A rare euro-denominated bond sale by China was quickly lapped up by bond investors last week in what was widely expected to be a blowout success – receiving just under €20 billion within a few hours of its opening of which only €4 billion was retained. What was less obvious was the reason for the deal.
The money raised is a tiny fraction of China’s $3.1 trillion foreign exchange reserves and a drop in the $13 trillion economy – so why bother?
The timing is uncanny – the world’s two biggest economies are embroiled in a 16-month trade dispute and this week French President Emmanuel Macron signed major trade agreements with China in what is seen as a harbinger of more deals between EU and China.
While a dollar deal is expected later in the month, the sovereign’s first euro-denominated bond since 2004 would also create a benchmark for other Chinese firms to follow. The yields of 0.197%, 0.618% and 1.078% on the bonds due 2026, 2031, and 2039, respectively, are also attractive to bond investors staring at a pile of negative-yielding sovereign bonds with even lower-rated sovereigns like Bulgaria, Portugal, and Spain trading at negative yields.
“We felt that doing a three-tranche deal would be good because it allows different points of play and since it was a rare issuer the transaction should not be a small one,” said a banker close to the unrated deal.
The bond received orders of €8.7 billion, €6.7 billion and €4.3 billion for the 7-, 12- and 20-year bonds respectively. The yields were equivalent respectively to 30, 40 and 58 basis points over mid-swaps.
Bank of China, Bank of Communications, China International Capital Corporation, BofA Securities, Citigroup, Commerzbank, Crédit Agricole, Deutsche Bank, HSBC, Societe Generale, Standard Chartered Bank and UBS were the joint lead managers and book runners.
The currently outstanding euro-denominated quasi-sovereign bonds from China all trade at a similar spread to their dollar cousins but the absolute yield is lower because of the underlying yields.
This opens up the doors for policy banks and quasi-sovereign issuers looking to lower their funding costs in an economic slowdown while also shunning the use of the dollar at a time when the world’s two biggest economies lock horns in a trade tussle.
“For European investors who want pure credit exposure in future, this is a good hedge. They can be compensated with the spread over the sovereign and they can do a relative value play. The lower cost and diversification play means we will see continued growth in euro-denominated bonds,” said Aninda Mitra, Senior Sovereign Analyst at Mellon.
Asia has been taking advantage of the lower-yielding euro yields with even junk-rated or high yield bond issuers selling euro-denominated debt. Last month, Fosun International issued a €400 million bond maturing in 2023 which was priced at a yield of 4.35%, lower than even a longer dollar-denominated bond sold in January when it priced a two-year bond at 6.875%.
In the year to date, euro-denominated deals out of Asia ex-Japan have totaled $25.6 billion, a significant rise over the $22.4 billion in the same period in 2018, according to Dealogic.
“For those looking for euro exposure and intending to hold to maturity, the latest Chinese sovereigns offer modest excess compensation in exchange for little in way of sovereign credit risk,” said independent research firm CreditSights in a note.” China remains at the very tightest end of the EM sovereign index and remains tight even of AA and higher developed market corporates.” China’s sovereign rating is A1/A+/A+ by Moody’s/S&P Global/Fitch Ratings.
Last week, the European Commission cut its euro-area growth and inflation outlook which came after ECB embarked on a fresh monetary stimulus campaign in September while cutting interest rates deeper into negative territory. Both the present and the previous ECB chiefs, Christine Lagarde and Mario Draghi, have asked euro governments to support the region’s economy with fiscal measures. All indications suggest worse may be ahead for Europe and interest rates will stay low for some time to come.