Northbound Swap Connect channel goes live

Investors can tap China’s interest rate swap markets directly through a pioneering derivatives mutual market access programme.

A version of this article first published on FinanceAsia sister publication, CorporateTreasurer.

The northbound channel of the world’s first derivatives mutual market access programme, Swap Connect, went live yesterday (Monday, May 15), offering access to China’s renminbi-denominated interbank interest rate swap (IRS) markets.

Jacky Mak, head of Fixed Income and Currency (FIC) Product Development at Hong Kong Exchanges and Clearing (HKEX) explained to FinanceAsia that the scheme offers participants the ability to trade and clear onshore renminbi-denominated IRS “without having to change their existing trading and settlement practices”.

“With the increased participation of international investors in China's fixed-income and bond markets, there is increasing demand for effective risk-management tools. Swap Connect will provide international investors with a cost-effective and convenient route to access China's liquid onshore interbank financial derivatives market,” he said.

“[The scheme] serves as an effective risk management tool and facilitates the hedging of interest rate risks, in particular for those investors trading bonds under northbound Bond Connect,” a spokesperson for the SFC added.

Broad benefits

The programme builds on plans to increase international participation in China’s fixed-income and bond markets, which were first announced in July last year by regulators, the Hong Kong Monetary Authority (HKMA), the Hong Kong Securities and Futures Commission (SFC) and the People’s Bank of China (PBOC). It offers investors participation in China-based interest swaps at very initial stage, all of which are priced, settled and cleared in renminbi.

“Broadly speaking, onshore interest rate swaps are less volatile and correlate better with onshore bond yields. This means that from day one, Swap Connect introduces a more efficient interest rate risk management tool for institutional investors to manage their overall China bond strategies,” William Shek, head of Markets and Securities Services for Hong Kong at HSBC told FA.

Vincent Sum, Hong Kong-based Banking and Finance partner at law firm, Mayer Brown, explained that eligible participants for the scheme would include “most key categories of institutional investor”, such as Qualified Foreign Institutional Investors (QFIIs); RMB-Qualified Foreign Institutional Investors (RQFIIs); qualified funds; Bond Connect investors; and any others already approved by the Chinese regulatory authorities.

Although the scheme is not open to direct participation from corporates, they can access some of the benefits through registered vehicles or funds.

“With Swap Connect, fund managers can now more accurately hedge their interest rate risks and mitigate the need to sell down their holdings if they are worried that yields are going higher,” Shek noted.

“Investors can hedge their RMB assets directly in the same currency, without incurring the volatility of the basis if the hedge is in non-RMB swaps.”

Sum agreed, “Overall, [the initiative] may assist investors in minimising the impact of fluctuating interest rates on their investment portfolios with a significant China focus in a high inflation and rising interest rate setting.” He added that the scheme offers various potential benefits for overseas investors considering growing their exposure to China and improved diversification opportunities.

Terry Yang, Hong Kong-based partner at Clifford Chance earlier explained to FA that the scheme first covers fixed-to-floating renminbi interest rate swaps based on three types of reference rate: a Shanghai Interbank Offered Rate (SHIBOR) of three months (3M) based on 10-year maturity; an overnight (O/N) SHIBOR levy based on three-year maturity; and a seven-day interbank repurchase rate (FR007) based on 10-year maturity.

Initial uptake

Transactions executed via Swap Connect are traded on new clearing and settlement infrastructure developed by HKEX subsidiary, OTC Clear, alongside China Foreign Exchange Trade System (CFETS) and the Shanghai Clearing House (SHCH).

Reports indicate that Monday morning’s trading received keen participation, with 37 initial transactions involving 16 institutions and amounting to RMB1.8 billion (US$ 258.86 million).
In a statement distributed to media just after the scheme’s opening hour, head of Business Development for Greater China at HSBC’s Markets and Securities Services division, Candy Ho, shared that the bank was one of the first institutions to participate, concluding trades for several global clients, including Singapore-headquartered fund manager, Dymon Asia, and US-based wealth management firm, CSI Capital Management.

“Dymon Asia is proud to be among the first overseas investors to access mainland China’s Interest Rate Swap market today,” Shawn Yuan, co-chief investment officer (CIO) of the Dymon Asia Multi-Strategy Investment Fund and CIO of the Dymon Asia China Absolute Return Bond Fund said in the statement.

Yuan added that the scheme “makes renminbi-denominated investments more attractive.”

Looking ahead

Discussing upcoming developments, Mayer Brown’s Sum said that the scheme could stimulate growth in the derivatives and capital markets of both Hong Kong and China.

His colleague, associate, Sylvia Leung said, “In future, we may see the addition of other over-the-counter (OTC) derivatives like forwards and credit default swaps, depending on market demand and conditions.”

Regarding the launch of a southbound channel, she said, “It is reasonable to expect that the timing of a Southbound launch would depend on the readiness of new regulations and systems, and contingent upon market demand and conditions.”

Shek concluded that his team would “continue to reflect corporate clients’ interests in accessing onshore swap markets with the relevant authorities.”


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