Bond Connect: 90 days and beyond
A full quarter has elapsed since Bond Connect was launched, and the mood remains confident.
Regional Head of Securities Services for Greater China and Northeast Asia
Despite its tight implementation time-frame last summer, Bond Connect, the access channel between the Hong Kong and Chinese financial markets, linking international investors with the $9 trillion China Interbank Bond Market (CIBM), is fast becoming a popular entry point for investors looking to grow their China exposures.
According to Standard Chartered data, 140 foreign investors were registered to use Bond Connect on the first day alone, and this now stands at 200, with a weekly trading turnover regularly surpassing Rmb16 billion.1 Early figures indicate that foreign investors have increased their Chinese bond exposures by Rmb37.8 billion in July 2017, bringing total holdings to Rmb841.5 billion. While these inflows were the highest since September 2016, we also see that the bulk of this capital was derived from returning Chinese investors leveraging on Bond Connect.2
Many of our major institutional clients are enthusiastically embracing Bond Connect, attracted principally by the strong yields on offer in China’s fixed income market and the absence of investment quotas relative to other access schemes.
“Bond Connect’s launch in Hong Kong was very high profile, and many offshore investors wanted access to China’s fixed income market. As a business, we were keen on being among the first international investors to leverage it, because of the yield opportunities in China, and this is obviously good for our end-clients,” said Gordon Tsui, head of fixed income at Taikang Asset Management (Hong Kong).
Favourable macro conditions are not the only factors in Bond Connect’s growing popularity. Bond Connect – when benchmarked against Stock Connect – was at a more advanced stage of readiness at inception, while domestic Chinese regulators have become increasingly proficient at navigating and implementing market reform policies, having acquired valuable experience in the preceding few years.
“Bond Connect is appealing because the application and registration process is simple, and there are no quotas under Bond Connect as there are with QFII,” said Endre Pedersen, Chief Investment Officer at Manulife Asset Management.
Let’s take a look at some of the reasons why Bond Connect is in an excellent position to drive inbound flows over the coming months.
A regulatory position of strength
In keeping with previous launches (such as the CIBM Direct mechanism in 2016), domestic regulators in China have shown unparalleled levels of engagement and focus throughout the launch phase.
The People’s Bank of China confirmed to the market ahead of Bond Connect’s inauguration that transactions would settle on a T+2 cycle as opposed to the hybrid T+0/T+1 deployed when the Stock Connect launched. This key development has helped to make the mechanism extremely appealing to international investors, in particular, those in North America, who face significant time zone limitations when faced with a T+0 settlement cycle.
It was also confirmed that real-time Delivery Versus Payment for both Chinese bond depositories will be introduced to Bond Connect later in 20173 in what will be a crucial step towards attracting heavily regulated foreign investors such as UCITS, insurers and pension funds to the Chinese market. This is a major step in ensuring global usability of Bond Connect within 2017.
In addition to sensible post-trade mechanisms, Bond Connect set-up processes are far more streamlined than alternative onshore access channels like CIBM, a point made by Standard Chartered clients such as Manulife Asset Management and Taikang Asset Management. Transitioning to Bond Connect is simple because clients can use their Hong Kong-based custodian provider instead of having to appoint a mainland bank, meaning that on-boarding can typically be finalized in under two weeks.
“Getting set up on Bond Connect is very simple and firms just need to approach their offshore custodian provider – such as Standard Chartered – and from there they can start trading onshore Chinese bonds,” said Tsui.
As onshore access is facilitated through offshore infrastructure, investors are able to benefit from the familiarity and scale of the Hong Kong market. “The Hong Kong legal set-up is a strong selling point, and it is appreciated by large investors such as insurance companies and pension funds from North America and Europe,” commented Edgar Gehringer, Head of Operations at Manulife Asset Management.
Applying the finishing touches
Further improvements and clarifications are still needed to be made to Bond Connect. While onshore FX hedging tools and the associated cost benefits have been well-received by clients, constraints do still exist. For example, restrictions around interest-rate hedging remain and Pedersen said he hoped such curbs would be rescinded soon. However, it is anticipated that interest rate swaps and repo transactions will be permitted from 2018.4
The continued application of capital controls remains a challenge for foreign investors in China, a point made by Manulife Asset Management, which expressed concerns that any inability or checks on repatriating funds could present liquidity challenges. “Investors want assurances that capital flowing through access channels such as Bond Connect can be repatriated in the event of volatility, and this is something the regulator needs to clarify,” said Gehringer.
The next 90 days
Client sentiment towards Bond Connect is universally positive, with many institutions using the scheme as an instrument to further consolidate their China access and complement existing investment strategies. “Bond Connect is one of many China initiatives, and it is very important to our overall China strategy. As an asset manager, we want multiple doorways into China as we feel this will benefit our investors. China is a massive market, and the opportunities are abundant,” said Gehringer.
A wave of money is likely to enter China throughout 2018, as a result of various index upgrades. The widely anticipated inclusion of Chinese A-Shares on the MSCI Emerging Markets Index in summer 2017 will facilitate passive A-share flows over the course of 2018, as will the addition of Chinese bonds to indices operated by Citi, Bloomberg, Barclays and JP Morgan.
As RMB internationalization and China access becomes a bigger and better proposition for clients, Standard Chartered is confident that foreign investors will increasingly test the waters through schemes such as Bond Connect. The past 90 days have been quite a pleasant journey to-date, but this is certainly only just the beginning of greater things to come.
1 Global Custodian – October 23, 2017 – Improving access to China’s capital markets
2 Reuters – August 3, 2017 – Foreign Holdings of Chinese Debt up in July, Bond Connect impact limited
3 Global Custodian – October 23, 2017 – Improving access to China’s capital markets
4 Global Custodian – October 23, 2017 – Improving access to China’s capital markets
About the Author
Barnaby Nelson is Regional Head of Securities Services for Greater China and Northeast Asia, for Transaction Banking at Standard Chartered. In this role, he leads the end-to-end delivery of Standard Chartered Securities Services proposition in several of the bank’s largest custody businesses across product development, sales, client servicing and operations.
Barnaby is also responsible for driving the business agenda among institutional investor and financial intermediary clients across North East Asia and Greater China, with a focus on supporting clients’ growth aspirations across Asia, Africa and the Middle East. Barnaby joined the bank from BNP Paribas, where he was Head of Client Development - Asia for the Securities Services division. Prior to this, he worked as Business Owner for Thomson Reuters’ information and market data feeds in Asia-Pacific.
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