Bond market investors get more reasons to cheer

China has taken yet another step in opening up its bond market, with offshore investors set to receive permission to use onshore bonds — held under the northbound leg of the Bond Connect program — as margin collateral for the derivative trading-based Swap Connect.

The People's Bank of China, the country's central bank, announced the plan during the Bond Connect Anniversary Summit 2024 held in Hong Kong on Tuesday.

The Bond Connect program links the bond markets of the Chinese mainland and Hong Kong, and its northbound leg provides international investors access to the Chinese onshore bond market. Launched in May 2023, the Swap Connect links the Hong Kong and Chinese mainland interbank interest rate swap markets.

OTC Clear, the clearing subsidiary under Hong Kong Exchanges and Clearing Ltd (HKEX), will start accepting these instruments as collateral for Swap Connect by the end of this year, HKEX said in an announcement on Tuesday.

While cash is the major source of collateral for Swap Connect at present, the new measure will provide overseas investors an additional choice, reducing their liquidity cost and improving capital efficiency, the Hong Kong Monetary Authority (HKMA) said in a circular on Tuesday.

In February, onshore government bonds and bonds issued by policy banks were approved as collateral for the HKMA's RMB Liquidity Facility. Under this arrangement, Hong Kong banks entering the onshore bond market can pledge such bonds held via the northbound leg of the Bond Connect program to the HKMA for intraday and overnight RMB funds, meeting their short-term capital demand.

John Thang, a regional head of markets for Standard Chartered, said the new measure will help energize onshore bond assets held by overseas investors, further elevating the appeal of onshore bonds.

The new arrangement comes at a time when foreign capital is flowing into the Chinese onshore bond market, with net capital inflows seen for nine consecutive months as of May, Thang said.

The rise has been more noticeable in May, more than doubling from April's number to 172 billion yuan ($23.7 billion), according to estimates by Stan Chart.

The optimization of the connect programs amid continued interest by international investors in the Chinese onshore bond market reflects the regulators' resolve to further open up the Chinese mainland financial market in an orderly manner, he added.

According to Bond Connect Company Ltd, the manager of the Bond Connect and Swap Connect programs, more than 1,100 institutions from over 70 countries and regions have entered the China interbank bond market as of the end of May.

Foreign holdings in China's bond market have reached 4.3 trillion yuan, an average annual growth rate of nearly 20 percent during the past five years.

As of the end of May, the northbound leg of the Swap Connect has attracted 61 participating foreign institutions, with over 4,300 transactions and a total nominal principal of about 2.2 trillion yuan.

Bonnie Y Chan, chief executive officer of HKEX, however, said that China's onshore bond market remains significantly underinvested by global investors although it is the world's second-largest in terms of size.

Foreign investors only account for about 3 percent of the onshore bond market's trading, which is incongruent with China's economic size. In this sense, there is still much room for growth, including the further expansion of the connect programs, she said.

Chan also said during Tuesday's summit that the HKEX is preparing to launch 10-year government bond futures.

This will serve as an important tool for international investors to manage the interest rate risks of RMB assets, further attracting the participation of foreign investors in the Chinese bond market, she added.