Burgeoning Bonds

By+Deng+Yaqing

Following on the heels of the two stock connect schemes between Shanghai and Shenzhen and their Hong Kong counterparts in 2014 and 2016， the Chinese mainlands Bond Connect with Hong Kong was launched on July 3. This marks a new chapter of mutual fi nancial market access between the mainland and Hong Kong.

In the initial phase， the long-expected cross-border bond trading link will allow only international and Hong Kong investors to trade onshore bonds. In other words， its only northbound for the time being.

As stipulated in the joint statement by the Peoples Bank of China （PBC） and Hong Kong Monetary Authority released on July 2， the “northbound” Bond Connect， which makes it possible for qualified overseas investors to buy bonds in the mainland interbank bond market， is operating on a trial basis. The trial includes treasury bonds， local government bonds， policy bank bonds， commercial bank bonds， corporate bonds and asset-backed securities.

A new channel

As of March 2017， the size of the mainland bond market had reached 66.3 trillion yuan（$9.77 trillion）， according to statistics from the PBC， second only to the United States and Japan globally.

“As a whole， the share of Chinese domestic bonds held by foreign investors remains very low，” said Ba Shusong， chief economist of Hong Kong Exchanges and Clearing Ltd.（HKEX） in an article published on Yicai.com. Ba believes that the opening up of Chinas bond market will not only press forward reforms on the infl ux end of the international balance of payments and increase its elasticity， but also improve the liquidity of the Chinese bond market in the mid and long term.

On the f irst trading day， a total of 4.9 billion yuan （$722.1 million） worth of bonds were bought up by foreign investors through the Bond Connect. As Chinas central bank keeps tightening its monetary policy， the yield rate of Chinese domestic bonds has surpassed those in many developed economies， which makes the former much more appealing.

For example， 10-year state treasury bonds are tagged with a yield rate of 3.6 percent， the highest among all large economies in the world， while similar bonds in the United States are sold with a yield rate of 2.3 percent.

The Bond Connect has provided another channel for the renminbi to fl ow back to the domestic market. The scheme will shore up the demand for the currency in overseas markets， promote trading and financing in the renminbi offshore market， vitalize the market and push Chinas bond market to open wider to the outside world. All of this will combine to facilitate the internationalization of the yuan， said Lian Ping， chief economist of the Bank of Communications， in a commentary published in China Securities Journal.

Lian added that the onshore renminbi benchmark price will to a larger extent infl uence that of the offshore market， enabling the onshore market to play a more dominant role in pricing yuan-denominated products.

“By starting northbound bond trading before southbound trading， cross-border capital influx will be boosted， international balance of payments will be improved， and the renminbi interest rate will stabilize，” said Lian. He believes that southbound trade is likely to start when international capital fl ow becomes more stable and other conditions are met.

At the present stage， the yuan is transitioning from a currency of settlement to a currency of pricing， trading and reserve. Renminbi internationalization is also a process of the currency being increasingly held by overseas institutions， said Chen Daofu， Deputy Director of the Financial Research Department of the Development Research Center of the State Council.

The Bond Connect scheme serves as a new， convenient channel to hold yuandenominated assets， which adds to the attraction of the yuan for overseas institutions， said Chen.

In addition， as the yuan joined the International Monetary Funds basket of currencies， the Special Drawing Rights， the demand for yuan-denominated bonds is widely expected to grow even more， Chen said.

HKs competitiveness grows

At the opening ceremony of the Bond Connect， Pan Gongsheng， Deputy Governor of the PBC， said that the launch of the cross-border bond trading link demonstrates the significance of Hong Kong as an international fi nancial center and a gateway to the Chinese mainland fi nancial industry.

Chief Executive of the HKEX Li Xiaojia said the Bond Connect represents a precious opportunity that Hong Kong cant afford to miss in terms of cementing its role as the most important offshore price-setter for the yuan.

“This determines whether Hong Kong will win out as the most important financial hub during Asian trading hours. Thats where the signifi cance of the Bond Connect really lies，” said Li.

The Bond Connect is valued mostly because it can supplement Hong Kongs deficiency in bond market development as an international fi nancial center， said Ba， who pointed out that the offshore market in Hong Kong had developed a set of market and management tools to tackle the global allocation and cross-border fl ow of the yuan， which can provide professional support for overseas institutions to hold yuan-denominated bonds.

In April this year， the fi rst fi ve-year trea- sury bond futures contract was unveiled in the Hong Kong market.

Ba said that besides strengthening Hong Kongs position as an international fi nancial hub， the bond trading link will also help build an ecosystem comprising both onshore and offshore yuan-denominated products.

“When southbound bond trading is launched in the future， the Bond Connect is expected to have a more remarkable impact on Hong Kongs bond market and its entire fi nancial system，” Ba predicted.

Though there has been no explicit timetable， Yang Delong， chief strategic analyst of China Southern Fund， anticipated that a southbound bond connect is likely to open next year， according to the past experience of the previous stock connect schemes.

“When renminbi interest rates become more stable or even show signs of appreciation， the foreign exchange reserve experiences steady growth and northbound bond trading accumulates enough experience， the government will find the conditions necessary to kickstart transactions in the opposite direction，” Yang told China Business Journal.