CO-PUBLISHED FEATURE The opening of China’s bond market and RMB internationalisation

This is the 40th year of China’s reform and opening up. As pointed out in the report of the 19th National Congress of the Commu¬nist Party of China, “China will not close its door to the world; we will only become more and more open”.

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Written by Li Songliang, Shi Di from NAFMII. The opinions expressed in this article are the authors’ own and do not reflect the views of NAFMII.

This is the 40th year of China’s reform and opening up. As pointed out in the report of the 19th National Congress of the Commu­nist Party of China, “China will not close its door to the world; we will only become more and more open”.

China’s financial industry is also expected to open up in more areas at more profound levels. This includes the opening up of the bond market, a major part of China’s financial liberalisation, which also interacts with and reinforces the inter­nationalisation of the domestic currency, the renminbi. An examination of this trend — and a look at the history of other countries — allows us to draw three main conclusions.


In order to expand cross-border usage of the RMB, the key is to promote its use as an in­vestment and reserve currency, rather than solely as a settlement currency as is mostly the case at the moment. The bond market can serve as a good channel to achieve such a goal. The bond market offers stable instru­ments for investment and financing which have reasonable storage value.

From an investment and financing per­spective, China’s bond market opening up can provide foreign investors with a variety of investment instruments that are denom­inated in RMB, and it can also provide foreign issuers with an RMB-denominated financing channel. All of these will help to promote the appeal of the RMB.

Unlike stocks, which are mostly issued by the private sector, bonds can be issued either by the private sector or the public sector, with flexible investment horizons and innovation potential. Therefore, compared with the stock market, the bond market can offer foreign investors diverse choices to meet their risk and reward pref­erences. Current market practices shows that large-scale demand of a currency is mainly reflected in the demand for its fixed-income products.

From the store of value perspective, a country’s foreign reserves are usually held in the form of government bonds. In particular, foreign reserves are usually invested in the bond market of the home country of the reserve currency. Take China for example, as of the end of January 2018, China held $1.17tr of U.S. treasuries, accounting for 37% of its foreign reserves. As early as of October 2014, the United Kingdom issued Rmb3bn bonds in London to fund the government’s reserves. Accord­ing to the ‘RMB Internationalization Report 2017’ published by the People’s Bank of China, based on incomplete statistics, as of the end of 2016, more than 60 countries and regions had included RMB in their foreign reserves. In 2017, the European Central Bank and the German Central Bank also included RMB in their reserves. As showed in the figure below, the amount of the RMB being included in foreign reserves has increased continuously.

From the perspective of preventing systemic financial risks, a developed and open bond market also serves as a buffer for currency internationalisation, as it can attenuate the impact of overseas demand for RMB assets on China’s financial market, and thereby creating a stable external environment for RMB internationalisation. Therefore, and taking into account risk prevention requirements, the opening up China’s bond market to support RMB internationalisation conforms to the cur­rent global and domestic macro financial environment.


RMB internationalisation will promote the further opening up of China’s bond market as well. On the one hand, RMB interna­tionalisation will drive active cross-border use of the RMB, giving overseas institu­tions stronger incentives to invest in RMB denominated assets or seek RMB financ­ing. Bonds, a highly standard and liquid product which can have built-in innovative mechanisms, are a great and suitable choice for foreign institutions. On the other hand, RMB internationalisation will also help the RMB become a reserve currency and a safe-haven currency, enabling foreign institutions to hold RMB bonds as both active and passive investments.

Look at the experience of developed markets: currency internationalisation was considered an important factor in promoting the opening up their bond mar­kets. In the mid-1980s, Japan proactively pushed forward yen internationalisation, which has largely supported the opening of Japan’s bond market. This push has attracted foreign institutions to issue Samurai bonds and invest in Japanese gov­ernment bonds. It has also promoted the development of the euroyen market.

Since 2015, thanks to a number of policies aimed at promoting China’s capital market opening up, together with the RMB’s inclusion in the International Mon­etary Fund’s special drawing rights (SDR) basket, China’s bond market has achieved remarkable results. A variety of foreign issuers have entered the market, includ­ing international development agencies, foreign governments, foreign financial and non-financial companies. As of the end of February 2018, a total of 52 institutions issued bonds denominated in RMB (i.e. Panda bonds) worth Rmb135.9bn in China’s interbank market.

