Plenty of questions have been raised and subsequently answered about the development of yuan-denominated bonds in Hong Kong.

Is there good reason for issuing yuan-denominated bonds? Yes.

They will permit Hong Kong banks to participate in the development of the SAR as a major trading center in the mainland currency.

Is there good reason for Beijing to allow yuan bonds to be sold in the SAR? Yes.

China wants to internationalize its currency and to stave off pressures to revaluate the yuan in light of the country's present fiscal surplus.

Is there room for growth in yuan bonds across Asian markets? Yes.

National fixed interest markets in Asia tend to be worth around 70 percent of gross domestic product, and even less in China. By comparison, in the US and Europe, the rate is at least 100 percent of GDP.

Still, there is a key question that has yet to be fully considered amid all the hyperbole.

Do yuan bonds have a long term future as an investment choice for Hong Kong investors, who typically tend to favor deposits and direct investment in the local stock market?

Since Beijing announced that financial institutions would be permitted to sell yuan bonds in Hong Kong, three banks have jumped in.

China Construction Bank (CCB), HSBC and Bank of East Asia have issued 9 billion yuan in bonds. The response by investors has been impressive.

According to CCB, its 2 billion yuan issue was twice oversubscribed, with three quarters of the allocation going to retail investors. However, this does not necessarily mean the bonds as an asset class will have medium- or long-term appeal for investors.

After all, the daily turnover of the Hang Seng Index rarely falls below HK$20 billion on any given day.

Furthermore, the most recent estimate put yuan deposits in the SAR at about HK$53 billion. Even if all those depositors switched to yuan bonds, it would not create a significant market even from the local perspective.

Another barrier to the development of yuan bonds is the low coupon rate they offer relative to corporate issues.

VAM Funds, which has recently launched an Asian corporate bond portfolio investment managed by Hong Kong's Enhanced Investment Products, says it can find yields above 6 percent in the Asian corporate bond market. Indeed, this quantitative investment fund will only invest in corporate bond issues yielding at least 4 percent.

Although the 2.5 to 3 percent currently on offer to Hong Kong investors for yuan bonds looks appealing against deposit rates, it cannot match the corporate sector if VAM is to be believed.

In short, there is likely to be a prosperous long-term future for yuan bonds in a broad context, but in the short- to medium-term the appetite for the asset class is not at all certain.

The author is a financial affairs commentator

(HK Edition 08/26/2009 page1)