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HSBC's Q&A on China's interbank bond market

Relaxed rules for qualified foreign institutional investors in China have brought new questions to the fore.

Last Friday, the China securities Regulatory Commission (CSRC) relaxed rules for Qualified Foreign Institutional Investors (QFII) in order to attract overseas investment. The revised regulation lowers the QFII threshold for investors, lets them invest directly in the interbank bond market through more than one securities dealer, and raises investors’ combined maximum stake in listed A-share companies from 20% to 30%. Since the announcement, the CSRC has released a circular detailing some of the consequences of the revised rules, but there is yet to be a corresponding document from the People’s Bank of China (PBoC).

Following the announcement, HSBC’s fixed income research team has endeavoured to answer some of the queries on the interbank bond market:

How many different bond markets are there in China?

Bonds are traded in three markets: the interbank market, the exchange market and the over-the-counter (OTC) market. The latter is targeted solely at retail investors and tends to see very little liquidity. Certain banks are required to provide bond quotes for this market. 94% of all bonds traded in China are deposited with the interbank custodian, 3% with the exchange market custodian, and 2% in the OTC market. The remaining 3% represent privately-placed bonds that are not listed

What is the current composition of China’s bond market?

34% of outstanding bonds in China are government bonds, 33% are policy bank bonds, 10% are medium-term notes, 9% are enterprise bonds, and 7% are PBoC bills. The rest is made up of commercial bank bonds, commercial paper, etc. Within the policy bank bonds category, about 70% are issued by the China Development Bank. Policy bank bonds are quasi-sovereign bonds issued by the China Development Bank, the Export-Import Development Bank of China and the Agricultural Development Bank of China. Bonds issued by these three entities have explicit state guarantee. Medium-term notes are bonds issued by large corporates and approved by the People’s Bank of China (PBoC). This is different from enterprise bonds, which are approved by the National Development and Reform Commission (NDRC).

 
 Source: HSBC

Which are the most liquid bonds in the interbank market?

The trading volume is highest for policy bank bonds, with an average daily volume of CNY88bn in June 2012. Medium-term notes are next, with an average daily volume of CNY60bn in the same month. Enterprise bonds (CNY42bn), PBoC bills (CNY38bn) and government bonds (CNY37bn) rank third, fourth and fifth, respectively.  

Who are the big players in the bond market?

Commercial banks hold two-thirds of outstanding government bonds, a similar proportion of outstanding medium-term notes, and four-fifths of outstanding policy bank bonds (Figure 6). One-third of enterprise bonds are held by insurance companies. Which bonds can be found in both the interbank market and the exchange market? Government, both central and local, bonds can be found in both markets. About one-third of all enterprise bonds (not medium-term notes) can also be found in both markets.

Which entities are not allowed into the interbank market?

All legal entities in China or permitted offshore institutions are allowed into the interbank market. Retail investors are, however, not allowed into the interbank market.

Are there arbitrage opportunities between the interbank market and the exchange market?

Theoretically, there are arbitrage opportunities. However, practically, the procedure to do so can be cumbersome. As the custodians for the two markets are different, investors will have to transfer their bond from one custodian to another before they can take advantage of the price difference. The wider bid-ask spread that typically prevails in the exchange market and the funding cost of transferring (it takes 1-3 working days to transfer) will also have to be taken into account.
Who are the custodians for the interbank market and the exchange market?

The China Central Depository and Clearing Corporation (CCDC) and the Shanghai Clearing House (SCH) are the custodians for the interbank market, while the China Securities Depository and Clearing Corporation (CSDCC) is the custodian for the exchange market.
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