The lowdown: Bond Connect

Bond Connect is a mutual market access (MMA) programme that links together China and Hong Kong’s bond markets. However, the first stage will only feature northbound trading, allowing international investors to tap China’s $9.4tr bond market, but not for Chinese investors to “go out” and invest overseas bond markets just yet.

The first MMA between Hong Kong and mainland China, the Shanghai-Hong Kong Stock Connect, was launched in November 2014, followed by the Shenzhen Connect, which was launched in December 2016.

CIBM Direct requires foreign investors to open accounts in China for each bond product seeking access, a cumbersome process which partly explains why foreign ownership in the onshore bond remains limited, standing at just Rmb830bn ($120.3bn) as of March 2017, according to CEIC Data, or less than 2% of the total market size.

Once Bond Connect is open for business, however, institutional investors with trading accounts in Hong Kong will be allowed to enter the onshore market without having to open separate onshore accounts and – just like for CIBM Direct – without a quota. This will likely make the new scheme an easier and faster way to gain exposure to onshore bonds.

At present, CIBM Direct investors make their purchases in onshore renminbi (CNY). But at this stage, it is not clear whether Bond Connect users will carry out FX conversions onshore or offshore. Should they be forced to trade in offshore renminbi (CNH), this would expose them to the risks arising from the differing exchange rates.

The other lingering question is around hedging capabilities. CIBM Direct investors were granted access to the onshore FX derivatives market in February, but the regulators have not specified whether Bond Connect investors will have the same access. In terms of credit hedging, CIBM Direct and Bond Connect investors will likely be unable to tap the onshore derivatives market, but they will be able to use the new five-year treasury futures launched by HKEX. The contract was launched in April also in anticipation of the Bond Connect.

A third issue revolves around the rumoured requirement for foreign investors to choose either the Bond Connect or the CIBM Direct scheme. Should they be mutually exclusive at a firm level – rather than at a product level – this could put those that have already applied for CIBM Direct access at a disadvantage when the Bond Connect launches.

The lack of quotas could be the result of the regulators expecting droves of global investors rushing to apply for CIBM Direct, should the major index providers decide to include China later this year (see below for more). A quota-less Bond Connect will allow investors to rebalance their portfolios swiftly.

We don’t know yet. Some in the market believe China is eyeing July 1 as the launch date, since it coincides with the 20^th anniversary of Hong Kong’s handover. Stay tuned for the latest updates.

It is not immediately clear from the regulators’ announcement what will be available via Bond Connect, and whether or not Bond Connect users will enjoy the full range of products available to CIBM Direct investors. CIBM Direct investors currently have access to all cash bonds in the interbank market.

The opening up of the world’s third largest bond market may see global investors, who have barely tipped their toes into the market, holding a lot more renminbi or renminbi-denominated assets. This may give renminbi internationalisation, which some say is at its lowest point since 2014, a much-needed boost.

For China, Bond Connect is another step in its strategy to open up its domestic markets, just as it did with Stock Connect and various other market access programmes for foreign investors.

China is also hoping for a full inclusion in some of the world’s largest benchmark bond indices, such as the Bloomberg-Barclays Global Aggregate Bond Index, Citi’s World Government Bond Index (WGBI) and JP Morgan’s Government Bond Index-Emerging Markets (GBI-EM). This could bring inflows of up to $300bn, according to Morgan Stanley. Bloomberg-Barclays and Citi already made partial inclusions of Chinese bonds earlier this year.

Regulators on both sides of the border will decide on when to roll out the missing half of the scheme, southbound trading, according to the joint statement by PBoC and HKMA.

Should they only give mainland investors access to the $220bn Hong Kong bond market, this would likely make the southbound channel less significant given the vastly different scale of the two bond markets.

Bond Connect is set to launch in July, but investors with CIBM Direct access may not be able to join the party, market sources told GlobalRMB.

Technical questions on price discovery and clearing need to be answered before the launch of Bond Connect, says DTCC.

Banks are looking to regulators for more clarity on FX, settlement and registration requirements on Bond Connect after premier Li Keqiang gave his blessing to the launch of Bond Connect in 2017.

With the launch of Bond Connect edging closer, Hong Kong Exchange (HKEX) turns to Tradeweb for help in developing the infrastructure to link the two markets.