Opportunities rise amid Broader access to Markets
Chinese and foreign custodians stand to benefit from the proliferation of cross-border schemes
Since Bond Connect was launched in 2017, the new cross border fixed income investment channel has attracted a number of overseas institutional investors. According to Bond Connect Company, a joint venture created by the Hong Kong Stock Exchange and the China Foreign Exchange Trading System, the number of international investors using Bond Connect reached 400 as of August 15. 61% of accounts are opened by global asset management companies and fund managers.
According to the latest Asian Local Currency Bond survey conducted by Asset Benchmark Research (ABR), the number of investors who are planning to use Bond Connect are 1.6 times that of CIBM Direct. Yet the total number of international investors subscribing to CIBM Direct is 1.2 times that of Bond Connect.
One key issue which was recently solved in Bond Connect is the delivery-versus-payment (DVP) settlement, which has been in place in domestic China market for a few years. However, for cross-border transactions, it took more than one year for DVP to be available. “For Bond Connect, we are not looking into it yet because the process is not yet DVP. A lot of UCITS funds or CSSF funds have not approved Bond Connect yet,” said one large foreign asset manager prior to the launch of DVP.
Delivery-versus-payment (DVP) settlement has been fully implemented in Bond Connect starting from August 24. All trades under the Bond Connect are now settled on a DVP basis.
In addition, Bond Connect launched block trade allocations in late August, which allows asset managers to allocate block trades to multiple client accounts prior to the trades. With the pre-trade allocations function, traders can execute a single block trade and allocate specific percentages or amounts of the trade to up to 30 individual accounts.
The launch of block trade allocations marks an important step forward for Bond Connect to enhance the scheme in terms of trading workflows and operational efficiencies. Buy-side investors are able to implement their trading strategy without spending additional time to manage the blocks. The adoption of block trade allocations is the second of the three conditions from Bloomberg Barclays index inclusion that have been met within a week after the recent full implementation of DVP. These developments are expected to accelerate the participation in Bond Connect by global asset managers and investors.
In August, the State Council announced interest income by overseas institutions from investments in the onshore bond market will be exempt from income and value-added taxes. The tax exemption period is tentatively set for three years.
As the implementation of DVP, launch of block trade allocation and tax exemptions remove obstacles for overseas investors, it is expected that foreign investors will increasingly shift to Bond Connect as a more efficient channel once the DVP is completed.
“If some of the hurdles are removed, we will move to Bond Connect. The ease of processing, the turnaround time are a lot easier under Bond Connect. The Bond Connect is an easy route for foreign investors,” comments another portfolio manager at a European asset management.
Another issue with Bond Connect is the funding of CNY for global custodians. “There’s the issue with the access with CNY. The global custodians haven’t figured out how to manage the trade flow for the funding for CNY,” said a Singapore institutional investor.
Meanwhile, CIBM remains attractive for several reasons. First, it allows investors to trade a wider range of hedging tools such as interest rate swaps and forward rate agreements. “We choose CIBM because of the availability of instruments,” said one institutional investor based in Singapore.
A more substantial benefit of using CIBM Direct is the exposure of onshore bond market information. “The problem with Tradeweb (the trading platform for bond connect) is that you seldom get information about the onshore bond market as you are not communicating with traders and sales in person over the counter. I believe CIBM Direct offers us more exposure to the onshore bond market. And in fact, we trade more often via CIBM than Bond Connect. 80% of our trade in onshore bond market are made through CIBM Direct,” a Taiwan based investor explained.
Overall, to foreign investors, global custodian banks are still the preferred banks when it comes to access to China onshore bond market. “Optionality is key. Currently, I would say the landscape is dominated by foreign banks because the connectivity of global custodian is key,” says a global asset manager based in Hong Kong.
Yet, their attitudes are changing. In the ABR study, 55% of respondents have already or may consider appointing local/regional custodians as opposed to relying on global custodians.
As MSCI officially included China’s A-shares into its emerging market index, overseas asset managers especially passive funds have been increasing their allocation to China’s domestic shares. The elimination of the total quota and the expansion of the daily quota paves the way for more institutional investors to increase exposure to the second largest stock market.
Overall, 66% of respondents say they use the Shanghai-Hong Kong Stock Connect. This percentage is up from 45% of last year’s respondents. Further, 63% of respondents use Shenzhen-Hong Kong Stock Connect.
The survey reveals that the scheme is more popular among overseas-based respondents, of which 57% use it to trade mainland listed stocks. In the survey conducted last year, more mainland investors used the scheme as opposed to overseas investors. None of our respondents short sell stocks on the Stock Connect schemes.
Pre-delivery risk was noted as the largest obstacle that hindered use of the Shanghai Hong Kong Stock Connect, followed by liquidity and settlement cycle.
Among the 34% of respondents that do not use the Connect, most simply do not see a business case. This view is especially prevalent across overseas-based investors. Other major reasons include the requirement for pre-notification of trades and existing QFII access that already covers their needs.
One respondent of a large institutional investor based in Philippines says that their remaining QFII quota has not yet been exhausted, hence a need to use the new link has not arisen. Another respondent which does use the link responds that they “still don’t have a policy for investing in that market”, implying that a wait-and-see attitude is still common among overseas investors.
Market infrastructure builders such as global custodian banks are also eyeing the opportunities from the MSCI inclusion. BNY Mellon is the first triparty agent to provide collateral services for securities settled through Hong Kong (HK) Stock Connect, supporting growing cross-border trade volumes into and out of mainland China. The bespoke solution expands the range of eligible collateral available to investors, just as international interest in Stock Connect gathers steam.
Hong Kong Exchanges and Clearing Limited (HKEX) on August 24 announced the launch details of the investor identification model for Northbound trading through its mutual stock market access programme with the exchanges in Shanghai and Shenzhen. The model was launched on 26 September 2018.
The article is based on a report on custody services by Asset Benchmark Research in association with Bank of Communications.