Bonds Jan 21

China's multiple bond investment channels get busy

Bulk of foreign inflows invested in government bonds; Credit bonds underserved but pioneering benchmarks like ATF 50 lead the way; Defaults enhance role of benchmark providers

China's multiple bond investment channels get busy
People wearing masks to prevent the spread of Covid-19 walk past the People's Bank of China office in Beijing in this file photo by AFP.

(ATF) The development of China’s bond market is critical to the world’s second largest economy as it seeks to improve the allocation of resources and greater integration with the global financial system.

Since 2010, when China took the first step to launch a pilot allowing foreign central banks and monetary authorities, foreign yuan clearing banks and participating banks to invest in its interbank bond market, Beijing has allowed global investors access to China’s capital markets via a number of channels, a report from ASIFMA said.

The initial foreign investor avenues to invest in China’s mammoth capital markets were from onshore. This meant they had to first set up an account in China, convert funds into yuan, make the investments onshore, and when they wanted to repatriate the income and profit from these investments, convert the money into foreign exchange and remit offshore.

Thus, they had to work with a trading, clearing and settlement infrastructure that is often incompatible with what they are used to globally, being exposed to foreign exchange risk with few hedging tools and the risk of repatriation being delayed or blocked.

China opened its capital markets for bonds and stocks to FIIs initially through the Qualified Foreign Institutional Investor (QFII) scheme which was introduced in 2002. This was followed by the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme in December 2011 using offshore yuan funds which came after Beijing decided to promote the internationalisation of the yuan in 2009.

Last June, the two schemes were merged into a single Qualified Foreign Investor (QFI) scheme and quotas for the two schemes were scrapped with new regulations introduced in September.

To further attract foreign investment in China’s capital markets, the authorities also introduced a number of “Connect” schemes beginning 2014 where foreign investors can invest in China’s capital markets from outside the Mainland, primarily from Hong Kong, without having to open accounts onshore in China.

'Opening up process'

“All routes have a role to play in the opening up process. And they all have their advantages which attract certain type of investors. Most intermediaries will look for the convergence of the channels offering a similar experience to investors,” said Philippe Dirckx, Head of Fixed Income at ASIFMA told Asia Times Financial.

In China, bonds are traded on the China InterBank Market (CIBM) where the government and policy bank bonds are traded, and the stock exchanges or exchange market where the corporate bonds are traded.

In 2010, Beijing allowed foreign central banks and monetary authorities, foreign RMB clearing banks and participating banks to invest in the CIBM under the CIBM Direct scheme.

“The bulk of foreign investment is channelled towards the Central Government bonds – which has grown significantly since the announcement of the upcoming inclusion of the CGBN in the FTSE Russell index,” said Dirckx.

As of 30 November 2020, Chinese central government bonds amounted to $2.2 trillion out of the $13.5 trillion local bond market.

“More work needs to be done to attract these investors in the other type of bonds.”

Since the launch in April 2020 of the Asia Times Financial China Bond 50 Index , the world’s first liquidity-focused, cross-sector Chinese bond index, other international benchmarks tracking China’s corporate bond market have been launched.

"Creating investable bond indices for the Chinese bond market requires a deviation from traditional bond index methodologies," said Christian Kronseder, CEO of ALLINDEX, which has created the benchmark in collaboration with Asia Times Financial. 

"The art lies in the fact to select not only the most appropriate bonds, but also bonds with a long time to maturity. This gives investors via ETF the full yield and bond like returns.

In November 2020, the Bloomberg Barclays Liquid China Credit Index, followed the Asia Times Financial index, with a launch.

These benchmarks could help bring foreign ownership of Chinese bonds at levels comparable with economies of similar size.

Dirckx said the fragmentation and complexity of the access channels, the foreign exchange controls, the limited access to hedging and financing tools were keeping foreign investment in the China bond market at a much lower level than any its international peers.

“Offshore access (via Bond Connect) to a broader range of products rather than just cash bonds and access to bond futures (for both hedging and investment purposes) are some of the areas that would help attract more foreign institutional investors,” Eugenie Shen, head of ASIFMA Asset Management Group, said. 

In the light of the recent pickup in bond defaults in the China, stock selection and the role of benchmark providers was also seen enhanced.

“Foreign institutional investors expect some bonds to default and think this is a good thing as it will help distinguish the better credits and facilitate a more rational distribution of capital which should lead to yield spreads that better represent actual risk,” ASIFMA’s Shen said.

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