China opens up interbank bond market

China grants certain foreign institutional investors wider access to the country’s $5.8 trillion interbank bond market in an effort to repair its reformist credentials.

China’s $5.8 trillion interbank bond market is being opened further to foreign institutional investors, offering evidence that the government remains committed to slowly liberalising its capital markets even as a pall is cast over domestic equity markets.

Foreign central banks, international financial organisations, and sovereign wealth funds will no longer have to seek prior administrative approval to invest in the country's onshore interbank debt market, the People’s Bank of China said late Tuesday. Instead these foreign institutions will now only have to file a one-page registration form of their investment plan with the PBoC.

Under the new rules, which came into effect on Tuesday, foreign institutions can now decide the scale of their investments at their own discretion, the central bank's statement said. In addition, they will also be able to expand beyond just buying and selling bonds in the cash market to trading forward contracts, interest rate swaps, and bond repurchases.

Most bonds issued by the Chinese government or by Chinese financial institutions trade on the country's onshore interbank market. So it's a significant gesture.

The piecemeal way in which the PBoC has opened up the market nonetheless highlights how China is “still wary of potential speculative activities by foreign entities,” ANZ said in a note. “[That’s why] foreign commercial banks, pension funds and hedge funds are not included in the scheme yet.”

Needing reassurance

The PBoC’s announcement comes against a backdrop of stock market chaos, with the benchmark Shanghai index at one point losing 30% of its value over a three-week period and trading for a time suspended in well over a thousand Chinese stocks. Beijing's subsequent interventions have since helped to steady the boat but they have also raised some doubts among domestic and foreign investors about how committed China truly is to reforming its capital markets.

So opening up the interbank bond market could help to reassure investors and put government efforts to internationalise the renminbi back on track, analysts said.

“The move is a big step for the [renminbi] internationalisation, as the key of it is to reform and open up domestic capital markets,” Ping An Securities said in a report. “The opening of the [onshore] debt market is an important step.”

Economists at ANZ are similarly inclined, arguing that "the announcement signals the PBoC’s determination to attain basic convertibility of [the] capital account by the end of 2015.” They called it an important step for China’s financial sector reform and a complementary measure aiding the Chinese currency's internationalisation.
Since President Xi Jinping took the helm in late 2012, China has stepped up its efforts to promote the global use of the renminbi as an international reserve currency and launched pilot programmes to liberalise the country’s capital accounts.

One notable initiative is the Shanghai-Hong Kong stock connect, which was launched last November and enables domestic and international investors to invest in each other’s stock market. Another such link between Hong Kong and its neighbouring city of Shenzhen is scheduled to open in the second half of this year.

Beijing’s liberalisation efforts have won endorsements domestically and overseas. The International Monetary Fund, which declared in May that the Chinese currency was “no longer undervalued,” is due to decide later this year whether to include the Chinese yuan in its pool of reserve currencies, along with the dollar, euro, yen, and pound.

China's bond markets

Currently there are two bond markets in China -- the interbank bond market, regulated by the central bank, and the exchange bond market, regulated by the China Securities Regulatory Commission. The former accounts for more than 90% of total trading volume, according to official data.

Foreign investors, who were first allowed to tap China’s interbank bond market in 2012 through the Qualified Foreign Institutional Investor scheme, currently only hold about 2% of all Chinese bonds, PBoC data shows.

Market participants say the PBoC’s new rules may well appeal to the foreign institutional investors it has targeted if they want to diversify their portfolio and currency reserves. After all, yields on Chinese currency fixed-income products remain high compared with what is on offer in dollar, euro, yen, and sterling bond markets.

“Potentially, it could bring in a huge amount of foreign capital,” said a Beijing-based fixed-income portfolio manager at Citic Securities, China’s largest brokerage. “Foreign investors can borrow [money] at very low interest rates [overseas], then they can invest in Chinese [onshore] bonds with yields of 5% to 6%. It’s a really good deal.”

However, he added the onshore yields won’t be affected in the near future.

“China’s policies always need a lot of extra details to support the implementation…Foreigners might want to wait and see for a while,” he said.

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