Among the issuers were International Finance Corporation (IFC), Asian Devel­opment Bank, the Republic of Poland, Hungary, Republic of Korea, British Columbia (Canada), HSBC (UK), Mizuho Bank (Japan), Daimler (Germany), Veolia (France), Air Liquide (France) and Wharf Holdings Limited (Hong Kong). In addition, the World Bank and Standard Chartered Bank (Hong Kong) have also issued an aggregate of 600m SDR bonds, also known as “Mulan bonds”, which are denominated in SDR and settled in RMB.

In addition, foreign investors can invest in China’s interbank bond market through Bond Connect, Qualified Foreign Institu­tional Investor (QFII), RMB QFII (RQFII), and China Interbank Bond Market (CIBM) Direct. As of the end of February 2018, 272 foreign institutions had invested in the interbank market through Bond Connect and over 900 foreign investors had partic­ipated in China’s bond market, including central banks, international financial organisations, sovereign wealth funds, commercial banks, insurance companies, investment banks, hedge funds and other asset management companies, and up to Rmb1.3tr was held by overseas institutions. In addition, Bloomberg announced in late March that it would gradually incorporate Chinese government bonds and policy bank bonds into the Bloomberg Barclays Global Aggregate Index, which would further attract global investors’ allocations to the Chinese bond market.

In particular, investment and financ­ing reinforce each other. In March 2018, the Republic of the Philippines issued a Rmb1.46bn Panda bond in China’s inter­bank market, with 88% of the issuance purchased by foreign investors through channels such as Bond Connect. Since the RMB was included into the SDR basket, RMB internationalisation and the opening of the bond market have since generated a positive interaction, and will continue to reinforce each other to drive the reform and opening up of the Chinese financial system.


Despite the speed of the opening up of Chi­na’s bond market over the past three years, the market is still not ‘open’ enough, and its role in supporting RMB internationalisa­tion can be further expanded. The amount of outstanding Panda bonds accounts for only 0.16% of the total amount of bonds in China’s interbank market. What’s more, foreign institutions only hold 5.66% of Chi­nese government bonds, far behind foreign investment in the United States (over 35%) and also behind Japan (more than 10%). In order to promote RMB internationalisation and to deepen financial reforms by opening up the financial market, China’s bond market needs to open further.

There are a number of opportunities in China’s bond market. First, China has the world’s third largest bond market, with an aggregate size of more than Rmb75tr and a variety of products being offered, which lays a solid foundation for its opening up. Second, with the RMB’s inclusion in the SDR basket, the global demand for RMB assets is rising. Third, the Belt and Road Initiative can further expand the role of China’s bond market. Lastly and most importantly, the Chinese government is proactively pushing forward the opening up of the financial system and has created a favourable environment for the opening of its bond market.

In spite of these opportunities, China’s bond market opening up also faces poten­tial problems and risks. The most serious one is how to make Chinese rules and practices converge with international ones, ranging from information disclosure, credit ratings, accounting standards, and investor protection rules, among others. Chinese regulatory authorities are actively looking for solutions to address the above issues.

Considering that the current rules under which China’s bond market operates were established several years in the past, suddenly changing any of these rules to meet international standards may nega­tively affect Chinese domestic participants and even create risks for China’s financial market. The opening up of the bond market should be a process of progressive explora­tion.

It is imperative to take into account the needs of both foreign and domestic partic­ipants, and it is particularly necessary to prevent systemic financial risks during the journey of opening up. In the early stage of developing the Panda bond market, we would like to welcome foreign institutions with a good understanding of the key issues that have prevented many foreign issuers from participating in China’s bond market, such as accounting, law, regulation and information disclosure, so as to form an operating practice acceptable to both domestic and foreign participants.

But we should also do the same for foreign investors, attempting to under­stand the issues that prevent them from participating in a market which may have an unfamiliar credit rating and taxation framework or have an underdeveloped infrastructure. Only then we will be able to find the right solutions that work for both domestic and foreign market participants.

An alternative solution is for China to learn from the experiences of developed mar­kets and to promote an innovative opening up strategy by establishing pilot markets. For example, Japan has established a Pro-bond market for matured domestic investors and foreign investors. This market serves as a “secure” segment of the bond market where policymakers can conduct innovative policy tests on a number of issues in a relatively bold way. This includes, for instance, lessening the requirement on information disclosure, providing flexibility on account­ing and auditing standards, and confining the risks to the domain of professional participants.