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March 1, 2017

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Wider crack in door to China bond market

WHEN Chinese officials talk about market deregulation, most people think of stocks. The relaxation of controls is also occurring in the interbank bond market, that opaque, somewhat esoteric zone where banks and financial institutions trade assets.

In February, China sent out signals that it would provide easier assess to Chinese bonds for foreign investors on the interbank market, paving the way for the inclusion of Chinese debt in major global bond indices.

The interbank market accounts for nearly 95 percent of China’s 63.8 trillion yuan (US$9.29 trillion) bond market, which has doubled in volume in the last three years.

Ma Jun, chief economist of the People’s Bank of China, said at a conference in Singapore last Thursday that the central bank is studying plans to extend the trading hours of the interbank bond market to provide better access for offshore buyers and to allow offshore investors to participate in the foreign-exchange derivatives market.

“The rules, when introduced, will reduce currency hedging costs for offshore investors and will be conducive for attracting foreign capital into China’s bond market,” Ma said, suggesting a possible tax cut on related bond trading and simplified procedures of foreign exchange.

Days after Ma’s speech, State Administration of Foreign Exchange, country’s foreign exchange regulator, issued rules on late Monday to allow foreign bond investors to use derivatives products such as swaps, forwards and options to guard against currency risk.

Ma’s comments came after Chinese authorities issued new licenses to the China unit of Citigroup to trade, settle and provide custody for bond products, and to JPMorgan Chase & Co to underwrite corporate bonds in the interbank market.

China is likely to overtake Japan as the world’s second-largest bond market in the next one or two years, said Tommy Xie, a Singapore-based economist at OCBC Bank. However, there is still a gap between a surging domestic bond market and relatively cautious foreign investors, he added.

At the end of 2016, foreign institutions held 850 billion yuan of Chinese bonds, or 1.3 percent of outstanding fixed-income assets, according to the China Central Depository & Clearing Co. The percentage has declined as the number of bonds being issued climbs.

“It has been seven years since China officially allowed eligible overseas financial institutions to become involved in the mainland bond market,” Xie wrote in a report. “Foreign capital is willing to lay out funds for long-term investment, but the risks of foreign-exchange policy and liquidity concerns hinder their interest.”

Market brokers, who talked on condition of anonymity, echoed the same mixed view on foreign involvement in the Chinese bond market.

“The major hesitation is how decisive they should be in expanding their balance sheets in Chinese mainland,” an analyst with CITIC Securities Co told Shanghai Daily. “With a tighter foreign-exchange policy ahead, they have to think about how easy it will be to repatriate money back to their own countries.”

Chinese authorities have been tightening foreign-exchange policies to stanch the outflow of money that dropped the nation’s foreign reserves to below the key US$3 trillion level in January. That has led to a shrinking offshore capital pool of yuan as well as uncertainties about cross-border investment.

In an apparent attempt to ease concerns, the People’s Bank of China in a Tuesday announcement assured foreign companies they could transfer funds overseas through commercial banks, without any need for permission from the foreign-reserve regulator. 

“Luring more foreign funds into the mainland market is not necessarily related to the issue of falling foreign reserves,” the analyst said.

From the standpoint of investors, the percentage foreign holdings in Chinese bonds by the end of 2017 will possibly still stay at the level of 1-2 percent, according to Alan Gao, a fixed income analyst of Chief Investment Office at UBS Wealth Management. 

“If you look at the interest-rate environment and currency angle in emerging markets, China may not be the most attractive allocation spot for bond investment,” Gao told Shanghai Daily. “Absolute return driven investors may choose Brazil or Turkey, which could offer better return despite higher volatility.”

Gao said another concern for foreign investors is confusion over the rating system on bond products. Some bonds with a domestic triple-A rating could possibly be ranked as junk bonds in overseas markets.

Despite the misgivings, reform moves seem to be continuing.

Pan Gongsheng, deputy governor of China’s central bank, met with executives from Bloomberg LP over the weekend to push the idea of China’s bonds being included into the widely used Bloomberg Barclays fixed-income indices that track global bond markets.

Shanghai Daily earlier reported that Bloomberg LP will launch two new fixed income indices that include yuan-denominated China bonds on top of the global indices.

Chinese regulators are “welcoming and supporting” the inclusion of Chinese bonds in major international indices, such as JPMorgan’s emerging-market bond index and Citigroup’s global debt barometer, according to the central bank.

Ivan Chung, who is in charge of China credit research for Moody’s Investors Service, told Shanghai Daily that he considers the inclusion in global benchmarks is instrumental to internationalization of Chinese financial market.

“Of course there are many problems to be fixed before inclusion, such as information disclosure and insolvency and liquidation procedures for foreign investors during possible bond defaults,” Chung said. “But it’s a long-term positive.”

Gao at UBS said major foreign asset management companies are actively adding China sovereign bonds and selectively looking at the local credit bond market for their Asian asset allocations.

“It’s a strategy ranging from five to 10 years,” Gao said. “Investors always do more infrastructure layouts before jumping into them when the time is right.”


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