The People’s Bank of China (PBoC), the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange jointly published draft rules on Wednesday evening, in a bid to bring more medium-to-long term foreign institutional investors to the Rmb108tr ($15.8tr) onshore bond market. The proposals are open for feedback until October 1.
The proposed measures are partly designed to clarify the custody and clearing of bonds in the interbank market, outlining clear requirements for custodian banks — and other firms providing market infrastructure services — to submit registration, trading, custody and clearing data to the PBoC. But the regulators have also eased the regulatory burden for foreign players.
Offshore investors in the interbank market, including those in Hong Kong, Macau and Taiwan, no longer need regulatory approval for each of their funds that invests in Chinese bonds. Instead, they need only register once at the parent level, allowing them to use that registration for each sub-fund.
The new rules apply to a wide range of investors: central banks, supranationals and sovereign wealth funds; financial institutions including commercial banks and insurers; securities companies, fund managers, futures companies and trust firms, and other mid-to-long term investors, including pension funds.
The regulators have also taken further steps to bring the interbank and exchange markets together. Under the new rules, investors that have already entered the interbank market will also be allowed to invest in bonds traded in the separate exchange market directly or through the connected market infrastructures, without having to apply for access separately.
According to the PBoC, there were nearly 900 foreign institutions from over 60 countries in the interbank market by the end of the first half.
Connecting markets
In July, the PBoC and the CSRC agreed to link the infrastructure — including the clearing, depository and settlement institutions as well as electronic trading platforms — of the interbank and exchange markets. That is a big step for a market that has long been defined by regulatory in-fighting.
In 2019, the CSRC said it was looking into possible channels for more non-Chinese capital to access exchange-traded bonds.
Foreign institutions have four main channels to access the onshore debt market — qualified foreign institutional investor (QFII), renminbi qualified foreign institutional investor (RQFII), CIBM Direct and Bond Connect. Investors under the QFII/RQFII schemes are already allowed to trade both interbank and exchange bonds, but those investing through Bond Connect and CIBM Direct currently have access only to the interbank market.
It is understood that Bond Connect and CIBM Direct investors will also enjoy exchange market access following the implementation of the new rules.
By the end of July, 461 investors participated in the Chinese bond market through CIBM Direct, and 574 via the Bond Connect scheme, according to the China Foreign Exchange Trading System and National Interbank Funding Center.
Limited appeal
The relaxation plans come after foreign holding in Chinese bonds hit Rmb2.34tr by the end of July after 20 consecutive months of increase, according to data from the China Central Depository & Clearing Co. The monthly jump, Rmb148.1bn, was the highest since September 2017. Institutions overseas have also been more actively using the Bond Connect channel, with Rmb446.9bn of turnover in July, including Rmb75.5bn of net buying — also a monthly record.
But the new rule may have limited appeal to offshore investors. For starters, the size of the exchange market is only a fraction of that of the interbank market — by the end of 2019, interbank bonds accounted for over 87% of the total outstanding volume onshore.
There is also more secondary activity in the interbank market, where around 90% of all onshore bonds are traded. Latest data from the PBoC suggested that in July, the average daily turnover in the interbank bond market was Rmb1.15tr, versus Rmb88.6bn for its exchange counterpart.
Moreover, foreign participation onshore is also concentrated in the ‘safer’ products, such as Chinese central government bonds (CGBs) and issuance from the policy banks. PBoC data showed that foreign holding accounted for about 2.4% of the total outstanding volume onshore. That percentage rises to 9% in CGBs.
But the vast majority of the government and policy bank bonds are traded in the interbank market, with most corporate bonds in the much smaller exchange market. That means investors have better incentives to tap the interbank rather than the exchange market.
“This is a bit of a chicken-and-egg situation,” said a senior debt banker with knowledge in China. “You could argue that foreign investors don’t really buy into corporate bonds because of the [lack of] access, but the truth is, even if they have better access, they probably wouldn’t want to because they are not comfortable going down the credit curve or don’t believe what they see on the ratings side. These things have always been a huge concern when it comes to China.”
Interbank over exchange
A senior capital markets banker in Hong Kong said that his clients outside China primarily focus on government and policy bank bonds. “They are attracted by the relatively higher return from the local market from names that they feel are really, really secure, such as the Ministry of Finance.”
“Some clients may have a bit more appetite for other names, but they should be very much focused on the top-notch, quality names, because they don’t want to be too worried about the credit situation with those names. They rather pick up higher yields from names they are pretty comfortable with, from a credit perspective.”
A senior analyst at an asset manager admitted that he still prefers CGBs to Chinese ‘credit bonds’ — bonds by corporate and financial institutions — because of default concerns.
“I still think the market needs to be concerned about corporate defaults going up before the coronavirus is over,” he said. “When default concerns fade, then it’ll be time to look at credit.”
There could, however, be a boost in both the size and quality of exchange bonds, as China pushes forward its agenda to merge the two markets. At the end of July, China Development Bank raised Rmb10bn from a domestic green bond that was sold — and later traded — in different markets simultaneously. Onshore bankers called it a “landmark trade” and told GlobalCapital China that more financial institutions or even non-financial issuers follow suit.