Flash Notes

The bond link between Hong Kong and the mainland has received formal approval on Tuesday (May 16), providing a new channel forinvestment into China’s bond market. The PBoC and HKMA are expected to sign a MoU to coordinate supervision of the programme.

    The Bond Connect which will not be subjected to daily quota, will only be “northbound” at the start to allow foreign and Hong Konginvestors access to China’s bond market, probably reflecting concerns over capital outflows.

    There is no expansion of eligible investor criteria which would still consist of overseas central banks, sovereign wealth funds,international financial companies, and medium- to long-term institutional investors. However, greater transparency and easier accesswill be positive for market development, with eye on the eventual inclusion of Chinese bonds in international bond indexes. Details onthe Bond Connect are scant at this point.

    Based on the State Administration of Foreign Exchange’s statement on February 27, foreign institutions that invest in the mainland’sinterbank debt market can trade products including forwards, swaps, cross-currency swaps and options with domestic settlement agents.

    The Bond Connect is expected to increase the activity level in the mainland’s bond market in the medium term and contribute towardsefforts in opening of the capital market and RMB internationalization. But as with the experience of the stock connect in Shanghaiand Shenzhen, current expectation of RMB depreciation could mute the market’s initial enthusiasm, particularly since internationalinvestors are already able to invest directly in the mainland’s interbank bond market since February 2016.

    Nonetheless, the potential is big. China bond market is third largest in the world. As of December 2016, total of corporate and governmentbonds stood at US$ 7.129 trillion. The average quarterly growth rate of the market over the past 5 years is 4.1% with governmentbonds growth at 3.9% while corporate bonds grew at 4.6%.

    Foreign holders of China bonds are primarily in Treasuries (56.1%), followed by Quasi-Govts (agri 9% and EXIM 8.1%). Foreignholdings since 2014 had been fairly constant at around 1.5% of total market size. There is certainly clear scope for increase in foreignholdings of China bonds when compared to the current exposures amongst other Asian Sovereigns.