03 Jul Happy Birthday, Bond Connect

Authors: Ann Rutledge (CSC); Wang Huan (汪欢,夏门国金), Chen Bolin (陈伯霖,夏门国金); Bolun Deng (CSC); Nancy Jiang (CSC), Amber Chen (CSC)

Bond Connect (债券通) opened for business July 3, 2017. If you’re like us, you’ve read about it dozens of times but still may not have a clear idea of how it works or why it exists. You may also have read about the macroeconomic uncertainty rippling through China’s capital markets this week and may be wondering what it means for China’s debt market generally. The authors believe, temporary volatility notwithstanding, Bond Connect will have a decisive impact on China’s domestic bond price formation going forward. To celebrate Bond Connect’s first anniversary, CreditSpectrum Corp. and XFinTech (夏金国金) authors have assembled an FAQ of key information about Bond Connect.

1.      What is Bond Connect? What does it connect?

Bond Connect (in Chinese 债券通) refers both to a trading architecture and a limited liability company based in Hong Kong. As a trading architecture, Bond Connect provides mutual market access to qualified Chinese and overseas institutional investors by linking Hong Kong Exchanges and Clearing Ltd (HKEx) to major Chinese debt capital market platforms. Bond Connect Company Limited (BCCL) is the operating company jointly owned by the China Foreign Exchange Trade System (CFETS) (60%) and HKEx (40%).

2.      What is the vision for Bond Connect?

Similar in concept to Shanghai-Hong Kong Stock Connect (沪港通, November 2014) for equities, Bond Connect is a controlled experiment in China’s bond market liberalization. Currently, only “Northbound” trade into China’s domestic markets is permitted, but not as yet (“Southbound”) trade into offshore accounts.

China’s domestic bond markets are the world’s third-largest, after the U.S. and Japan. China nurtured their development from 1981-2010 under a shroud of protection. However, since 2011, China has modernized its fixed income product platform to include a securitization channel; created laws that favor capital market formation and market discipline; and embarked on a determined, phased approach to currency and market liberalization.

Hong Kong-based Bond Connect takes China’s bond market liberalization a step further in scaling back some effective barriers by granting direct access to the onshore market from offshore accounts. In a nutshell, it flips the switch on China’s prior supply-side approach by exposing China’s domestic bond market to the external forces of demand. The ultimate vision is an onshore-offshore market-based RMB bond trading ecosystem.

3.      Is Bond Connect the only portal for Chinese domestic bonds?

No, it is the fourth channel for overseas investors in China’s domestic bond market. But, only Bond Connect allows qualified investors to obtain price quotations and trade through electronic markets directly into China from offshore. See points (3)-(4) on the flow chart. The first channel, QFII (2002), gave limited scope to a limited number of investors to invest in Chinese assets. RQFII (2011) expanded the list of qualified investors and allowed them to invest directly in RMB bonds and stocks. CIBM Direct Access (2016) streamlined the application process and gave an even wider base of qualified investors access to a deeper and broader market than QFII and RQFII. Bond Connect builds on the concept of CIBM with expanded mutual access.

4.      What bond instruments can be accessed through Bond Connect?

All of the below, subject to market conditions:

  • Treasury bonds
  • Local municipal debt
  • Treasury bills
  • Policy financing bonds
  • Government sponsored entity bonds
  • General obligations, subordinate debt, hybrid bonds, secondary market instruments, assets-backed securities
  • International development bank bonds
  • Enterprise bonds
  • Non-bank financial institution bonds, short-term security dealer bills
  • Non-bank financing instruments like CP (Commercial Paper), MTN (Medium-Term Note), SCP (less than 270 days CP), PPN (Private Placement Note), ABN (Asset-Backed Note)

5.      What institutions supply trading/support services to Bond Connect?

The PBC (People’s Bank of China) and HKMA (Hong Kong Monetary Authority)’s CMU(Central Moneymarkets Unit) are authorized to support Bond Connect under the PBC Order [2017] No. 1, Temporary Regulations for Mutually Connected, Mutually Operated Bond Markets in China and Hong Kong (内地与香港债券市场互联互通合作管理暂行办法).

