Bond Access – What the Chinese onshore bond market has to offer

More than two years after its launch in the summer of 2017, Bond Connect has become one of the major routes for foreign investors to access China’s onshore bond market. It now stands alongside older channels – such as the Qualified Foreign Institutional Investor (QFII and RQFII) scheme and the China Interbank Bond Market Direct (CIBM) scheme. With more options available, investors are looking beyond issues relating to access and more to the actual opportunities present in the world’s second largest bond market.

Bond Connect’s success is evident in its strong growth. By the middle of 2019, it had more than 1000 international investors taking part, which is more than double the previous year¹. Trading volumes are also on the rise, with RMB172.2 billion worth of trades taking place in June. The scheme is part of a broader plan to open up China’s financial markets to the world, which is demonstrated by an ongoing string of developments. In September for example, China removed the investment quota restrictions for QFII and RQFII.

Bond Connect and its role in an increasingly open financial system was the topic of a panel discussion held at HSBC’s annual Credit Conference, which brought together market participants from across the financial spectrum – including investors, rating agencies, and traders.

A smoother trade experience

They started by discussing the relative merits of each channel into onshore China, and how Bond Connect differs from the rest. Convenience is one of the main draws to the programme, as it allows for account set up and trade settlement all in Hong Kong. Contrast this with CIBM Direct scheme, where an investor is required to sign an agreement with an onshore custodian bank.

Looking ahead however, the panel discussed the idea that three separate routes into China onshore bond market, each with their own rules and processes, might be unnecessary and that there could be convergence among the existing channels. One speaker highlighted that with its smooth trade settlement and the ease at which investors can move cash in and out of investments, Bond Connect could prove a model for improvements in the other schemes.

Although the panel highlighted growing interest among international investors in Bond Connect, they also acknowledged some obstacles that are making some portfolio managers take second thoughts before allocating the market. One of the major issues is the lack of hedging options, since there are limited ways investors to hedge interest rate risk, and there is no access to the onshore bond futures market. Expanding access to risk management tools will likely attract more investors into the onshore bond market.

Understanding local dynamics

Now that accessing China’s onshore bond market is relatively straightforward, international investors need to learn about a market that operates according to very different dynamics when compared to fixed income markets in other parts of the world. One panellist stressed the importance of understanding how local investors think, something that it is only possible to do with credit analysts on the ground in mainland China.

Another area that investors need to familiarise themselves with is local credit ratings. Bonds in onshore China are rated very differently compared to credits in other markets – not only are top ratings much more common in China, the ratings given onshore do not easily translate to ratings given by an international credit rating agency.

One panellist, representing a Chinese domestic ratings agency, said that she was aware that the high concentration of top ratings was an issue for many foreign investors, and the agency is implementing a dual scale that gives a company a rating according to its domestic scales, as well as one that is more akin to the ratings used by international agencies.

Some of the investors on the panel said that they were keen on there being greater levels of consistency between onshore and offshore ratings. There also needs to be more dispersion in the ratings given onshore so that investors can better assess the risk they take on when buying a bond.

Furthermore, many foreign investors require an international rating for a credit be part of their investable universe, highlighting the continued importance of the international ratings system going forward. That said, China is opening up to international rating agencies, allowing them to rate onshore bonds.

The inclusion of Chinese bonds into major international indices earlier this year means that investors will have to become familiar with the domestic fixed income landscape in China. One investor panellist said that index inclusion means that it is only a matter of time before international investors have to make a decision whether their portfolios are underweight or overweight China according to the benchmarks. These are the decisions that investors across the globe will have to make, he said, so it makes sense for them to be aware sooner rather than later of how they will access the market and how they can build onshore capability to take care of their investments.