It has long been mooted that a bond-trading link between China and Hong Kong would follow the Stock Connect that has been in place for two years. But now a proposal is on the table, some feel it would be little more than a sideshow to the main event: the opening of the China interbank bond market (CIBM) to foreign institutional investors.
A retail-focused Bond Connect, as proposed this week by Hong Kong's Financial Services Development Council (FSDC), "could become a distraction for little real benefit”, argued Mark Austen, chief executive of the Asia Securities Industry & Financial Markets Association (Asifma).
“It is doubtful that such a connection will bring large additional flows,” he said. “In bond markets around the world the primary investors are institutional, and there generally is little retail participation.”
Presently 92% of $8.7 trillion domestic bonds are traded on the CIBM while the rest are traded on the Shanghai and Shenzhen bourses. The bulk of investments in the market are expected to come from overseas institutions.
Moreover, retail investors in Hong Kong may not be able to appropriately assess the risks of the mainland debt market, with widespread expectations that credit defaults are set to rise in China, added Austen. Hence there are likely to be substantial constraints on the debt securities they can buy.
"Adding retail investors to the market but with caveats around what they can invest in is fine, but the fact is we don't expect it to generate a very large take-up," he noted.
Hong Kong retail investors can only access Chinese bonds indirectly through funds that invest via cross-border schemes such as the qualified foreign institutional investor (QFII) programme and its renminbi-equivalent (RQFII). The FSDC said the Bond Connect would expand investment channels for the retail segment.
But Austen said the question remained as to whether retail investors could navigate the risks associated with rising credit defaults in China -- or whether they would be even allowed to.
“We are not sure they [the Hong Kong Securities and Futures Commission] would be willing to approve a scheme whereby retail may lose 100% of their investment on a default, especially where the regulatory structure and investor protection still has some way to develop in China,” said Austen, who is based in Hong Kong.
The FSDC has proposed that Hong Kong retail investors should be allowed to invest in bond securities available to mainland retail investors, who can only buy “large public offering bonds”.
The issuers of such bonds must have a credit rating of AAA and a minimum annual average net after-tax profit of at least 1.5 times the annual bond interest payments, with no record of default or delayed payments over the past three years.
Access to HK bonds
The proposed Connect would also provide Chinese investors with much-needed access to the $400 billion Hong Kong debt market, said the FSDC. Domestic investors can only access foreign bonds via the qualified domestic institutional investor (QDII) scheme, which has been suspended since last April.
In any case, less than 3% of the $90 billion of QDII quota are can be used for bond-only funds, while only two fixed income products have so far been approved under the mutual recognition of fund programme, the paper said.
Moreover, the FSDC noted that Chinese demand for foreign bonds had grown further recently in light of renminbi depreciation and the sluggish mainland equity market. For instance, China Asset Management raised Rmb1.9 billion for a QDII bond fund in just one day in July, .
Yet how much access to Hong Kong's debt market will help mainland investors obtain global exposure is another question.