Fund managers are weighing the impact of Chinese bonds being included in global fixed-income benchmarks, which they see as likely to happen this year thanks to the further opening of the mainland interbank bond market (IBB) last month. The designation of the renminbi as a global reserve currency this year has also raised expectations.
Admittedly, questions remain over details such as capital remittance and how to convert offshore money into onshore renminbi, but Chinese authorities are expected to provide details in the coming weeks.
This comes alongside Beijing's push for the inclusion of local A-shares in the MSCI EM index series, with industry observers tipping an announcement as early as this year that implementation will take place in 2017.
Inclusion in JP Morgan's emerging-market government bond index (GBI-EM) and Citi's World Global Bond Index (WGBI) would attract $138 billion of flows into products referencing them, estimates Nicolas Jaquier, EM economist at UK-based Standard Life Investments. This is based on his calculation that Chinese bonds would account for 10% of the JPM GBI-EM and about 6% of the Citi WGBI, which have $180 billion and $2 trillion of assets managed against them, respectively.
The JP Morgan GBI-EM is tipped to be the first of its peers to make the move, with the timing of inclusion dependent on benchmarks' criteria. The US bank reportedly said in mid-March that it was reviewing Chinese bond inclusion in the index. The criteria for entering the Citi WGBI are seen as stricter, so that is expected to come later. The third key global bond index is the Barclays Capital global aggregate.
Manu George, Singapore-based Asian fixed-income investment director at UK asset manager Schroders, expects Chinese bonds to be included in at least two key global benchmarks before the end of 2016, agreeing that JP Morgan GBI-EM would be the first mover.
The Yield Book, a subsidiary of Citi's index business, said this month: "We will continue to monitor market developments resulting from the recent regulatory changes and to assess China's eligibility for inclusion into our international indices."
A country must satisfy three criteria for WGBI inclusion: a bond market of at least $50 billion, a credit rating of As from Standard & Poor's and A3 from Moody's, and a lack of barriers to entry.
Another executive tipping mainland bonds to enter global indices this year is Jan Dehn, head of research at EM fund house Ashmore. "This will probably be the most important event in fixed income for decades.
"It was a game changer when they dropped the [IBB] quota system a few weeks ago," added Dehn, noting that the mainland fixed income market stands at $7.4 trillion, around 40% of US GDP, according to Deutsche Bank. "And when [China is] in the global indices, people will have to buy. This will reverse the capital outflow we're currently seeing from China."
Luke Spaijc, a Singapore-based portfolio manager at fixed income specialist Pimco, was a little more circumspect, saying that Chinese bonds would be included in global major indices in the next year or two. In light of this, and the possible inclusion of A-shares in the MSCI global EM index series this year, he said foreign investors were moving quickly to trade in China.
Once inclusion is announced, the JPM GBI-EM usually incorporates new markets at a pace of 1% a month after implementation, so it is likely to take 10 months for full inclusion, noted Jaquier. "It could eventually entail some significant shifts in global investors. It will create opportunities for foreign investors, but they will have to remain selective within the large corporate bond market."
Schroders' George said any investments in or overweighting of Chinese bonds would depend on the yields and macro conditions prevailing at the time of inclusion. Meanwhile, Pimco's Spajic said foreign investors would most likely target local corporate credit to add yield.
Chinese seven-year AA corporate bonds are yielding 4.61%, as against 3.32% for the Barclays global aggregate's average yield-to-maturity (6.28 years average duration).
Standard Chartered estimates that China's IBB market will more than double to Rmb10.5 trillion ($1.62 trillion) by 2020 from Rmb4.8 trillion as the end of 2014, and that foreign investors will hold 7% of IBB bonds in China by then, up from 1.6% in 2014.
The big catalyst for this will be last month's removal of quota controls for foreign institutions, including asset managers (except hedge funds), for accessing the mainland IBB market, which accounts for 93% of Chinese onshore bonds traded.
Additional reporting by Joe Marsh.