that have had the temerity to downgrade the sovereign credit of Asia's largest economy? It can guide the markets itself.

The lead book runners on the $2 billion deal -- China's largest state-owned banks -- have been telling clients to compare the nation's credit to three sovereigns: AAA-rated Germany, and Japan and Israel, both of which share the same A+ rating as China, on the S&P Global Ratings scale.

The Ministry of Finance is offering 10-year debt at a spread of 40 to 50 basis points over Treasuries, Carrie Hong of Bloomberg News reported on Wednesday. On that basis, China would be closer to Germany than the two countries with which it shares a rating.

China's Dollar Bond Is a Puppet Show for Markets

That premium is already a polite nod from China to markets. As I wrote two weeks ago, the debt could be sold at no spread at all, given the likely buyers.

Classified as Reg S , the bonds cater specifically to Asian investors, or Chinese asset management firms. Wang Yi, the new head of the financing department at the ministry, told investors that he expected a large chunk of investors from China, according to financial news provider Caixin, which attended its investors' briefing on Wednesday night. The Chinese were long-term investors so others could feel confident to buy, Wang was reported to have said. 

Wink, wink. In other words, the price of these debt securities is unlikely to fall. While state-owned enterprise bosses can please Beijing by holding on to a prized issue, hot money will be able to make a nice carry, too.

Brokers in Hong Kong are willing to offer 90 percent leverage to investors for this deal at just 40 basis points over Libor, or 1.6 percent, according to my channel checks. A coupon rate of, say, 2.8 percent would therefore translate to a carry of 1.2 percent, amplified 10 times. Thanks for shopping with China. 

Even the Hong Kong government is joining this boss-pleasing wagon. Residents planning to buy the dollar bond can expect to get a profit tax exemption, Financial Secretary Paul Chan was cited by Xinhua as saying. That makes the issue even more alluring. 

The finance ministry said it was selling the five- and 10-year dollar bonds to provide new benchmarks for Chinese corporations. Spreads have already been narrowing for China's investment-grade SOEs. 

China's Dollar Bond Is a Puppet Show for Markets

But here's the problem. If much of these notes are held for the long term, then liquidity will be thin. In this case, how meaningful will the sovereign bond be as a benchmark? State Grid's issues this year are not only larger, they also have more tranches -- from three to 30 years -- and are marketed under regulations that permit them to be sold to investors worldwide.

In half a year's time, we may have to go back to quasi-sovereign bonds like State Grid's for guidance.

After China's heavily scripted party congress, this is little more than another puppet show.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

  1. So-called Regulation S, or Reg S, securities can't be marketed to investors in the U.S. 

To contact the author of this story: Shuli Ren in Hong Kong at sren38@bloomberg.net.

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