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Burgeoning Bonds
Cross-border bond transaction gets green light, giving a leg-up to renminbi internationalization
By Deng Yaqing | NO. 29 JULY 20, 2017
The launching ceremony of the bond connect is held at Hong Kong Exchanges and Clearing Ltd. on July 3 (XINHUA)

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 mainland's Bond Connect with Hong Kong was launched on July 3. This marks a new chapter of mutual financial 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, it's only northbound for the time being.

As stipulated in the joint statement by the People's 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 inter-bank 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.

An aerial view of the International Financial Center (left) at the Victoria Harbour in Hong Kong on June 22, 2016. The launch of the bond connect is expected to further cement Hong Kong's status as an international financial center and make it more appealing to global investors (XINHUA)

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 China's bond market will not only press forward reforms on the influx 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 first 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 China's 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 flow 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 China's 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 influence 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 flow 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 yuan-denominated assets, which adds to the attraction of the yuan for overseas institutions, said Chen.

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

HK's 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 financial center and a gateway to the Chinese mainland financial industry.

Chief Executive of the HKEX Li Xiaojia said the Bond Connect represents a precious opportunity that Hong Kong can't 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. That's where the significance of the Bond Connect really lies," said Li.

The Bond Connect is valued mostly because it can supplement Hong Kong's deficiency in bond market development as an international financial 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 flow of the yuan, which can provide professional support for overseas institutions to hold yuan-denominated bonds.

In April this year, the first five-year treasury bond futures contract was unveiled in the Hong Kong market.

Ba said that besides strengthening Hong Kong's position as an international financial 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 Kong's bond market and its entire financial 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.

Copyedited by Bryan Michael Galvan

Comments to dengyaqing@bjreview.com

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