Swap Connect to enhance liquidity of China-HK Bond Connect

The new Swap Connect, which will be launched in six months’ time, will provide one more hedging tool for offshore Chinese bondholders under the China-Hong Kong Bond Connect.
Swap Connect to enhance liquidity of China-HK Bond Connect

The liquidity of the Bond Connect between Hong Kong and mainland China will be enhanced as regulators from both sides on Monday announced the imminent granting of access to interest rate swaps (IRS) trading in the onshore market, for offshore investors.

This is the first time that the financial infrastructure between Hong Kong and mainland has been expanded to cover derivatives, following the launch of cross-border stock and bond trading. The swap initiative launched on the first working day after the special administrative region celebrated the 25th anniversary of its return to China on July 1.

“The northbound Swap Connect will be useful for those who have large offshore Renminbi (RMB) liabilities. They can have one more derivative choice to manage their asset-liability duration mismatch. It is ‘one more’ because today they can use offshore derivatives like the offshore yuan (CNH) swap or non-deliverable onshore yuan (CNY) IRS,” the Hong Kong-based chief investment officer of an international life insurance company told AsianInvestor.

The Swap Connect will be launched after six months of preparation, according to a joint announcement of the People’s Bank of China (PBOC), the Hong Kong Securities and Futures Commission (SFC), and the Hong Kong Monetary Authority (HKMA) on Monday.

Under the scheme, overseas bondholders can trade in the mainland interbank financial derivatives market and hedge their risks. Initially, only northbound interest rate swaps will be available. Other products will be included in due course depending on market conditions, according to the announcement.

Darryl Chan, HKMA

“Derivatives are a very important part of the further opening up of the onshore market in the next step,” said Darryl Chan, executive director at HKMA.

Currently, Bond Connect only allows spot transactions. “For all bond markets, derivatives are very important for risk management. I think the swap we announced today is a breakthrough,” he told a panel discussion celebrating the 5th anniversary of the launch of Bond Connect in 2017.

Noting that the interest rate swap is a relatively short-term tool, Chan said that up next, HKMA will strive to provide offshore bondholders more access to long-term tools, such as bond futures, including government bond futures, which are popular among investors.

He said favourable arrangements on buyback will also be studied for investors to better manage liquidity. “More choices on risk management will encourage longer holding periods, which in return helps to reduce fluctuation.”

“The availability of more hedging tools will definitely help liquidity,” said William Liu, Asia managing partner at law firm Linklaters, during the same event.


As of the end of May, foreign holdings of Chinese bonds were 3.66 trillion yuan ($546.5 billion), accounting for only 2.7% of China’s bond market. The northbound Bond Connect contributed to about 60% of the trading volume of overseas investments in the mainland interbank bond market.

Over the past three years, the annual growth rate of China’s bond market was 18%, surpassing the global average of 8%.

However, since the beginning of 2022, foreign investors have been cutting their positions amid a narrowed interest differential, a strong US dollar, and geopolitical risks.

But in the long term, it is believed that Chinese bonds can still offer diversification benefits to investors.

Edmund Ng, 
Eastfort Asset Management

“Total return is very important for investors. So the interest rate environment has to be more stable. I think China has a much more stable environment as compared to most of the other major bond markets, as they are going through a rate hike cycle while China is either neutral or still going on an accommodative mode,” said Edmund Ng, CIO of Eastfort Asset Management.

“So, in that case, from a total return on the bond side, I would say China has that benefit,” Ng, who had been head of the direct investment division at HKMA for eight years until 2015, said during the Bond Connect event.

But on the currency side, as the RMB had depreciated against the US dollar by about 4.5% so far this year, the return of Chinese bonds will be affected, Ng noted.

For dollar-based investors, the US Treasury will probably still be preferred to avoid volatility as the stronger dollar trend continues, he said.

“For non dollar-based investors, that's a different story. Because the RMB has been outperforming most of the other currencies with a more stable bond environment. I would say that these two factors combined are actually a positive to a total return of allocating more or diversifying into the China bond market,” Ng said. 

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