Signs of life are returning to the Shanghai free-trade zone’s (FTZ) bond market, which had largely gone quiet in late 2023 following a concerted effort by Chinese authorities to curb excessive borrowing by local governments. This revival is underscored by Shanghai Electric Group Co., an energy equipment maker backed by the municipality, which began marketing so-called pearl bonds on Wednesday. This issuance marks the first bond sale in almost three years by a non-financial company, signaling a cautious reopening of the market under a new regime of tighter rules for both issuers and investors.
Policymakers Balance Opening with Stability
Chinese policymakers are actively encouraging companies to issue more yuan-denominated bonds offshore through various mechanisms, including the FTZ. However, this push for greater financial opening is carefully balanced with measures designed to prevent a risky buildup of debt. In recent months, the government has taken steps such as discouraging firms from raising money at higher yields, extending approval times for overseas borrowing proposals, and restricting the use of certain popular loan structures.
Lei Zhu, head of Asian fixed income at Fidelity International, characterized the market’s trajectory, stating, “The 2023 pause in FTZ offshore bond issuance is a good example” of “China’s open-tighten-reopen cycle.” Zhu further elaborated on the underlying policy direction: “The overall direction toward greater financial opening has remained largely unchanged, but policymakers adjusted the pace when financial stability risks began to build.” This perspective highlights Beijing’s pragmatic approach to financial liberalization, prioritizing stability while gradually expanding market access.
From Popular Avenue to Regulatory Halt
Established in 2013, the Shanghai FTZ was initially designed to allow both domestic and foreign companies to sell offshore bonds in any currency. Over time, however, the market became predominantly characterized by yuan-denominated debt. By 2023, the FTZ had evolved into a particularly popular avenue for local government financing vehicles (LGFVs) — entities often burdened with significant debt — to raise capital. This surge in LGFV activity ultimately prompted regulators to intervene, halting purchases of pearl bonds by domestic banks to mitigate systemic risk.
Market Resumption and Modest Growth
Following the regulatory pause, banks and securities firms were permitted to resume using the pearl bond market last year after officials lifted the restrictions. Data compiled by Bloomberg indicates a notable increase in activity, with year-to-date issuance surging to more than five times what it was last year over the same period. Despite this significant percentage increase, the total sales have amounted to $512 million, which remains a fraction of the market’s potential, given its previous size of $19 billion.
For international investors, pearl bonds offer a degree of reassurance. Fidelity’s Zhu noted that the market is fully regulated by onshore Chinese authorities, who permit only high-quality issuers. This regulatory oversight is particularly important for offshore investors, many of whom have experienced a wave of property-sector defaults in recent years, making the emphasis on issuer quality a key differentiator for pearl bonds.
Broader Capital Market Opening
The revival in the Shanghai FTZ bond market is not an isolated event but rather part of broader indications that China’s efforts to open its capital markets are yielding results. Issuance of dim-sum bonds, which are yuan-denominated bonds sold outside mainland China, has reached a year-to-date record. Similarly, offshore bond sales by Chinese companies linked to the Shanghai Clearing House have also risen. Furthermore, Panda bonds, utilized by foreign entities to sell yuan bonds in mainland China, have reached a new high this year, collectively pointing to an expanding landscape for yuan-denominated debt instruments across various international and domestic platforms.
Shanghai Electric’s Pioneering Issuance
Shanghai Electric Group Co.’s new debt offering is its first offshore bond sale since 2020. The company, which saw its credit rating upgraded by Moody’s to A3 with a stable outlook in June, is structuring this issuance to comply with the new FTZ rules. The three-year notes are being sold through its overseas subsidiary and will be guaranteed by the company’s Hong Kong subsidiary. Additionally, the offering is supported by a keepwell deed from Shanghai Electric Group, providing an extra layer of comfort for investors. Initial price guidance for these notes has been set around 2.4%, according to a person familiar with the matter.
This issuance by Shanghai Electric is a critical test case for the revitalized market, demonstrating how Chinese authorities are attempting to foster offshore yuan bond issuance while maintaining stringent controls over debt accumulation. The measured reopening reflects a strategic balancing act, aiming to enhance financial openness without compromising the stability that policymakers have worked to restore after the challenges of the past year.
