Given the recent flurry of announcements relating to the inclusion of Chinese bonds in various global bond indices and the announcement of the upcoming Mainland China-Hong Kong Bond Connect, we sat down with Teresa Kong to get a better understanding of the context and implications of these developments.
Can you outline the composition of China’s bond market?
The Chinese onshore market is the third largest in the world, after the United States and Japan. The total size of the market as of the third quarter of 2016 was over US$7 trillion (RMB 48 trillion). While most corporate bonds trade on the stock exchange, Chinese government bonds and policy bank bonds trade on the larger and more liquid China interbank bond market (CIBM). The largest issuers in the CIBM are the Chinese government and the Chinese policy banks: Agricultural Development Bank of China (ADBC), China Development Bank (CDB) and the Export- Import Bank of China (Chexim). There is also another Chinese bond market that trades offshore, known as the “dim sum” market where International bond investors can buy bonds that clear through international clearing houses like Euroclear and Clearstream. The dim sum market was a natural outgrowth of the Chinese government granting Hong Kong-based banks the ability to take renminbi (RMB) deposits. As demand for RMB-denominated deposits grew, banks needed to invest the RMB deposits in RMB-denominated assets. At the same time, offshore companies, including Chinese companies that listed offshore were given the ability to issue bonds in RMB offshore. As supply and demand for offshore RMB-denominated bonds grew, the dim sum market also grew. Since the first dim sum bond was issued in 2007, it has grown into a US$75 billion (RMB 578 billion) market.
How have international investors been accessing China’s bond market?
The dim sum market is readily accessible and does not require local accounts or any additional local registration. Access to China’s onshore bond market has traditionally been granted through the country’s Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) programs. Since 2016, international investors have been able to access CIBM through a new scheme that is less onerous than QFII or RQFII, but still requires registration. The newly announced Mainland China-Hong Kong Bond Market Connect promises to further streamline this process. Expected to launch later this year, it is likely to give international investors access to China’s bond market.
Recently, both Citigroup and Bloomberg announced they would be making changes to some of their bond indices. Can you explain what those changes are?
Citigroup announced that it was adding Chinese onshore bonds to its emerging market and regional government bond indices, and creating a new version of its popular World Government Bond Index (WGBI), called WGBI-Extended, that doesn’t have strict rules against barriers to entry for investors. This follows Bloomberg’s move in January to launch a new version of its Global Aggregate (Global Aggregate + China) Index that includes Chinese onshore debt, and J.P. Morgan’s announcement in March 2016 that it was putting China under review for potential inclusion in its Government Bond Index-Emerging Markets (GBI-EM Broad).
What does the index inclusion mean for global investors?
The trend among established bond indices is clear. As China continues to liberalize its financial markets, mainstream benchmarks used by investors globally will move to bring onshore Chinese debt into indices. China is home to the world’s third-largest bond market, so it stands to become a large part of investors’ portfolios over the next few years. This means investors will need to gain deeper knowledge and understanding of the onshore bond market so they can effectively evaluate and invest in Chinese issuers.
What are some of the hurdles for global investors in allocating to Chinese debt?
Two challenges that offshore investors face are access to markets and pricing of risk. Barriers to entry are being lifted, but global investors still need to meet regulatory requirements outlined in the various schemes, to be able to buy and sell bonds onshore. Pricing risk in onshore bonds is another challenge that investors need to overcome. For the large portion of the market consisting of state-owned entities, credit analysis historically has been about understanding the policy priorities of the government, the strategic importance of the industry, and the strength of a company’s ties to the local, provincial, or central government. Companies will need to have disclosures and transparency for offshore investors to evaluate the potential risk and return of an investment.