Welcome, you are now entering China

Cross-border flows have always been a key part of the renminbi globalisation story. The ability to use the currency widely has been one of the strands underpinning Beijing’s strategy. However, the emphasis was always clearly on creating avenues to encourage and generate offshore renminbi liquidity while controlling the flow of money that made its way back into the country.

All that changed when a sharp devaluation in the FX last summer followed by an extended period of depreciation in the currency, caused a record amount of capital to leave the country. Since then China has shifted direction with the emphasis clearly on encouraging inflows from global investors.

New initiatives have included providing access to the onshore FX market and the bond market has been a particular focus. Most recently, Shanghai announced plans to launch an offshore renminbi (CNH) bond market in its Free Trade Zone.

But the most game changing move was the decision in February by the People’s Bank of China to open up the China interbank bond market (CIBM) by allowing almost all types of foreign real money institutional investors to directly invest without a quota. Official guidelines are still yet to be published but there is no doubt that the decision counts as one of the most significant steps towards liberalising the country’s capital markets. Moreover, far from being a backward move, encouraging more inflows into the Mainland is viewed as a necessary next step towards renminbi internationalisation.

“You are seeing a measured and structured two-way opening up of the capital account and the regulators want to involve international investors in the onshore capital market,” said Cian Burke, global head of securities services at HSBC.

“Currently, a quota is not a limiting factor to inbound investment. However, if the A-share is included into the MSCI emerging market indices or the CIBM becomes part of global bond investment indices, then investment inflows will be impacted,” said Burke.

This view is echoed by Lisa O’Connor, head of securities services, transaction banking, greater China and North Asia, at Standard Chartered.

“I would expect the regulators to continue to make all the schemes as user friendly as possible,” she said. “Many of the changes we are seeing under both Shanghai-Hong Kong Stock Connect and CIBM are driving the consideration of including China into key indices which is an expected longer term goal.”

And positioning for a future pick-up in inbound investment was one of the issues the PBoC highlighted when it made the announcement to open up the CIBM.  At the time the central bank said it believes the scheme could “accommodate rising demand for RMB fixed income assets by global institutional investors following the inclusion of the RMB in the International Monetary Fund's SDR basket last November.”

However, if China’s long-term goal remains making the renminbi a global currency, regulators really need to consider removing some of the current suspensions of outbound channels. Since the end of last year, Beijing has systematically shut down programmes that allowed renminbi to flow offshore as it sought to stop the currency devaluing. 

In November, the PBoC banned cross-border lending, onshore bond purchases and interbank repo transactions between the onshore headquarters of Chinese banks and their offshore clearing entities/branches.

The contraction of offshore schemes then moved to imposing a reserve requirement ratio on offshore renminbi deposits and suspending two-way cash pooling services. Finally, this year saw the suspension of the renminbi qualified domestic institutional investor (RQDII) and QDII schemes. 

“There is a chance this could backfire as the focus is all about investing money into China in an environment where it is becoming extremely difficult to get money out,” said a RQFII portfolio manager with a Chinese firm based in Hong Kong.

“Some of my clients’ decisions to redeem their investment is over concerns about the regulatory uncertainty.”

This should be a concern for regulators as foreign holdings of Chinese assets remain minimal for now.

“The amount of international investors is still relatively small compared with the total opportunities that exist within China,” said HSBC’s Burke. “The onshore market is still very unfamiliar to many foreign investors."

And it looks likely to stay that without a catalyst to trigger substantial inbound investment, argues Pierre Humblot, COO fixed income Asia Pacific and COO global emerging market debt at JP Morgan Asset Management.

“There is a lot more interest nowadays in accessing China, but the real desire to invest will only really happen when China is included in one of the global bond indices,” he said. “That would definitely be the trigger for the China onshore market to develop further, as you will see passive institutional investors allocating their portfolio into China.”

Once investors have decided to take the plunge, the question is then which route do they take to enter China.

Before the recent relaxation of rules regarding investing in the CIBM, there were only two inbound channels for onshore bond investment: the qualified foreign institutional investor (QFII) and renminbi QFII schemes which work on a quota based system.

Under the RQFII scheme, any manager that wanted to invest in China’s domestic bond market first had to wait for the jurisdiction where they were based to receive a country level quota from the PBoC. Then they would need to apply for a RQFII licence from the China Securities Regulatory Commission (CSRC) and then to receive an individual quota from State Administration of Foreign Exchange (Safe).

Since Hong Kong received the first RQFII licence in late 2011, the PBoC has awarded quotas worth Rmb1.2tr ($184bn) but of that only Rmb480bn has been allocated, according to GlobalRMB data.

The lengthy and complicated nature of the quota-based scheme means the CIBM opening has been broadly welcomed. But as O’Connor notes, one the key questions is how it might change the view of the existing investment programmes.

“In the past, the RQFII programme was used more for CIBM investment, but with the new direct access in place, it now really depends on what you’d like to achieve as an investor and then to base your strategy around the options,” she said. “QFII/RQFII would still be attractive to those who want more than cash bond exposure, which is what the CIBM access offers at the moment. To those who invest in equities or have more of a mixed portfolio, these two schemes still have their advantages.”

That said, some existing QFII and RQFII portfolio managers are worried that the two programmes could get side-lined.

“I’m losing some clients at the moment as they have been granted direct access to interbank bonds, not to mention the new channel seems to provide more efficient and simplified investment procedures,” said the RQFII portfolio manager.

But any debate about which scheme is better will  count for nothing if China cannot convince investors that its markets are trustworthy and that the Chinese economy is not heading for a hard landing. HSBC’s Burke recognises the challenge but believes China is on the right path.

“There are still concerns about the currency depreciation or changes in the broader investment landscape. For example, the volatility in the A-share market since last summer is still giving investors reason to continue to review the market,” said Burke.

“There will be short-term challenges, in terms of a slowing Chinese economy, but corporate governance is becoming stronger and transparency of what you are investing in is also improving,” he added.