CFETS (1994) is the full-service operator of China’s wholesale debt capital market, CIBM(China’s Interbank Market, 1997). CFETS provides dealing, trade settlement and quotation services for a broad spectrum of RMB money assets: FX and interbank FX trading, as well as RMBS lending and interbank bond trading. China also has two retail investor-oriented bond exchange market operators, SSE (Shanghai Stock Exchange, 1990) and SZSE(Shenzhen Stock Exchange, 1990). CFETS trades are cleared through SHCH (Shanghai Clearing House, 2009) or CCDC (China Central Depository &Clearing Co., 2001), depending on the instrument. CSDCC (China Clear, 2001) provides clearing services to both operators.

HKEx (1986; recapitalized in 2000) is Hong Kong’s monopoly exchange for securities trading. Besides stocks, it also makes available futures, options and other exchange-traded structured products available to the public trader. HKEx ranks consistently at or near the top of the league charts in critical measures of exchange viability and growth: market capitalization, IPOs and exchange-traded derivative volumes. Its clearing corporation CCASS (Central Clearing And Settlement System) provides clearing and settlement services for securities, mainly stocks. It is not involved in Northbound Bond Connect trade.

Tradeweb is an electronic market, currently the only market that transmits Northbound orders to CFETS. Banks that participate in Hong Kong’s RMB interbank payment system, RMB CHATS, can provide clearing and settlement RMB settlement services to investors trading through Bond Connect.

6.      Walk me through a Northbound trade on Bond Connect

Please refer to the Flowchart at the top. The boxes of light grey shading (bottom) in the Flowchart are Hong Kong based. Those of dark grey shading (top) are domestic Chinese institutions. Bond Connect is in the center, with trading activity marked in red font and clearing activity marked in black.

Trade-related institutions appear to the right and clearing-related institutions to the left. Northbound trades are initiated via a Request for Quotation (RFQ). Investors submit an RFQ to an overseas electronic market platform (2), currently Tradeweb. They must also approach a local custodian registered with CMU, the central clearing party (3). The RFQ is transmitted instantaneously to the dealer platform, CFETS (4). When one or more dealers respond with a price, the investor may confirm (or not) the price and conclude the trade inside CFETS (4). CNAPS (6) supports RMB real-time settlement services for payments cleared at (5). CIPS and RCPMIS (6), China’s cross-border interbank payment system enables buyers and sellers to settle their accounts offshore in offshore currencies throughRMB clearing and participating banks in Hong Kong (7) that are party to RMB CHATS.

7.      Are the trading hours of Bond Connect and those of the affiliated trading platforms identical?

Approximately the same. Northbound trading hours are aligned with China’s Interbank Market, on business days 9 AM to noon and 13:30 to 16:30 (Beijing/Hong Kong Time) but slightly different than the trading hours for Shanghai and Shenzhen Stock Exchanges (9:15 – 11:30 and 13:00 – 15:00).

8.      What has been the growth pattern of trade through Bond Connect?

Over 356 offshore accounts have accessed CIBM through Bond Connect, 59% incorporated in Hong Kong and over 30% distributed across 30 other jurisdictions like the U.S., U.K., and Singapore. According to the latest statistics (May 2018) CIBM average daily volume was RMB 527.8 BN (USD 79.1, EUR 68.6 BN (see PBC June 19, 2018; 中国人民银行6月19日发布的 <2018年5月份金融市场运行情况>). Total exchange volume was RMB 11.6 TN (USD 1.74, EUR 1.51 TN – see http://www.sohu.com/a/236762662_100087589).

Bond Connect-related trade is still well under 5% of total CIBM flows. Nevertheless, foreign investment nearly doubled from the level in June 2017 through May 2018, proving the case for Bond Connect before its first birthday.

CreditSpectrum Corp. and Xiamen International Financial Technology Co. Ltd. Copyright (c) 2018