HK/China Equity Long-Short

Osbert Tang, CFA

Credit

iShares China CNY Bond UCITS ETF / Credit

iShares China CNY Bond UCITS ETF is an exchange-traded fund incorporated in Ireland. The Fund tracks the performances of the Bloomberg Barclays China Treasury + Policy Bank Total Return Index USD. Settlement: ICSD.

iShares China CNY Bond UCITS ETF (CNYB NA)

Amounting to Rmb17.8trn based on the outstanding value, China's policy bank bond represent a material portion of the country's onshore bond market as it accounted for a 16% share.  Over the last twenty years, their total outstanding value has leaped by 17.5x, or a CAGR of 15.7%. YTD, a total of Rmb4.4trn of policy bank bonds have been issued, only 10% less than government bonds.We believe policy bank bond is an interesting alternative for government bond and expect more fund flow into this bond category in the future. Foreign investors currently own 4.6% of these bonds but their total holdings have surged a whopping 60% YTD. With comparable creditworthiness with that for China sovereign, on average, their 10-year bonds are yielding 64bps higher than government bonds since 2016, making it an attractive option for foreign investors.

Amounting to Rmb17.8trn based on the outstanding value, China's policy bank bond represent a material portion of the country's onshore bond market as it accounted for a 16% share.  Over the last twenty years, their total outstanding value has leaped by 17.5x, or a CAGR of 15.7%. YTD, a total of Rmb4.4trn of policy bank bonds have been issued, only 10% less than government bonds.We believe policy bank bond is an interesting alternative for government bond and expect more fund flow into this bond category in the future. Foreign investors currently own 4.6% of these bonds but their total holdings have surged a whopping 60% YTD. With comparable creditworthiness with that for China sovereign, on average, their 10-year bonds are yielding 64bps higher than government bonds since 2016, making it an attractive option for foreign investors.

China Onshore Credit: Policy Bank Bond as an Interesting Alternative to Government Bond

China's government bonds are integral part of the country's onshore bond market. Having an aggregate value of Rmb19trn, these bonds represented 17% of the total outstanding notional value of the market. Their issuance will also set a new annual record in 2020 - YTD, total amount of Rmb4.77trn has been issued and this is already 14.5% higher than the value issued in 2019. With the first China bond ETF in Singapore that invests purely in Chinese government bonds to be listed in this week and the potential announcement by FTSE Russell on a decision to add the Chinese bonds to its global benchmark, we see more interests being attracted to China's government bond market. In fact, over the last five years, the foreign percentage ownership has risen sharply from just 2.6% in Jan 2016 to the current 9.2%; and this is set to further increase going forward, in our view.

China's government bonds are integral part of the country's onshore bond market. Having an aggregate value of Rmb19trn, these bonds represented 17% of the total outstanding notional value of the market. Their issuance will also set a new annual record in 2020 - YTD, total amount of Rmb4.77trn has been issued and this is already 14.5% higher than the value issued in 2019. With the first China bond ETF in Singapore that invests purely in Chinese government bonds to be listed in this week and the potential announcement by FTSE Russell on a decision to add the Chinese bonds to its global benchmark, we see more interests being attracted to China's government bond market. In fact, over the last five years, the foreign percentage ownership has risen sharply from just 2.6% in Jan 2016 to the current 9.2%; and this is set to further increase going forward, in our view.

