Chinese bonds more popular than ever with foreign investors as Bond Connect turns 7

Foreign investors have advanced their holdings in China's US$20 trillion domestic bond market since the Bond Connect mechanism was introduced to link them to new growth and diversification opportunities in the world's second-largest economy. As the mechanism celebrates its seventh birthday, further enhancements are poised for launch.

Since the Northbound Bond Connect commenced trading in July 2017, overseas investors' holdings of onshore Chinese bonds have jumped nearly 4.8 times to 4.22 trillion yuan (US$580 billion) in May, according to official data. This also marked the ninth consecutive month that foreign investors added to their exposures.

As Beijing issues ultra-long treasury bonds to finance the country's infrastructure projects, financial authorities in Hong Kong and mainland China have vowed to further enhance the Bond Connect scheme, which allows mutual market access through financial connections between mainland China and Hong Kong. Southbound trading started in September 2021.

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"The onshore bond market has been one of the top performing fixed-income markets over the past year, with yield on the downward trend and many investors having realised capital gains from their investment," said Lillian Tao, head of macro and global emerging-market sales for China at Deutsche Bank. Offshore investors could keep their funding costs manageable as they leveraged US dollar swapped yuan funding, she added.

"At present, international investors hold 4 trillion yuan of onshore bonds, including 3.1 trillion yuan of treasury and policy bank bonds," Kenneth Hui, executive director of the Hong Kong Monetary Authority (HKMA), said in a media briefing on Friday. "If they can use some of these holdings as collateral to get liquidity from the HKMA, it will encourage the international investors to be more willing to hold the onshore yuan bonds."

Hui's comment referred to a measure started in February that allows Chinese government bonds and policy bank bonds to serve as collateral in HKMA's RMB Liquidity Facility.

HKMA CEO Eddie Yue Wai-man said in a statement on Friday that more use cases of onshore yuan bonds are in the works. For example, regulators are discussing whether to allow international investors to use onshore bonds under Northbound Bond Connect as margin collateral for northbound trading under the Swap Connect. Launched a year ago, Swap Connect allows outside investors to trade mainland Chinese interest rate swap contracts.

Currently, more than 50 per cent of Swap Connect collateral is cash, according to Hui. Using onshore bonds as collateral will reduce liquidity costs and strengthen capital management, he said.

HKMA executives said the measure would promote the synergies between Bond Connect and Swap Connect, invigorate market participation in the Connect schemes, and benefit the yuan's internationalisation.

"Investors are looking for more FX and rate-hedging tools as well as funding access," said Ju Wang, head of Greater China foreign exchange and rate strategy at BNP Paribas. Global investors are watchful for announcements regarding broader access to China's onshore repo market and overseas China government bond futures, she added.

Workers labour at the construction site of the Yulin North Railway Station in Yulin, in south China's Guangxi Zhuang Autonomous Region, on November 22, 2023. Photo: Xinhua alt=Workers labour at the construction site of the Yulin North Railway Station in Yulin, in south China's Guangxi Zhuang Autonomous Region, on November 22, 2023. Photo: Xinhua>

The People's Bank of China has yet to reveal details of the further opening up of the repo market to all offshore institutional investors that already have access to the interbank bond market, including Bond Connect investors, after announcing its intention to do so in January.

Access to the over-the-counter wholesale funding market is currently limited to sovereign entities, multilateral financial institutions and offshore yuan clearing banks.

Last November, bourse operator Hong Kong Exchanges and Clearing said it would launch China treasury bond futures to help regional and global investors more effectively manage their interest rate and investment risks.

HKMA's Yue said these measures are still being negotiated and the organisation hopes to announce them soon.

Riad Chowdhury, head of Asia-Pacific at MarketAxess, a bond trading platform, expressed optimism about the long-term potential of China's bond market.

"China is the world's second-largest economy with various growth engines, which will probably need to come to the market to issue bonds," he said. "As they keep issuing bonds, they'll see interest from investors all over the world, and this kind of virtuous cycle will continue."

China has moved towards "high-quality" development and technological innovation as new engines in its economy. Bond issuances will help finance the new growth, Chowdhury said.

Foreign ownership in China's onshore bond market remains relatively low compared with other global economies, said Freddy Wong, head of Asia-Pacific at investment manager Invesco Fixed Income. "Onshore yuan bonds have a low correlation with other major bond markets and bond indices, as well as US and Chinese equities," he said. "Hence onshore yuan bonds serve as good diversification for global investors."

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2024 South China Morning Post Publishers Ltd. All rights reserved.

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