As Shanghai-Hong Kong Stock Connect celebrates its 10-year anniversary, the momentum behind access schemes – from equities to bonds to ETFs, and now derivatives and financing – as preferred channels for offshore investors to tap Mainland China’s financial markets is gathering pace.
The China fixed income landscape is particularly appealing, especially given its relatively stable risk-adjusted returns. And for investors, a longer-term view of the market is essential rather than judging current yield levels compared with other markets.
“A lot of international investors are building up Renminbi (RMB) assets and exposure, especially in government bonds given the liquidity, and they want to use similar hedging strategies as in other international markets,” said William Shek, Head of Markets and Securities Services for HSBC in Hong Kong, and also Head of FX, EM Rates & Commodities, Debt Trading and Financing in Asia Pacific.
China’s recent reforms are creating a firmer foundation for sustainable growth as global investors seek out attractive and diversified returns to manoeuvre the macroeconomic environment.
Various policy measures introduced in Hong Kong and the Mainland in 2024 to date continue to build market access and investor momentum, including:
- In January – expanding the eligible collateral for the Hong Kong Monetary Authority's RMB Liquidity Facility to include onshore bonds, and announced the further opening of the onshore repurchase market
- In May – enhancing Swap Connect by introducing International Monetary Market (IMM) trades based on IMM dates, as well as a solo compression service and back-dated trades
- In July – supporting offshore investors using onshore China government bonds (CGBs) held under Northbound Bond Connect as margin collateral for Swap Connect transactions
In short, such initiatives are boosting the investment and allocation value of RMB-denominated assets to international investors, with Hong Kong playing a key role as an effective gateway to China and also as a RMB risk management hub.
“A driver for some of these measures is to be increasingly in line with familiar international practices and make it more appealing for offshore fixed income investors to access the onshore bond and derivatives market,” explained Shek. “They can now benefit from reduced liquidity costs, more capital efficiency for Swap Connect and greater choice of non-cash collateral.”
Four ways for global investors to benefit from access to China
1. Sourcing alpha in new ways
Investors welcome the schemes and recent policy measures because these create more options for how to manage fixed income portfolios.
Some offshore bond buyers, for example, can now trade CGB futures from Hong Kong. This makes it more efficient for them to hedge interest rates. In turn, they can position the overall portfolio better and act more quickly in response to shifting macro dynamics.
2. Participating in a more liquid market
The Northbound Bond Connect scheme already offers efficient access to the onshore bond market – the average daily turnover between January and July 2024 surpassed RMB44 billion ($6 billion), with 825 approved institutional investors as at the end of July1.
Yet initiatives announced this year such as the use of onshore bonds as collateral in the offshore markets creates new liquidity management tools that will entice more global investors.
3. Diversifying via onshore bonds
Looking at foreign flows into China's bond market, from January 2024 to the end of July 2024, Northbound Bond Connect trading volume surpassed RMB6.5 trillion2.
Apart from performance from returns due to FX hedging as a key driver for these flows, another stems from the low correlation with US interest rates, which provides a diversification benefit that trading onshore China bonds can create for offshore portfolios.
4. Deploying new risk management tools
Plans to open the onshore repo markets to all foreign investors in the China Interbank Bond Market (CIBM), via both CIBM Direct and Bond Connect, will enable global portfolios to better manage risk.
Another key initiative to give investors new risk management tools involves a more convenient channel to trade interest rate swap products onshore. At the same time, offshore treasury bond futures are expected to be available in Hong Kong at some point soon, and would give global investors a way to more efficiently hedge interest rate risks arising from onshore bond allocations, plus use additional strategies such as cash bonds versus futures.
Boosting swap-related China flows
To build on collaboration between regulatory authorities in Hong Kong and Mainland China, there is scope to evolve access schemes to accommodate needs and requests from global investors.
“There is a disciplined and consistent approach to developing new schemes and then enhancing them based on market feedback,” said HSBC’s Shek.
For example, there are opportunities to further enhance Swap Connect. The success in the offshore interest rate swap market, especially for US dollar swaps, bodes well for the introduction of multilateral compression. Notably, this would create more opportunities for offshore investors to optimise their portfolios.
Other possibilities include expanding product coverage, such as by extending the tenor for interest rate swaps beyond the current 10-year limit, or also the possibility of adding more products such as cross-currency swaps.
Making long-term China bond allocations pay
With greater access to onshore bonds combined with strategies and tools to manage allocations, China fixed income has the potential to become a more viable asset class in which to deploy funds.
Ultimately, while offshore investors must monitor developments as new policy measures are announced, agility and dynamism are key to navigating the onshore bond opportunity.
Sources
1 - https://www.chinabondconnect.com/en/Resource/Market-Data.html
2 - https://www.chinabondconnect.com/en/Resource/Market-Data.html
