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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The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Andre de Silva, CFA
Foreign exchange: Basis for financial analysis
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Definitions for currency trades on DFs and NDFs
Buy: refers to buying the first currency in the named pair in exchange for the second currency in the named pair.
Sell: refers to selling the first currency in the named pair in exchange for the second currency in the named pair.
The tenor of the instrument will be denoted and will refer to a settlement date relative to the opening date of the trade idea e.g. 1m refers to a settlement date 1 month forward from the open date of the trade idea. NDF trades normally fix two working days prior to the settlement date.
Distribution of currency trades
The nature of foreign exchange forward trade ideas is such that there will always be an equal number of buy and sell trades (buying one currency in exchange for selling another), both outstanding and historically.
Fixed income: Basis for financial analysis
This report is designed for, and should only be utilised by, institutional investors. Furthermore, HSBC believes an investor's decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other considerations.
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its fixed income research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies in corporate credit and based on country-specific ideas or themes that may affect the performance of these bonds in the case of covered bonds, in both cases on a six-month time horizon; 2) to identify trade ideas on a time horizon of up to four months, relating to specific instruments, which are predominantly derived from relative value considerations or driven by events and which, in the case of credit research, may differ from our long-term opinion on an issuer. Buy or Sell refer to a trade call to buy or sell that given instrument; HSBC has assigned a fundamental recommendation structure, as described below, only for its longer-term investment opportunities.
HSBC believes an investor's decision to buy or sell a bond should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of terms as well as different systems to describe their recommendations. Investors should carefully read the definitions of the recommendations used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the recommendation. In any case, recommendations should not be used or relied on in isolation as investment advice.
HSBC Global Research is not and does not hold itself out to be a Credit Rating Agency as defined under the Hong Kong Securities and Futures Ordinance.
Definitions for fundamental credit and covered bond recommendations
Overweight: For corporate credit, the issuer’s fundamental credit profile is expected to improve within the next six months. For covered bonds, the bonds issued in this country are expected to outperform those of the other countries in our coverage over the next six months.
Neutral: For corporate credit, the issuer’s fundamental credit profile is expected to remain stable for up to six months. For covered bonds, the bonds issued in this country are expected to perform in line with those of the other countries in our coverage over the next six months.
Underweight: For corporate credit, the issuer’s fundamental credit profile is expected to deteriorate within the next six months.
For covered bonds, the bonds issued in this country are expected to underperform those of other countries in our coverage over the next six months.
Definitions for trades (Rates & Credit)
Buy and Sell refer to a trade call to buy or sell a bond, option on an interest rate swap ("swaption"), interest rate cap or floor, inflation cap or floor, or Total Return Swap ("TRS"). The buyer/seller of a TRS receives/pays the total return of the underlying instrument or index at the end of the period and pays/receives the funding leg.
Buy protection and Sell protection refer to a credit default swap (CDS): the protection buyer/seller is effectively selling/buying the reference entity's credit risk.
Pay and receive refer to a trade call to pay or receive the fixed leg of an interest rate swap (IRS), a non-deliverable IRS, the firstnamed leg of a basis swap, the realised inflation leg of an inflation swap, or a forward rate agreement (FRA). An investor that executes a pay or receive trade is said to be "paid" or "received."
Payer and receiver refer to inflation caps or floors and to swaptions: a payer is an option giving the right but not the obligation to enter a paid position in an interest rate or inflation swap, and a receiver is an option giving the right but not the obligation to enter a received position in an interest rate or inflation swap.
ASW (also asset-swap, Buy on asset swap, Buy on an asset-swapped basis): Buy a bond packaged with a swap that is tailored to eliminate the bond’s interest rate risk, effectively transforming the bond to a floating rate instrument whilst preserving the credit exposure to the bond issuer.
RASW (also reverse asset-swap, Sell on asset swap, Sell on an asset swapped basis): Sell a bond packaged with a swap that is tailored to eliminate the bond’s interest rate risk, effectively transforming the bond to a floating rate instrument whilst preserving the credit exposure to the bond issuer.
Distribution of fundamental credit and covered bond recommendations
As of 15 September 2021, the distribution of all independent fundamental credit recommendations published by HSBC is as follows:
All Covered issuers Issuers to whom HSBC has provided Investment Banking in the past 12 months
Count Percentage Count Percentage
Overweight 114 25 64 56
Neutral 219 49 86 39
Underweight 115 26 40 35
For the purposes of the distribution above the following mapping structure is used: Overweight = Buy, Neutral = Hold and Underweight = Sell. For rating definitions under both models, please see "Definitions for fundamental credit and covered bond recommendations" above.
Distribution of trades
As of 30 June 2021, the distribution of all trades published by HSBC is as follows:
All Covered instruments Issuers to whom HSBC has provided Investment Banking in the past 12 months
Recommendation Count Percentage Count Percentage
Buy 142 76 84 59
Sell 44 24 22 50
For the purposes of the distribution above the following mapping structure is used: Buy/Sell protection/Receive/Buy Receiver/Sell Payer = Buy; and Sell/Buy protection/Pay/Buy Payer/Sell Receiver = Sell. ASW is counted as a buy of the bond and a paid swap, and RASW as a sell of the bond and a received swap. For rating definitions under both models, please see "Definitions for trades (Rates and Credit)" above.
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Recommendation changes for long-term investment opportunities
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