China gives the nod for investors to buy offshore debt via Hong Kong, opening the southbound leg of Bond Connect

·7 min read

Mainland China’s investors will be allowed to buy and sell offshore debt through Hong Kong in a widening of the Bond Connect transborder investment channel that enhances the city’s role as China’s financial centre.

The so-called southbound leg of the Bond Connect will take effect from September 24, according to an announcement by the Hong Kong Monetary Authority (HKMA), the city’s de facto central bank.

“The launch of southbound trading of Bond Connect marks another milestone of mutual access between Hong Kong and mainland. The southbound trading will deepen the two-way opening up of the mainland financial markets and promote the vibrant development of the Hong Kong bond market and hence strengthen Hong Kong’s status as an international financial centre,” Eddie Yue Wai-man, the CEO of HKMA, said in a media briefing.

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The much-anticipated opening, hot on the heels of the September 10 launch of the Wealth Management Connect scheme for cross-border investments in asset management and wealth products in the Greater Bay Area, is the latest financial liberalisation measure to bolster Hong Kong’s role as China’s financial gateway to the world. The current iteration widens the scope of the Connect scheme, which provided the first transborder investment channels in 2014 between the capital markets of Shanghai and Shenzhen with the rest of the world via Hong Kong.

Eddie Yue Wai-man, CEO of the Hong Kong Monetary Authority at the office of the de facto central bank at the IFC in Central on 9 March 2021. Photo: Winson Wong
Eddie Yue Wai-man, CEO of the Hong Kong Monetary Authority at the office of the de facto central bank at the IFC in Central on 9 March 2021. Photo: Winson Wong

“Launching southbound trading under Bond Connect to complete the two-way connection of the bond markets will promote further mutual access between the two financial markets,” Hong Kong Chief Executive Carrie Lam Yuet-ngor said. The scheme will “reinforce Hong Kong‘s status as an international financial centre.”

Under the first Stock Connect, launched in 2014, Chinese investors can buy Hong Kong-traded stocks via the Shanghai Stock Exchange, while global capital can access Shanghai-listed Chinese stocks via Hong Kong. The first link was expanded two years later with a transborder channel linking Shenzhen and Hong Kong.

Since then, more linkages have been built, including a little-used channel called the Shanghai-London Connect for European funds to access China’s shares via the UK-based stock exchange. The first Bond Connect was established in July 2017 for global traders to buy China’s onshore bonds through Hong Kong. As many as 2,733 global institutional investors have been approved to use the northbound link to access China’s US$17.5 trillion bond market. It had a daily average turnover of 26.5 billion yuan (US$4.11 billion) in the first eight months of 2021, according to data provided by bourse operator Hong Kong Exchanges and Clearing (HKEX).

The Hong Kong Monetary Authority’s deputy CEO Edmond Lau (centre) at the press conference announcing the Wealth Management Connect scheme in the GBA on 10 September 2021. Other attendees (left to right) are Senior Adviser Donald Chen; Executive Director Darryl Chan; Executive Director Alan Au; and Head of Banking Conduct Florence To. Photo: K.Y. Cheng.
The Hong Kong Monetary Authority’s deputy CEO Edmond Lau (centre) at the press conference announcing the Wealth Management Connect scheme in the GBA on 10 September 2021. Other attendees (left to right) are Senior Adviser Donald Chen; Executive Director Darryl Chan; Executive Director Alan Au; and Head of Banking Conduct Florence To. Photo: K.Y. Cheng.

Foreign holdings of yuan-denominated bonds via the northbound Connect surged 35 per cent to 3.78 trillion yuan in August compared with a year ago, as global funds poured into China amid a period of low interest rates in search of higher yields in the country.

“The launch of southbound trading will further underline the unique function of Hong Kong in connecting mainland capital and the wide range of products in the international market,” Financial Secretary Paul Chan Mo-po, said. “Not only would this enhance the attractiveness of Hong Kong as a bond issuing platform and the liquidity of the bond market in Hong Kong, but also further facilitate the progress of renminbi internationalisation.”

