Appetite for dim sum bonds growing

NEW YORK (CNNMoney) -- Dim sum bonds may sound like something on a Chinese brunch menu, but they're actually one of the hottest investments to come out of the world's second-largest economy.

In fact, total issuance for these bonds, issued in the Chinese yuan, reached nearly $14 billion last year, as 84 companies and government institutions jumped into the fray, according to Dealogic.

That's already more than the combined total issued since the bonds debuted in 2007. And so far this year, issuance has already topped $1 billion.

The so-called dim sum bond market really began to take off in mid-2010, after the People's Bank of China loosened its grip on the yuan by unpegging it from the dollar and lifting trading restrictions that led to offshore yuan trading in Hong Kong.

Though China still maintains control of its currency, experts say the policy shift was a necessary step to eventually allow the yuan to float freely and have financial markets set its value, potentially making China less reliant on the U.S. dollar.

"China's decision to allow its mainland currency to trade offshore was a real turning point for the dim sum bond market," said Edmund Harriss, manager of the Guinness Atkinson Renminbi Yuan and Bond Fund (GARBX). "It led to a growth of yuan deposits in Hong Kong, and served as an impetus to find an instrument where that idle cash could be invested."

Harriss launched his fund last June to capitalize on the growth. Similarly, Guggenheim Investments introduced the Guggenheim Yuan Bond ETF (RMB) in September, while Van Eck Global followed with the Market Vectors Renminbi Bond ETF (CHLC) in October and Invesco PowerShares launched thePowerShares Chinese Yuan Dim Sum Bond ETF (DSUM) in November.

Emerging markets have their mojo back

For Chinese companies, the dim sum bond market allows them to borrow yuan at relatively lower yields in Hong Kong and remit them back home.

And for multinationals like McDonald's (MCD, Fortune 500), Caterpillar (CAT, Fortune 500), Yum! Brands (YUM, Fortune 500), British consumer goods company Unilever (UN) and Mexico's America Movil (AMX), dim sum bonds help cut borrowing costs. Companies can directly borrow in yuan to fund their Chinese business operations, while also hedging against the yuan's rise against the dollar.

There aren't exactly a slew of companies clamoring for dim sum bonds just yet, given the low borrowing rates in the United States. But those that have major business operations in China are more likely to give them a try, especially as the market matures and liquidity grows, said Harriss.

That may be sooner rather than later, says Axel Merk, president of Merk Mutual Funds, a Palo Alto, Calif.-based money manager specializing in currency investments.

"A lot of Asia is financing debt in U.S. dollars, but not from U.S. banks," said Merk. "European banks serve as the biggest funding source for emerging markets, and they're facing some challenges right now."

Amid fears that lending in Europe is drying up, China's fixed income market could develop even more quickly, he added.

But it has a long way to go. The dim sum bond market is only 0.08% the size of the U.S. bond market, making it more susceptible to market shocks.

And while China is moving in the right direction with its policies, it still maintains rigid control and it will likely take years for its capital markets to be fully developed, said Harriss.

"Its entire banking system is funded by deposits," said Harriss. "As long as the deposit space is secure, China's banking system is secure. That's why China is still wary about how money moves in and out of its borders."

Because of China's control and limits on the flow of its currency between onshore and offshore markets, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) crafted measures to help protect banks and their clients making transactions in offshore yuan.

The new guidelines include a mechanism that would allow banks to settle their transactions in U.S. dollars in the event that the offshore yuan market collapses.