A bond-trading link between mainland China and Hong Kong opened on July 3, a symbolic date coinciding with the 20th anniversary of the city’s handover. The latest channel into China’s 66 trillion yuan ($9.7 trillion) bond market offers the most efficient access point for foreigners and marks another effort by the nation to open up. While analysts see huge potential for an increase in overseas holdings of Chinese bonds, they caution that the new program doesn’t guarantee a jump in investments, a lesson learned from similar initiatives in cross-border stock trading.
1. What’s the purpose of the new link?
China has the world’s third-largest debt market, behind the U.S. and Japan, but foreign holdings amount to less than 1.5 percent. That’s even after the People’s Bank of China opened interbank trading, which is 90 percent of the market, to most types of investors last year. Offshore traders bought just 101 billion yuan of onshore notes in 2016, a tiny fraction of the total volume. Authorities in Beijing, hungry for more inflows, authorized the bond connect’s opening -- though it’s notable that unlike two existing stock connect systems the new one only goes in one direction, from Hong Kong to the north.
2. Why’s that?
To ensure that money comes in rather than goes out. Chinese investors are hungry for offshore assets given concerns about the yuan’s depreciation, and both the stock connect programs and a separate cross-border system for buying mutual funds have seen more money leaving the mainland than being brought onshore. That’s something regulators are trying to contain.
3. Why might the new link be more successful?
It helps that it’s not based in mainland China. The new program allows global investors to trade out of Hong Kong without going through most of the approval procedures required on the mainland. What’s more, it makes use of the well-developed infrastructure in Hong Kong and lets traders complete transactions through settlement accounts in the city, a more familiar environment to global asset managers.
4. How will it work?
Overseas institutions can bid in the primary market and trade sovereign, local government, central bank, financial institution and corporate bonds, as well as certificates of deposit and asset-backed securities in the secondary market. They can either use yuan they already own or open a specialized account at a yuan settlement or clearing bank in Hong Kong to change currencies. Investors must bid a minimum amount of 1 million yuan. Trading hours are 9 a.m. to 12 p.m. and 1:30 p.m. to 4:30 p.m. on days when both markets are open.
5. Why have previous programs failed to attract much buying?
Partly because of red tape. The Qualified Foreign Institutional Investor programs require a license from the China Securities Regulatory Commission as well as a quota from the State Administration of Foreign Exchange. If an investor wants to trade in the interbank bond market, they’ll need to make additional filings. Even when that’s done, there are lock-up periods aimed at preventing speculative short-term trading. While the PBOC’s less complicated procedures don’t have quotas or lock-up times, it takes at least two months to complete the registration process, and may also mean additional mainland staff or new local offices.
6. Will the new program mean more money flowing into China?
While the bond link will likely be the best channel for foreign investors, actual investment decisions are based on the appeal of Chinese bonds. The yield on 10-year government notes, at about 3.6 percent, is the highest among biggest economies. But the unpredictability of government policies -- such as a deleveraging campaign that has led to a bond market rout -- could keep investors away. The cost and complexity of currency hedging amid concerns about yuan depreciation is another factor that may make potential buyers wary.
The Reference Shelf
- Bloomberg’s story on the announcement of the bond-connect program, and the PBOC’s statement.
- QuickTake Q&As on China’s links to its Shanghai and Shenzhen stock exchanges, and its seal of approval from MSCI Inc.
- Management regulation, including FX arrangement, and National Interbank Funding Center’s trading rules.
- A scorecard of China’s toolkit to manage monetary policy.
- A survey on potential inflows.
— With assistance by Helen Sun