Using Silk Road bonds as a funding vehicle for the vast capital needs of the One Belt, One Road (OBOR) project appears a handy catchall subsuming devilish details. Fast-track development of this product is at the top of the wish list of China’s leading credit agency, Dagong Global Credit Rating.
The agency is working with the International Capital Markets Association, which has established a panel to debate the concept and attempt to establish a framework to underpin what might well prove to be one of the most conspicuous new asset classes to emerge since green bonds went mainstream a few years ago.
However, the preference of Chinese financial authorities for the instruments to be denominated in renminbi might hamper growth of the Silk Road bond sector. Renminbi denomination presents significant foreign exchange risk for asset managers on an unhedged basis and hedging costs for those who seek to mitigate that risk.
This is not to say that there isn’t a depth of liquidity in the renminbi market that would be able to support Silk Road issuance from, for example, sovereigns that are in the OBOR zone and might seek to issue Panda bonds—renminbi issuance from outside China—to fund associated infrastructure projects. But given the vast capital needs of OBOR, it would be rational to open the Silk Road brand to issuance in a variety of currencies (particularly the US dollar, given that much of international project finance is priced in dollar terms).
A $3.55 billion offering from Bank of China in 2015 suggests that this might turn out to be the case. The bank issued debt in four currencies under the Silk Road brand with the stated intention of on-lending the proceeds to OBOR projects. That same year, China Construction Bank branded a two-year renminbi bond under the Silk Road label. In recognition of what appears to be the genesis of a mammoth new primary and secondary debt market, Dagong has been pushing for the establishment of an Internet trading platform for Silk Road bonds, standardized ratings criteria and a stand-alone settlement system.
Meanwhile, further momentum was established for the potential of Silk Road bonds last December, when Guangzhou Silk Road Investment placed $200 million of five-year paper, largely to Asian investors.
While the emergence of a Silk Road bond market as a burgeoning asset class might have excited a large number of market players, the reality is that the instrument is less than ideally suited to the vagaries of project finance. Cash flows need to be tailored to meet the cost of servicing regular bond coupons during construction—when revenue is nonexistent for a prolonged period—as well as project milestones.
This is where multilateral development banks such as the Asian Infrastructure Investment Bank and the Asian Development Bank come in: to sweeten the investment proposition on OBOR-related project bonds with credit wraps and guarantees. If this helps propel Silk Road bonds to the upper reaches of the ratings curve, the momentum of this emerging new asset class could be forceful indeed.