China Opens Currency Derivatives to Lure Overseas Bond Investors

China is giving overseas investors access to its foreign-exchange derivatives market to allow hedging of bond positions, in the latest bid to attract inflows.

Foreign institutions that invest in the interbank bond market can trade products including forwards, swaps, cross-currency swaps and options with domestic settlement agents, the State Administration of Foreign Exchange said in a statement posted on its website Monday. Access is limited to the hedging needs of private-sector investors’ onshore bond positions, the regulator said.

The People’s Bank of China opened the interbank bond market to foreign institutional investors last year to attract long-term inflows amid a weakening currency and a flight of capital. Ma Jun, chief economist at the research bureau of the People’s Bank of China, said last week that regulators were taking steps to further open the bond market to boost the chance of inclusion in global bond indexes. Monday’s announcement is a “significant” development in market liberalization, Goldman Sachs Group Inc. said in a research note.

“The opening up is bolder than most had been expecting, as there is no specific restrictions on the notional amount of FX exposure,” said Becky Liu, Hong Kong-based head of China macro strategy at Standard Chartered Plc. “We expect this move to invite strong capital inflows into China’s onshore bond market, and it could lead to a narrowing of China’s capital outflows in the months ahead.”

The measure addressed one of the main concerns that investors had around China’s bond market, given the volatile offshore yuan market, analysts led by Danny Suwanapruti at Goldman Sachs wrote in a note published Tuesday. Several more steps need to be taken, such as market access, liquidity, reporting rules, settlement dates and clarification on the taxation of non-residents, they said.

Overseas investors held 852.6 billion yuan ($124 billion) of onshore bonds at the end of last year, or 1.5 percent of the 56.3 trillion yuan market, which is the world’s third largest. Foreign inflows are likely to accelerate this year to 980 billion-1 trillion yuan, according to Standard Chartered.