Eligible institutional investors in mainland China can now invest in Hong Kong’s bond market through a new Southbound Bond Connect that should boost cross-border use of the renminbi and accelerate its role as an investment currency.

The new ‘southbound’ link follows the 2017 launch of a Northbound Bond Connect that significantly boosted international investors’ access to onshore China bonds. Together they provide a two-way street for liberalising mainland China’s capital-account. For share investors, the Shanghai-HK Stock Connect opened in 2014 with the Shenzhen-HK Stock Connect added in 2016. And a retail-focused Wealth Connect was also launched in September 2021.

Hong Kong’s bond market is worth about USD300 billion, mainly denominated in Hong Kong dollars and renminbi. Initially the link will cover those currencies but issues in US, Australian and New Zealand dollar, plus euro and Macau paraca bonds, will eventually be included. And to manage the magnitude of the cross-border flows, a daily quota of RMB20 billion (USD3 billion) has been set, plus a RMB500 billion annual quota.

Two-thirds of the HK-dollar bonds have maturities of less than a year and almost half the renminbi bonds mature within three years. These short-dated instruments will likely make the Southbound Bond Connect attractive to banks and fund managers while insurance companies stay with the onshore bond market, where longer duration central and local government bonds are readily available.

But the bond market’s much smaller size means Southbound Bond Connect volumes will probably be small compared with the Southbound Stock Connect, where inflows into Hong Kong’s stockmarket totalled HKD1.84 trillion between 2017 and 2020.

These latest launches show that Beijing is continuing its stance of deeper integration with the rest of the world, despite geopolitical tensions and the pandemic. Mainland China’s external assets are only 50 per cent of GDP and liabilities just 40 per cent, compared with over 100 per cent in developed markets, including the US, Eurozone and Japan.

But as Chinese investors become more sophisticated, they are demanding more diverse financial products, including global bonds. The Southbound Bond Connect advances capital-account liberalisation.

Connect schemes’ infrastructure can be expanded swiftly to increase cross-border flows after their trial stage. Daily quotas for the Shanghai-HK and Shenzhen-HK Stock Connect were steadily relaxed, with some abolished.

Since the Northbound Bond Connect began, the number of users and trading volume has grown significantly. There are now 2,730 investors from at least 34 jurisdictions, compared with 288 investors in March 2018. Monthly trading turnover had increased from RMB62 billion to RMB578 billion by August 2021 with most foreign investors’ onshore China bond trades now made through the Connect link.

Improving international investors’ access to China government bonds is leading to their gradual inclusion in the FTSE-Russell World World Government Bond Index, which could bring a further USD130 billion into the market over three years.

Meanwhile, continuous improvement to the Bond Connect scheme has seen block-trading permitted, the settlement cycle extended, new e-platforms added and the number of market-makers increased to 56 from an initial 20, permitting more efficient pricing. Derivatives such as interest-rate swaps could follow.

First published 16th September 2021.

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