Photographer: Qilai Shen/Bloomberg

So Far, So Good for China's Bond Connect

  • Value Partners sees risk-reward potential on short-dated notes
  • Inflows could top one trillion yuan in 2H, analysts say

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The new avenue for foreign investors to buy into China’s domestic market is proving its worth little more than a week after starting up, with onshore borrowers even using it to complement their funding.

The Bond Connect that allows purchases of Chinese bonds in Hong Kong kicked off on July 3 with 7 billion yuan ($1 billion) of trading, according to the central bank. While bond yields in developed markets have been rising in recent weeks amid a hawkish shift in central bank rhetoric, returns on Chinese yuan debt are higher -- and with the exchange rate stable, that’s proving a lure for some foreign investors.

“We saw deals that offered good risk-reward potential on the launch day of Bond Connect, and placed our money on short-dated paper from reputable bank issuers -- it’s a good alternative to our cash holdings,” said Gordon Ip, head of fixed income at Hong Kong-based Value Partners Group Ltd. “China’s onshore bond market is a big market with great potential, and we’d like to stay relevant to it since day one.”

Several Chinese issuers received overseas orders for bonds since the connect was established, according to market participants:

  • Agricultural Development Bank of China’s 16 billion yuan of securities issued on July 3 saw record bid-to-cover ratios of around 10 times for all three tranches, with Bond Connect orders boosting those totals.
  • China Development Bank Corp. followed, saying its 20 billion yuan of issuance got around 10 billion yuan in offshore orders. 
  • Corporate issuers have also seen demand through Bond Connect, with China Huaneng Group, China Three Gorges Corp., China United Network Communications Corp., Aluminum Corp. of China Ltd. and State Power Investment Corp. all getting offshore orders for issues.

While the PBOC hasn’t published data on purchases or turnover through the Bond Connect since the first day, the transactions are seen swelling in time as foreign investors become comfortable with Chinese bonds.

The bigger goal for China is inclusion of its debt in benchmark global indexes -- read about that here.

Analysts at banks including Goldman Sachs Group Inc. estimate that index inclusion could usher $250 billion or more of passive investment into an onshore bond market now valued around the equivalent of $9.8 trillion. Bullish short-term calls for inflows include estimates from ICBC International Holdings Ltd. and Standard Chartered Plc indicating around 1 trillion yuan of new investment in the second half of 2017 via Bond Connect.

Onshore bonds could be all the more attractive if the yuan stays stable -- the currency has risen more than 2 percent against the dollar this year. By contrast, the dynamic has made Chinese dollar bonds potentially less desired.

The Bond Connect is designed to bring more convenience to foreign investors at the operational level by using familiar trading interfaces of established electronic platforms, without having to register on the mainland. With foreign ownership of the world’s third largest bond market at less than 2 percent, there’s a long way to go. For one thing, the high cost of foreign-exchange hedging will limit demand, observers say.

Inflows on the order of $200 to $300 billion “could take years to materialize depending on the timing of the inclusions and investors’ views on the market,” according to a July 10 report by UBS AG Wealth Management. “We expect foreign investors to look mainly at government and financial bonds during this early stage,” it said.

— With assistance by Carrie Hong, Jing Zhao, Ling Zeng, and Xize Kang

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