Finance

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Unlike Hong Kong's stock-trading links with Shanghai and Shenzhen, the bond connect between the former British colony and China may not be as slow to gain traction.

The People's Bank of China and the Hong Kong Monetary Authority this week unveiled plans to establish a mutual access program between the mainland and Hong Kong bond markets. Details on timing have yet to be announced but there's speculation it could start on July 1, the 20th anniversary of Hong Kong's handover.

China opened its interbank bond market, where more than 90 percent of notes are traded, to overseas fund managers in February last year. The bond connect goes one step further, allowing global institutional investors the ability to bypass onshore mainland licenses and trade via Hong Kong. As HSBC Holdings Plc notes, foreign investors who go through Hong Kong won't have to deal with mainland trade-settlement procedures, which are "relatively tedious."

Brighter Outlook
The yuan has appreciated 0.8 percent against the U.S. dollar this year, arresting last year's slide
Source: Bloomberg

Easier access to the world's third-largest bond market may be one answer to ultra-low yields elsewhere. With default rates expected to increase, the extra yield on AA-rated company bonds due in five years over similar-maturity government securities rose to the highest since 2015 this month.

Investors aren't seeing it quite that way just yet: Foreign ownership of Chinese debentures is about 1.78 percent despite last year's opening.

Offshore Appetite
Foreign holdings of Chinese onshore notes totaled 830 billion yuan, or about $120 billion, in March
Source: Bloomberg

If China allows foreign-owned firms to provide credit ratings by July 16, the mood may change. The average yield on five-year AAA-rated corporate securities has risen 104 basis points this year to 4.999 percent. Similarly scored notes in Asia pay 2.903 percent.  Furthermore, the yuan has appreciated 0.8 percent against the U.S. dollar this year after depreciating 6.5 percent in 2016, adding to the allure of Chinese paper.

Worth the Risk?
AAA-rated dollar bonds in Asia pay about 2.9 percent, versus almost 5 percent for five-year corporate notes in China
Source: Bloomberg

China would be a winner, too.

Opening its bond market further increases the chance notes may gain entry into some of the world's most important fixed-income indices. According to Goldman Sachs Group Inc., if bonds from China were included in three key benchmarks , the country would see inflows of about $250 billion, helping to offset foreign-exchange outflows that have been around $10 billion to $20 billion a month.

Of course, the math isn't that simple. Assuming the bond connect works in a closed loop, in the same way the Shanghai and Shenzhen stock-connect programs via Hong Kong operate, investors will always buy or sell in the currency they started off with.

More broadly, though, it is a way to counter outflows, as bond fund mangers pour in billions in the search for yield. For international investors -- and China -- this could be win-win.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Retail and short-term funds are excluded.

  2. Not taking into account currency differences.

  3. Namely, JPMorgan's GBI-EM Global Diversified Index, Citigroup's World Government Bond Index and the Bloomberg Barclays Global Aggregate Index.

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net