Acquisition by LSE could increase demand for China bonds

London Stock Exchange's acquisition of Citigroup's fixed income analytics unit may accelerate the inclusion of Chinese bonds on Citi's main bond indexes, analysts in London said on Tuesday after LSE announced the $685 million purchase.

"It will push index inclusion forward, because business with China will be a bigger part of LSE's business than it will be as part of Citi's business," said Jan Dehn, head of research at London-based Ashmore Investment Management.

Currently, China's $7 trillion inter-bank bond market is the third-largest in the world, but foreign ownership is less than two percent, much lower than other key emerging markets' average of 20 to 30 percent.

This mismatch points to opportunities for foreign investors to buy Chinese bonds for appreciation and risk diversification, but momentum has not yet picked up because the big three global indexes – Citi, Barclays, and JP Morgan – have not yet started to include Chinese bonds in their much-tracked main indexes.

Dehn said LSE could now be bidding to win first-mover advantage. "Once one major index provider gets serious, the others will have to follow or risk losing market share. Usually, markets end up with just one benchmark index as the dominant one."

LSE has focused on cementing greater China links in recent years. In 2015, the bourse's own index arm FTSE Russell became the first famous foreign index provider to start tracking China's onshore bond market. A feasibility study to link the London and Shanghai stock exchanges is underway, and 19 exchange-traded funds tracking Chinese stocks and bonds are already traded on LSE.

One example is the Fullgoal FTSE China Onshore Sovereign and Policy Bank Bond 1-10 Year Index ETF, launched on the London Stock Exchange in 2016.

So far,Fullgoal's ETF has only attracted 8 million euros ($9 million) worth of international investment, but Fullgoal Asset Management's head of international business, Michael Chow, said the "potential is huge" when index inclusion happens.

"Without index inclusion, it's hard to get international investors interested, but we firmly believe inclusion will be sooner, rather than later."

Chow agreed with Dehn about the likely impact of the LSE's acquisition, adding that index inclusion acceleration may lead to synergy achieved between FTSE Russell and Citi's index teams.

Others disagree. "I would not expect inclusion criteria to be relaxed just because the owner has changed," said Wilfred Wee, a portfolio manager at London-based Investec, who explained that index inclusion still requires Chinese bonds to have easier foreign access, simpler operational requirements, and more conventional trade settlement procedures.