PBoC, HKMA announce how Bond Connect will work

The joint announcement by the People’s Bank of China (PBOC) and the Hong Kong Monetary Authority (HKMA) on the much-awaited Bond Connect between the bond markets of Hong Kong and mainland China was a significant step in the right direction. However, further details will have to be worked out before the new platform can go full-steam ahead.

Initially, the Bond Connect will allow Hong Kong and overseas investors to invest in the Chinese interbank bond market (CIBM) through mutual access between the Hong Kong and mainland financial institutions. This direction of investment (from Hong Kong, going north to China) is known as northbound trading. There will be no investment quota for northbound trading.

“The latest Bond Connect development and announcement have been more favourable than previously expected, mainly because the bond connect would cover the interbank market and with NO quota. That’s basically a full opening up of the onshore bond market to foreign investors, signifying another meaningful progress in the renminbi internationalization agenda by the Chinese government,” says Gregory Suen, investment director of fixed income at HSBC Global Asset Management.

Further, for northbound trading, the Bond Connect will use trading, custody, settlement, and other financial infrastructure that is common to Hong Kong and the mainland. But the announcement is silent on how this will work in practice.

Investment from the mainland to Hong Kong, also known as southbound trading, will be introduced later. “Mainland investors are to invest in the Hong Kong bond market through mutual access between the financial infrastructure institutions of the two places,” says the joint announcement.

In terms of operations, the Bond Connect will abide by the relevant laws and regulations of the bond markets of Hong Kong and the mainland. Northbound trading will follow the current policy framework for overseas participation in the CIBM and at the same time respect international norms and practices.

The scope of eligible investors and products under northbound trading will be consistent with the scope specified in the relevant notices promulgated by the PBoC.

On the issue of risk management, the PBoC and the HKMA say they will take all necessary measures to establish, in the interest of investor protection, effective mechanisms under Bond Connect to respond to any misconduct in a timely manner.

PBoC and HKMA will also enter into a memorandum of understanding to establish effective supervisory cooperation arrangements and liaison mechanisms in order to maintain financial market stability and fair trading, says the joint statement.

While the joint announcement provides some insights into how the Bond Connect will work, analysts say more details have to be announced.

“We cannot assume Bond Connect will work identically to Stock Connect. There are different ways to trade bonds in the China market, and they are typically traded over-the-counter today. There is quite a way to go to define what the Bond Connect model will look like. For example, how they will price discovery, execution and settlement look,” says Matthew Chan, head of institutional trade processing & data services, APAC, with the Depository Trust & Clearing Corporation (DTCC).

Nevertheless, the launch of the Bond Connect scheme is seen as an exciting development by market analysts who welcome it as a means of expanding access to the Chinese onshore bond markets.

“Bond Connect is likely to increase global investors' participation in onshore bonds over the medium- to long-term. The various schemes to access the onshore bond markets offer portfolio managers great flexibility to invest in the world’s third-largest bond market,” says Bryan Collins, fixed income portfolio manager at Fidelity International.

“Given how simple the process appears to be (operational details still need to be confirmed), we expect more new investors would try to get involved in the onshore market,” agrees Suen. “The current exposure of foreign investors is still very small and has lots of room to grow, especially as there have been more noises about index inclusion of the onshore bond market.”

Investors and asset managers generally view the Chinese bond markets as a growing asset class that offers attractive yields because it has a low correlation with other asset classes and currencies.

“With expanding access, coupled with the strong investment case, Chinese onshore bonds will attract more capital inflows and participation from global investors,” says Collins.

According to Barnaby Nelson, regional head of securities services, Greater China & North Asia at Standard Chartered Bank, “We view it [the Bond Connect announcement] as an extremely positive development – especially in the context of index inclusion. CIBM Direct is a strong and extremely viable mechanism – and we believe that it will continue to be attractive to major institutional investors.”

“The Bond Connect will provide a parallel channel for accessing the China bond markets during a period when over US$300 billion of AUM will be rebalanced into CIBM as a result of index inclusion decisions. During that period, ease and speed of access will be key, and so the Connect may offer valuable scale for investors who already have brokers and custodian relationships live in Hong Kong,” continues Nelson.

“Further ahead, it is possible that the Bond Connect could also offer two additional benefits, namely retail participation, and enabling CIBM bonds to be eligible as collateral in Euroclear / Clearstream. Neither of these appear to be part of the day-one plans.”