Financial liberalisation

Offshore financial institutions now more hopeful of access to China’s bond futures

A new pilot scheme to allow Chinese banks to trade government bond futures is a very healthy step in the right direction towards fully liberalising the market and allowing foreign investors to finally tap it, experts believe.

Market observers are hopeful offshore financial institutions will soon be granted access to China’s bond futures market, a move that would see liquidity in the hemmed off market increase dramatically.

This expectation comes off the back of the Chinese government’s recent measure to further open up the country’s market for bond futures, which are contracts for future delivery of a bond instrument.

On February 21, the China Banking and Insurance Regulatory Commission (CBIRC), announced it would allow local insurers and banks to trade Chinese government bond futures. Initially, five Chinese state-owned banks will trade Chinese government bond futures on a trial basis, namely Bank of China, Industrial and Commercial Bank of China, Agricultural Bank of China and China Construction Bank, and Bank of Communications

"International investors have been lobbying China's regulators to liberalise bond futures trading for some time and it is clear [they] are listening. We believe this latest announcement is just the first step in the full opening of China's bond futures markets to offshore entities,” Hayden Briscoe, head of fixed income at UBS Asset Management, told FinanceAsia.

Apart from this first batch of five Chinese state-owned banks, more banks and insurers will be soon allowed to trade Chinese government bond futures going forward, said the CBIRC. “This will also broaden the base of investors in the market.”

The entry of these five Chinese banks into China’s bond futures market can bring in billions of renminbi of additional funds into this market, analysts at the China Construction Bank estimate. After China’s bond futures market is fully open to banks and insurers, it is likely to bring in Rmb30 billion ($4.3 billion) of additional funds, expanding the market by 20%, the analysts projected.

For now, the policy applies only to the onshore entities of international financial institutions but not offshore entities, Briscoe noted. "We would like the policy to be extended to include offshore entities. Foreign investors always want more liquid markets.”

One incentive for the Chinese authorities to further open the bond futures market to foreign investors in future is China’s need for capital. China's current account is neutral at the moment, but trending towards a deficit, so the Chinese government will want to do all that it can to attract foreign capital, added Briscoe.

Prior to this announcement, brokerages and fund houses were allowed to trade bond futures, but not insurers and banks. In January, Chinese commercial banks held Rmb10 trillion of Chinese government bonds, while foreign banks held only Rmb330 billion, according to official Chinese data.

Risk management tool

The participation of banks and insurers will enable them to meet their risk management needs, broaden the range of financial products and improve bond asset management, said the CBIRC.

Previously, Chinese banks’ capacity for hedging was limited to buying and selling bonds or to use interest rate swaps. Gaining access to the bond futures market should be a more efficient means of hedging risk on their balance sheets. The introduction of bond futures for Chinese banks is expected to boost liquidity and help with price discovery for bonds.

"International investors have been longstanding advocates for the reform which enhances liquidity across the yield curve because it facilitates arbitrage between on-the-run (recently issued) and, the hitherto, relatively illiquid off-the-run (well-established) bonds," Briscoe said.

Although China’s $13 trillion bond market is the world’s second largest after the US, the Chinese market is far less liquid than its counterpart. To illustrate this, the average daily trading volume on Bond Connect was Rmb22.4 billion ($3.2 billion) in January. Bond Connect is a channel that enables international investors to trade in China’s onshore bond market via Hong Kong. In comparison, the average daily trading volume of US Treasuries surpasses $100 billion, according to the US-based Securities Industry and Financial Markets Association.

“Insufficient liquidity is one of the major problems faced by China’s bond market,” said a report of Analytical Credit Rating Agency (ACRA), a Russian credit rating agency, on February 28, 2019.

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