Only a few days after the announcement that the Wealth Connect Scheme between mainland China and Hong Kong would officially launch in October, regulators unveiled a new initiative that could another boost for the Hong Kong bond market.

The Hong Kong Monetary Authority (HKMA) and the People’s Bank of China (PBoC) jointly announced yesterday (September 15) that southbound trading (from mainland to Hong Kong) under Bond Connect would launch on September 24. The move could see Chinese onshore investors acquiring more diversified assets for their offshore portfolios, especially those large institutional investors with large USD positions in hand.

The advent of southbound trading means the scheme finally expands in both directions, as had always been intended. The annual capital quota for southbound has been set at the equivalent of Rmb500 billion, with the daily quote set at Rmb20 billion.

Paula Chan, Manulife IM

Initially, experts believe offshore bonds from Chinese issuers were among the most compelling for onshore Chinese investors, who were familiar with the issuers because they had already launched domestic bonds.

“Within fixed income, we expect to see potential demand for Asian and China USD-denominated bonds. Asian/China credit enjoys a spread pick-up versus US and European credit with similar ratings and could be a good potential investment for investors looking for decent returns for their offshore assets. Fixed income will also remain attractive because of the stability they provide relative to higher risk assets, “Paula Chan, senior managing director and senior portfolio manager for Asia fixed income at Manulife Investment Management, told AsianInvestor, in an interview.

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ALL CONNECTING

Bond Connect allows investors from mainland China and overseas to trade in each other's bond markets through a market infrastructure linkage in Hong Kong. Northbound trading (Hong Kong to mainland China) commenced on July 3 2017, providing a broader group of international investors with access to China’s interbank bond market. The HKMA noted that more than 2,700 institutional investors from around the globe had participated in northbound trading in the four years since its launch.

Northbound trading was in August. Average daily turnover reached Rmb 26.3 billion, representing year-on-year growth of 35%. Monthly trading volume accumulated to Rmb 577.6 billion. Chinese government bonds and policy financial bonds remained the most popular tradable bond types, accounting for 47% and 42% of monthly trading volume respectively according to latest data from Bond Connect website.

Source: Bond Connect Website
Arthur Lau, PineBridge

MULTIPLE FUNCTIONS

“We see one key benefit of southbound connect which is that it offers onshore Chinese investors an extra option for currency hedging within their portfolios. Institutional investors will likely be the first movers given they’re already holding dollars, versus individuals who face a foreign exchange limitation,” according to Arthur Lau, head of Asia ex-Japan fixed income at PineBridge Investments, told AsianInvestor.

But strong inflows into offshore bonds could take time.

"The opening of two-way flows is likely to encourage improved liquidity of the Dim Sum bond market, and arbitrage opportunities across both offshore and onshore markets from an asset allocation perspective," Jason Pang, portfolio manager of JP Morgan China Bond Opportunities Fund, told AsianInvestor in an email.

He believes that given the less attractive yield, it could take time for investors to pour their capital into the market.

"As it stands, the offshore market yields (dim sum) are actually tighter vs. onshore Chinese Government bonds, as such it is unlikely we see big inflows to offshore at this juncture. However, this can change over time as the interbank liquidity differs somewhat in CNH vs. CNY markets."

The links between the capital markets in the two jurisdictions have strengthened in recent years.

Under Stock Connect, launched in 2014, Chinese investors can buy Hong Kong-traded stocks via the Shanghai Stock Exchange, while global capital can access Shanghai-listed Chinese stocks via Hong Kong.

Early entrants to the scheme are likely to be attracted to Hong Kong-listed fixed income products for currency hedging purposes as well.

Bond Connect, as well as Wealth Connect and Stock Connect, is part of the Chinese governmnent's vision for a financially integrated Greater Bay Area, which comprises nine cities on the southern Chinese mainland, Hong Kong and Macao. Insurance may be next as Hong Kong and mainland Chinese authorities were hammering out details for the introduction of an Insurance Connect scheme, according to a South China Morning Post report last summer, although no draft ideas have been produced so far.

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