What Will China's New Bond Connect Program Offer International Bond Investors? 1

China to opens its doors wider to international bond investors

The Chinese government has given its consent for the Hong Kong-China Bond Connect scheme to be launched this year. The cross-border bond scheme would allow foreign investors to access China’s onshore bond market (DSUM) (KCNY) via Hong Kong (EWH). Eligible investors would include central banks, sovereign wealth funds, international banks, and medium to long-term institutional investors.

Over the last two decades, authorities in China (FXI) (YINN) have taken numerous steps to make its onshore sovereign and corporate bond market available to foreign investors:

  • In 2002, the country introduced the Qualified Foreign Institutional Investors (QFII) scheme.
  • This was followed by the RMB Qualified Foreign Institutional Investors (RQFII) scheme in 2011.
  • Later in 2016, China made a significant move by opening up the China Interbank Bond Market (CIBM) which allowed some foreign investors to access the market directly. This scheme mainly dealt with the removal of quotas, lock-up periods, and repatriation limits of QFII and RQFII scheme.

New scheme to enable hedging currency risk while investing in the onshore bond market

The new China Bond Connect scheme will allow foreign investors to hedge currency risk in onshore derivative markets. In addition to this, the scheme can also help in easing the domestic outflow pressure by attracting long-term foreign investors. Arthur Lau, co-head of emerging market fixed income and head of Asia (ex-Japan) fixed income at Pine Bridge Investments, believes that the investors will mainly invest in government bonds and policy bond banks focusing more on the foreign exchange market and rates.

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Rating downgrade to have little impact on China’s bond market

On May 24th, credit rating agency Moody’s Investor Service changed China’s outlook from stable to negative, while downgrading China’s sovereign debt rating from Aa3 to A1. According to Moody’s, the alarming debt situation in the economy could affect the financial soundness of the country in the future. However, the rating downgrade is expected to have a negligible impact on China’s bond market, since the market is currently dominated by the local investors. Moreover, despite the downgrade, the country’s sovereign debt rating remains higher than other Asian (AAXJ) (VPL) countries that have higher participation in the global debt market (BNDX) (VWOB).

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