The financial bridge between China and the rest of the world

The recent launch of Swap Connect and the upcoming inclusion of Indian government bonds into a global index highlight the deepening links between Asia’s financial markets and the rest of the world.

Tight monetary policy in the US has impacted bond markets across the world. In Asia, the high-rate environment has led to a sharp decrease in the issuance of USD-denominated debt, as regional issuers decide to tap their increasingly liquid domestic markets for cheaper financing. To find supply, international investors are looking more towards Asia’s local currency markets.

This shift in focus coincides with two major developments that will attract and facilitate international participation in Asia’s bond market: the recent launch of Swap Connect in Hong Kong and the upcoming inclusion of Indian government bonds into a major global index.

Both events highlight how the actions of regulators, index providers, and trading venues are deepening investment links between Asia and the rest of the world.

In September, J.P. Morgan announced that it would start to include Indian government bonds to its Government Bond Index – Emerging Markets in June 2024. It will be a staggered inclusion, with India’s weighting increasing by one percentage point per month until it reaches 10%¹ .

“There is significant enthusiasm in India for index inclusion, because offshore investors will now play a meaningful role in this large bond market,” said Saket Banka, Head of Institutional Sales, India, HSBC. He described how index inclusion is forecast to attract capital flows of around USD 20 billion to USD 22 billion, which accounts for around 10% of the annual supply of Indian government bonds that come to market². With foreign investors currently holding around 1% of the overall outstanding bonds, new flows would bring foreign participation closer to levels seen in other Asian markets³.

The recent index inclusion announcement follows a series measures undertaken by India’s central bank and securities regulators to the streamline offshore access to the market.

The landmark change occurred in 2019, when the license application process was simplified – most notably KYC requirements were reduced, while many of the necessary forms were digitised. Since then, there has been a large increase in the number of investors with the Foreign Portfolio Investor (FPI) license required to trade in India.

The deeper investor base will affect local market dynamics and the broader economy. From a markets perspective, more investors will lead to better price discovery and a more transparent market, while the macroeconomic effect of new flows into the economy could reduce the government’s cost of borrowing. Going forward, there are hopes that other index providers will decide to add Indian debt to their benchmarks.

The other recent development for Asia’s fixed income market was the arrival of Swap Connect, a new piece of market infrastructure that was launched in May. It consists of a Northbound channel that allows international investors to trade onshore interest rate swaps.

This is the latest iteration of the successful series of Connect programmes, which since the launch of the original Shanghai Hong Kong Stock Connect in 2014 has created an increasingly wide investment link between onshore and offshore China.

In 2017, Bond Connect launched, and although it quickly became a popular channel for foreign investors, there was an unmet demand for access to effective hedging tools. While there are offshore swaps available, the onshore market for interest rate swaps (IRS) is more liquid, and less volatile, with pricing that is better correlated to local bonds.

Swap Connect provides access to onshore China via Hong Kong market infrastructure. In other words, investors are connecting to onshore market makers by using a simple interface that has the same look and feel as in other markets they trade, with a clearing model that aligns with international standards.

In its first few months, Swap Connect has attracted the attention of fixed income investors, with many live already. In the short-term, traders are still coming to terms with differences in market conventions between onshore and offshore. For example, in the onshore market IRS are spot swaps on T+1 or T+2, while in the offshore market IRS are typically forward start. But over the long-term, Swap Connect shows the direction that China’s markets are moving in.

“Swap Connect is a sign that the Chinese authorities remain committed to the opening of China’s financial markets and they are willing to provide foreign investors with the access channels that they need,” said Pin Ru Tan, Head of Asia Pacific Rates Strategy, HSBC.

Taken together with India’s upcoming index inclusion, Swap Connect, highlights a trend of improved access to Asia’s fixed income market. These developments also support the expectations that foreign participation in major markets – such as China and India – will become closer to the levels seen in other markets, as international investors capture opportunities in these fast-growing economies.