As the operator of Asia’s third-largest capital market, HKEX scrapped the trading and settlement fees of fixed-income index funds traded in Hong Kong on May 31 to spur the local bond market, in preparation for the expansion of the Bond Connect scheme.

The latest fees waiver, proposed last year, was the first policy to be executed under the stewardship of Nicolas Aguzin, the former JPMorgan Chase banker who started work on May 24 as the HKEX’s new CEO. The HKEX main board now has 1,722 debt securities listings, with an average daily turnover of HK$410 million (US$52.7 billion) in the first eight months, 60 per cent more than the same period last year.

Hong Kong was Asia’s hub for arranging international bonds last year, capturing 34 per cent of issuances, or US$196 billion. The United States was in second place at 18 per cent, while the UK was third with 17 per cent and Singapore with 5 per cent, according to HKMA’s Yue.

Nicolas Aguzin, chief executive of Hong Kong Exchanges and Clearing Limited (HKEX), the operator of the world’s third-largest capital market. Photo: HKEX
Nicolas Aguzin, chief executive of Hong Kong Exchanges and Clearing Limited (HKEX), the operator of the world’s third-largest capital market. Photo: HKEX

The southbound Bond Connect is likely to begin by enabling offshore yuan-denominated debt, known as dim sum bonds, according to several market participants.

Increased capital flows will be welcomed by international asset managers, said JPMorgan Asset Management’s portfolio manager Jason Pang.

“The opening of two-way flows is likely to lead to improved liquidity in the dim sum bond market, and widen the arbitrage opportunities across both offshore and onshore markets,” said Pang.

The issuance of dim sum bonds rose to 172 billion yuan in the first seven months of 2021, just shy of the 185 billion yuan record in the same period in 2014, according to research conducted by Standard Chartered. Total outstanding dim sum bonds stood at 607 billion yuan at the end of July.

“The new link is set to accelerate the development of primary and secondary bond markets in Hong Kong,” said Justin Chan, head in Greater China of global markets at HSBC, the biggest of Hong Kong’s currency-issuing banks. “Offshore bonds could appeal to onshore mainland investors who wish to diversify their portfolios. As the market grows, more global bond issuers will be attracted to Hong Kong.

China’s yuan deposits shrank to US$34.9 trillion in July from a month earlier. With more Chinese investors seeking out dim sum bonds through the southbound Bond Connect, the improved liquidity will encourage more issuers to look at raising funds by issuing yuan-denominated debt, said Li Bing, head of Asia-Pacific at Bloomberg.

“I expect more Chinese onshore companies to look at issuing more dim sum bonds in Hong Kong, as the pool of investors that they are familiar with in Hong Kong expands with the southbound Bond Connect,” said Li.

The launch of the southbound route came after successful development of the northbound route in the past four years, which saw the number of international investors increase from 150 to now more than 2,700, while the average daily turnover has also increased by 17 times, from 1.5 billion yuan per day in 2017 to 26 billion yuan a day now, Yue said.

Unlike the northbound that has no quota, the southbound route caps the daily net outflow at no more than 500 billion yuan per year and up to 20 billion yuan a day.

Only mainland institutional investors who have Qualified Domestic Institutional Investors (QDII) status or can invest through the yuan denominated QDII scheme can invest, according to Edmond Lau, HKMA’s deputy CEO. “These restrictions will ensure a stable launch of the new scheme,” he said.

Like northbound bond trading, the trading and settlement of the southbound route will be done through the China Foreign Exchange Trade System and HKMA’s Central Moneymarkets Unit. The PBOC has appointed 41 banks, including the Chinese units of HSBC and Citibank, as well as mainland players such as ICBC and Postal Savings Bank of China to act as primary dealers to ensure liquidity.

Mainland investors will trade through a number of banks that will act as market makers for the scheme. Initially, mainlanders will trade Hong Kong dollar and yuan bonds in Hong Kong, including 204.6 billion dim sum bond. “We will consider expanding to other currencies bonds at a later stage,” Lau said.

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