“Dim Sum” on the Financial Menu
News of the launch of an exchange-traded fund (ETF) that invests in so-called “dim sum” bonds (yuan-denominated bonds that are issued and traded outside of mainland China) marks an important step in the evolution of China’s fixed-income markets. Though still a relatively small market centered in Hong Kong, expectations are for continued growth in response to demand by foreign investors for exposure to China’s renminbi (RMB).
The “dim sum” market also offers increased financing options for private companies in the region that tend to get crowded out of mainland debt markets by state-owned enterprises. This issue was discussed at length at a recent Harvard Law School symposium co-sponsored by CFA Institute, at which regulation and competitiveness in the U.S. and Chinese markets were discussed, as well as cross-border-investment issues and the future of the dollar and the renminbi in the global financial system.
Development of a mainland Chinese corporate bond market is complicated somewhat by the lack of a robust secondary market, reflecting the tendency for investors to buy and hold bonds in China. Interest rates in China are also strictly managed by the state, making it difficult to price risk appropriately. As a result, bond price formation is challenging. Still, powerful forces exist for further development of a domestic bond market, including the likely desire of Chinese savers to access financial products that suit their time horizons and risk preferences, and growing financing needs of private enterprises.
The Harvard discussion of prospects for a growing Chinese bond market was accompanied by considerable debate over the potential for the yuan to become further internationalized, perhaps even to become a reserve currency. Indeed, it is this prospect that may contribute in part to investor demand for RMB-denominated investments. Symposium participants noted some of the structural changes required before convertibility could become a reality, but also pointed to the potential continued growth in offshore yuan-denominated investments as a powerful driving force in China’s currency evolution to becoming a truly international currency.
Even in a market that is evolving at a deliberate pace like China’s, interconnections with the global financial architecture are important. The symposium (which gathered market practitioners, government officials, and policy makers) addressed China’s growing importance in the financial ecosystem, including the consequences for prudential regulation. Europe and the United States find it difficult enough to reconcile market differences to be effective at complex tasks like systemic risk detection and mitigation; add in more diverse market, political, and legal systems in other important markets like China, and the slow pace of global regulatory coordination becomes more understandable, if no less urgent. As the Chinese proverb goes, “It’s better to be a dog in a peaceful time than be a man in a chaotic period.”