Are Capital Controls Exacerbating Risk on Domestic Dollar Bond Market?

The Chinese government’s efforts to rein in capital outflows are spurring the expansion of a potentially risk-fraught market for dollar denominated bonds.

Figures from UBS Wealth Management indicate that domestic borrowers have raised a record-breaking $51.7 billion in dollar-denominated bonds so far in 2017.

While the authorities have restricted purchases of currency abroad by Chinese nationals, the State Administration of Foreign Exchange still permits them to buys dollars and park them in deposit accounts with domestic banks.

Data from Bloomberg shows that Chinese banks are purchasing roughly half of the country’s dollar bonds, while US-based money managers now account for just 7% of deals, as compared to 46% in 2014.

This cascade of dollars from domestic investors to bonds via Chinese banks could oftentimes be culminating in hazardous junk investments with inexperienced issuers.

Chinese banks have marked preference for state-controlled issuers, including asset management firms who are wont to channel funds towards risky high-yield investments supplied by local governments and property developers.

These include China Huarong Asset Management Co., whose sold over 60% of their latest three-year and five-year floating rate notes offer to Chinese banks.

On the other side of the equation Huarong has been busy buying up junk bonds from local property developers, recently acquiring $70 million of the 10-year notes offered by Country Garden Holdings Co. which are related beneath investment grade, alongside two other junk offerings.

Speaking to Bloomberg, Qiang Liao, senior director of financial institutions at S&P Global Ratings said that the junk bond issuers at the end of the investment chain have meagre experience with hedging currency risk.

Should the Renminbi see a sharp decline, these borrowers could struggle to service their dollar debts.

Bloomberg puts the volume of dollar denominated junk bond offerings at $12.7 thus far this year, for a mammoth year-on-year increase compared to the figure of $1.9 billion during the same period in 2016.

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