Bonds Sep 25

China's entry into global bond indexes, reforms to draw $3 trillion inflows 

WGBI to include China's government bonds (CGB) starting October 2021; China to press ahead with market reforms to attract $3 trillion over next decade; CGB foreign ownership to rise to 20% from 8.5%

China's entry into global bond indexes to draw $3 trillion inflows 
A bank teller counts Chinese yuan/ RMB. File photo by AFP.

China government bonds will be included in the FTSE World Government Bond Index (WGBI), in an acknowledgement of the rapid development and deepening of the world’s second largest bond market.

Index provider FTSE Russell announced early on Friday (Asian hours) the inclusion of bonds from the $16 trillion market will take effect from October 2021.

“It reflects ongoing progress by China toward market reforms and increased access for global investors,” FTSE Russell said of the much-awaited announcement.

“Confirmation of the start date to be provided in March 2021 following ratification from FTSE advisory committees and index users that recent regulatory reforms and infrastructure enhancements meet the practical needs of investors.”

China’s government bonds have been on the Watch List for WGBI inclusion since 2018 and the government made major changes to regulations which will allow access to international investors, including improving secondary market bond liquidity, enhancing the foreign exchange market structure and developing global settlement and custody processes.

Last week, Beijing amended some trading rules allowing flexible settlement periods, another move in a series of reforms it has been executing for some time now.

Morgan Stanley analysts estimate the inclusion could help funnel $60-$90 billion of investment money into the country in the next few years with monthly inflows of $3-4.5 billion.

“While our forecast could be smaller than the street's consensus, we believe that the importance of adding China to the global index reflects the fact that China's bond market has opened up and is easy for foreign investors to access. This supports our view that China will continue to reform its financial market and attract US$3 trillion of inflows in the next decade,” they said in a note.

Standard Chartered expects inflows of $150 to $180 billion, and that it would lift foreign ownership of China Government Bonds to 20% by end-2022 from 8.5% currently.

“We welcome China government bonds’ inclusion into another major global index. Prior to the FTSE Russell inclusion, international investors had already been deploying capital towards Chinese bonds, given existing representation in the Bloomberg Barclays Global Aggregate Bond Index and the JP Morgan Government Bond Index – Emerging Market,” Jason Pang, a Portfolio Manager at JP Morgan Asset Management, said.

“The attraction is also clear to see in China bond market’s compelling yield levels (2.5 to 3.5% range) relative to other developed market government bond markets priced at zero or negative yields.”

Pang estimated the index inclusions would translate to significant passive inflows as tracker funds and ETFs move in lock step with these indexes, sending approximately $250 billion to $300 billion into China’s onshore bond market. CSOP Asset Management expects the three major global bond indexes, collectively, will attract about $320 billion of inflows into China’s onshore bond market.

“This will provide meaningful tailwinds to China bonds over time,” Pang said while adding foreign ownership in Chinese government bonds have risen to over 9% from 2% in recent years.

Japanese fund following

The FTSE Russell WGBI index is widely followed by Japanese investors, with a vast majority of them passive. Given Japan has an extended holiday, such a 5-day Golden Week holiday, the flexible settlement cycle is important to them. The settlement cycle for onshore investors in China is T+0 or T+1. However, for foreign investors it is up to T+3. But T+3 is not long enough to cater to long holidays and given Japanese investors are very passive – they prefer not trade before or after the holidays, the analysts said.

China’s bond markets have turned in a strong performance with year-to-date returns of 4.5% thanks to the strength of the yuan currency and high coupons, CSOP Asset Management said.

“As most major economies’ central banks still adopt low or zero-rate monetary policies, China government bonds with yield pick-up potential (close to 3% as represented by FTSE CGBI as of August 2020), relatively high credit quality (A1/A+/A+ by Moody’s, S&P and Fitch) and diversification benefit becomes more attractive to international investors in a low-growth, low-rate world,” they said in a note after the index inclusion.

And yet there are hurdles faced by institutional investors investing in Chinese onshore government bonds onshore.

“It still takes time and operational effort to register for investment channel such as CIBM Direct and Bond Connect,” said CSOP Asset Management, while adding that sheer market size itself may not imply underlying bond liquidity access for foreign investors if without local market insights.

“It may be costly to managing onshore China bonds internally, i.e. investment, trading and operation setup,” they said, suggesting that investors take the exchange traded funds route to gaining exposure to the world’s second-largest bond market.

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