When the Shanghai Free Trade Zone (FTZ) was set up in 2013, it was touted as a bid to deliver economic reform. Just a few weeks into his role as premier, the late Li Keqiang spotlighted China’s pilot zone as a site for a new age of “opening up” five years on from the 2008 financial crisis.

“It is time to choose a new opening pilot and use opening up to promote reform,” he declared six months ahead of its launch. The zone’s primary functions were to attract more foreign direct investment, facilitate trade and give a boost to domestic industries. 

Covering nearly 11 square miles, the zone now comprises more than 50,000 companies. But in recent years it has become known for a different reason altogether: financialisation.

Following ministry of finance encouragement in 2017, local governments started to raise debt in FTZs. Over the past few years, FTZ bonds, also known as ‘pearl bonds’, have risen in popularity among local governments and companies — both foreign and domestic — to raise debt funding. For the most part, these bonds have been issued in the Shanghai FTZ.

In the first half of 2023, the issuance of these securities outpaced that previously seen in 2022, according to data compiled by Fitch Ratings, surging to RMB66.4bn ($9.3bn).

Market slowdown

Then came a government crackdown in May. The People’s Bank of China, the country’s central bank, required banks to stop purchasing FTZ bonds from issuers that have no actual business in the Shanghai FTZ, according to “window guidance” reported by Bloomberg. The article cited sources familiar with the matter. Typically, it has been Chinese banks that have bought up FTZ bonds.

Sherry Zhao, senior director of Asia-Pacific international public finance ratings at Fitch Ratings, says that now that companies and issuers have to have operations in the FTZ, the issuance of these securities has all but stopped. “These issuers are from all over China and so many of those who issued China FTZ bonds before the window guidance are no longer eligible,” she says.

“Once the Chinese government saw that this was booming and deemed that there weren’t sufficient regulations in place, they got cautious and virtually disbanded it,” she says. “It's possible that they will re-open it when it is better regulated, but for now, we don’t know if it’s going to be reviewed or not.”

Over the past few years, in addition to local governments, companies from the mainland and beyond have also raised debt through these channels. In 2021, Hong Kong-based CMB International became the first issuer of bonds not denominated in RMB in the Shanghai FTZ. Clifford Chance advised on this deal.

Angela Chan, partner at Clifford Chance, says that the success of China FTZ bonds demonstrates “what can develop in FTZs when the market conditions are ripe”.

“The primary driver of these bond issuances has been the cost of funding offshore,” Ms  Chan explains, adding that they “allow local governments and companies alternative access to onshore funding, but are less costly than offshore issuance”. 

Any company with the relevant bank or clearing accounts in the FTZ can issue bonds via these means. FTZ bonds are a means for issuers to access financing without the higher costs of listing offshore. Offshore bonds, otherwise known as ‘dim sum’ bonds, are RMB-denominated bonds that are not issued in mainland China, but typically in Hong Kong, and offer foreign investors exposure to the Chinese currency while getting around foreign exchange controls. By contrast, Chinese onshore bond issuance involves more government regulation as to how the money raised can be used.

“[FTZ bonds] are features of jurisdictions with capital and exchange controls,” notes Philippe Dirckx, head of fixed income at Asia Securities Industry & Financial Markets Association.

Like GIFT City, India’s first greenfield smart city, which also issues bonds, they tend to offer preferred access conditions to the domestic market and more flexibility for both offshore investors and onshore issuers, he says.

Now, Mr Dirckx says, the market for China FTZ bonds is “reassessing where to go from here, but one can expect that, in the medium term, quality issuers will remain attracted by the opportunities of the FTZ”.

Opportunistic entry

The uncertainty is not deterring issuers from further afield from entering the fray. In October, Singapore-based real estate investment company CapitaLand launched its inaugural RMB600m FTZ bonds through its China-focused trust. The Singapore government investment company Temasek owns roughly 15% of CapitaLand China Trust. 

As the first Singapore-based issuer to take this step, “this issuance is in line with our strategic objective of diversifying our debt opportunities for greater flexibility”, a spokesperson for CapitaLand tells fDi.

With current interest rates in Singapore higher than those in China, the freshly issued FTZ bonds provide the China-focused trust with “the opportunity to increase the proportion of its RMB-denominated loans to 20% with this bond issuance, while reducing its exposure to Singapore dollar-denominated loans”, the company says.

CapitaLand has been the only issuer of a China FTZ bond since May, according to data from the Singapore Exchange. The same data set shows that 2023 outstripped 2022. Though they are not required to by law, issuers can list their bond issuance on exchanges such as Macau or Singapore.

If domestic issuers have halted their issuance, will there be more non-mainland China based activity?

“It is hard to predict as issuers tend to be opportunistic,” says Mr Dirckx. “The interest rate differential, onshore investors’ appetite and market liquidity will be some of the key factors going forward.”

Renminbi internationalisation

Meanwhile, since the inception of this phenomenon, a lot has been made of how China FTZ bonds can contribute to the internationalisation of the Chinese currency.

“By providing a platform that reduces the impact of capital and foreign exchange controls, and allowing the [renminbi] to be treated in the FTZ as a ‘normal’ currency, acts as a bridge that could, in time, be broadened with the relaxation of the regulations,” Mr Dirckx says.

As FTZ bonds are often denominated in renminbi, such securities “do contribute to the internationalisation of the renminbi, albeit on a smaller scale when compared with the other debt products that are more popular”, says Ms Chan.

Meanwhile, for mainland Chinese issuers, such as local governments who wanted to raise money with more flexible financing, the recent crackdown will just mean that they look elsewhere for their financing needs.

“Now, these issuers will do as they did before 2022: they’ll issue bonds domestically and go to banks for financing. FTZ bonds were just a new funding channel so they can just return to traditional funding channels,” Ms Zhao says.

This article first appeared in the December 2023/January 2024 print edition of fDi Intelligence

Do you want more FDI stories delivered directly to your inbox? Subscribe to our newsletters.