China Onshore Credit: Update on the China Government Bond Market

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The 2Q20 default figure of the onshore bond market is better than our expectation, pointing to a sustained resilience of credit quality that has not experienced severe impacts from COVID-19. In 2Q20, the default of non-financial credit bonds amounted to Rmb26bn, an increase of 5% YoY and 12.4% QoQ (excluding the distortion from the huge Founder Group default in 1Q20) which, in our view, is a manageable figure. The number of issuers that defaulted for the first time in 2Q20 has also dropped to 4 from 5 in 1Q20, though all of them are privately-owned enterprises.
By sector, the default in 2Q20 is diversified, with the top three being internet software and services (24%), conglomerate (22%) and oil &amp; gas &amp; energy (14%). Despite better-than-expected default figures in overall 1H20, we are still cautious that the worst in this round of default may yet to come. We remain concern on the retailing sector, but have become more skeptical on the exporter sector due to the weakened demand for consumer discretionary products from the developed economies which are still clouded by the pandemic.  
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The 2Q20 default figure of the onshore bond market is better than our expectation, pointing to a sustained resilience of credit quality that has not experienced severe impacts from COVID-19. In 2Q20, the default of non-financial credit bonds amounted to Rmb26bn, an increase of 5% YoY and 12.4% QoQ (excluding the distortion from the huge Founder Group default in 1Q20) which, in our view, is a manageable figure. The number of issuers that defaulted for the first time in 2Q20 has also dropped to 4 from 5 in 1Q20, though all of them are privately-owned enterprises.
By sector, the default in 2Q20 is diversified, with the top three being internet software and services (24%), conglomerate (22%) and oil &amp; gas &amp; energy (14%). Despite better-than-expected default figures in overall 1H20, we are still cautious that the worst in this round of default may yet to come. We remain concern on the retailing sector, but have become more skeptical on the exporter sector due to the weakened demand for consumer discretionary products from the developed economies which are still clouded by the pandemic.  


China Onshore Credit: Bravo! 2Q20 Default Figure Better than Expected

The issuance of onshore bond in China has actually accelerated YTD despite the COVID-19 outbreak, with total issuance increased 25% YoY. In particular, by proportion, the issuances of short-term commercial paper and corporate bonds have increased most significantly. The growth in new issue has supported a 15.4% YoY growth in the onshore bond market to a value of Rmb104.3trn.On the contrary, foreign investors' net increase in position in the market has slowed, with more significant increase in treasury bonds and net decline in negotiable certificate of deposits and enterprise bonds as they turned risk averse. We, however, see brighter outlook in the market for foreign investors. In our view, there are at least six recent factors that will drive their participation.

The issuance of onshore bond in China has actually accelerated YTD despite the COVID-19 outbreak, with total issuance increased 25% YoY. In particular, by proportion, the issuances of short-term commercial paper and corporate bonds have increased most significantly. The growth in new issue has supported a 15.4% YoY growth in the onshore bond market to a value of Rmb104.3trn.On the contrary, foreign investors' net increase in position in the market has slowed, with more significant increase in treasury bonds and net decline in negotiable certificate of deposits and enterprise bonds as they turned risk averse. We, however, see brighter outlook in the market for foreign investors. In our view, there are at least six recent factors that will drive their participation.

China Onshore Credit: How Has Foreign Investors' Position Changed and What Is the Outlook?

As suggested by the default figure in 1Q20, the credit quality of the onshore bond market seems to be holding up despite a slowdown in economy. The 1Q20 headline default figure of Rmb58bn for non-financial credit bonds are inflated by the default of Founder Group; and excluding this, it is better YoY and QoQ. The amount of new non-financial credit bond issuance also reached a high of Rmb3.5trn in the quarter, a 36.7% YoY increase and a 2.2% QoQ increase. The worst, nonetheless, does not look to have come already, in our view. We anticipate default will rise in the next two quarters on the aftermath of the COVID-19 outbreak. Private enterprises will continue to lead but potentially more local SOEs will come. By sector, property and retailing look to be more vulnerable and are needed to be watch out for.

As suggested by the default figure in 1Q20, the credit quality of the onshore bond market seems to be holding up despite a slowdown in economy. The 1Q20 headline default figure of Rmb58bn for non-financial credit bonds are inflated by the default of Founder Group; and excluding this, it is better YoY and QoQ. The amount of new non-financial credit bond issuance also reached a high of Rmb3.5trn in the quarter, a 36.7% YoY increase and a 2.2% QoQ increase. The worst, nonetheless, does not look to have come already, in our view. We anticipate default will rise in the next two quarters on the aftermath of the COVID-19 outbreak. Private enterprises will continue to lead but potentially more local SOEs will come. By sector, property and retailing look to be more vulnerable and are needed to be watch out for. 

China Onshore Credit: 1Q20 Default Aren't that Bad-Looking, But......