Last Thursday (24 September), FTSE Russell announced its plan to add Chinese government bonds to its influential World Government Bond Index by stages, starting from October 2021. In fact, since April 2019 and February 2020, the Bloomberg-Barclays Global Aggregate Index and the J.P. Morgan Government Bond Index – Emerging Markets have respectively started the inclusion of Mainland bonds by phases. The latest decision by FTSE Russell means Mainland bonds will be part of the world’s all three main fixed income indices, representing a growing recognition of RMB as one of the world’s major reserve assets and a stride forward for RMB internationalisation.
Globally around US$3-5 trillion assets tracking these three indices right now will have to allocate Mainland bonds in proportion to the weighting assigned by the index providers. Based on a 5-10% weighting1, some US$200-300 billion will flow into Mainland bonds according to market estimates. This is before taking into account funds indirectly tracking, or active funds benchmarking their performance to, these indices. The impact of index inclusion is highly significant. From the beginning of 2019 to August this year, foreign holdings in the Mainland interbank bond market jumped by over RMB1 trillion (or up 62%); more than 35% of which were bought and held through Hong Kong’s Bond Connect channel. The inclusion is only a precursor to the ongoing, massive inflows into Mainland bond markets. Indeed, Chinese government bonds provide significantly higher yields than most developed markets government bonds, and RMB exchange rate has been staying largely stable in recent years. Better returns with manageable currency risk would be compelling to international investors, especially in today’s persistently low global interest rates environment.
Fast growing activities in Bond Connect
Bond Connect played an active part in the development and liberalisation of Mainland bond market. Mainland authorities allowed foreign investors to directly participate in the bond market as early as 2010. The launch of Bond Connect by the HKMA and the People’s Bank of China in 2017 accelerated and deepened the open-up process. In just two to three years, Bond Connect has been widely accepted by international investors. Through Bond Connect, international investors can conveniently access the Mainland bond market through Hong Kong -- that speaks the common language of international regulatory standards and market practices -- while continue to be served by well-established and trusted financial intermediaries. Smooth operation of Bond Connect is one of the key factors leading to the inclusion of Mainland bonds in major indices. This once again demonstrated the unique proposition of Hong Kong as a trusted and efficient conduit between the Mainland financial markets and international investors.
Bond Connect has become a popular choice among international investors, complementing other existing access channels for Mainland bond market. In three years’ time, Bond Connect investor community has grown from scratch to now 578 strong, comprising financial institutions and asset managers big and small from all over the world. Average daily turnover expanded over 10 times from RMB1.48 billion in the first month of launch to RMB19.5 billion this August. Bond Connect accounted for 52% of foreign investors’ total turnover in the Mainland interbank bond market in the first eight months of this year, and 29% of the RMB1.96 trillion net inflow into Mainland bonds since July 2017, when the scheme was launched. There should be much headroom for Bond Connect activities to grow on the back of index inclusion, generating further business opportunities for financial services providers in Hong Kong.
Upgrading Bond Connect to support open-up of Mainland bond market
Just like other mutual market access arrangements, Bond Connect has been a story of continuous refinements following its smooth launch. HKMA has been working closely with the People’s Bank of China and relevant parties to introduce market-oriented enhancements to meet investors’ need, raise operational efficiency, lower trading costs, and provide more flexibility. These well-received initiatives include: delivery-versus-payment settlement, block trading function, and tax exemption in 2018; addition of new electronic trading platform, extension of settlement cut-off time, and increased options for settlement cycle in 2019. This year, we rolled out special settlement cycle service2, extended trading hours and, as announced just the past Thursday, introduced new flexibility for investors to engage more than one bank to conduct relevant currency conversion and foreign exchange hedging. In a way, Bond Connect is like a newly acquired machine that needs constant fine-tuning, enhancements and upgrading to improve its functionality and performance efficiency. Technical as they may seem, each system and process adjustment to Bond Connect has brought concrete convenience and benefits to investors. As compared to three years ago, we have definitely gone a long way in improving investor experience.
There is still much potential for Mainland bond market to further open up. We are only seeing the beginning of massive inflows in the next few years. Meanwhile, there is room to further improve the mechanism through which foreign investors participate in the Mainland bond market. Enhancements to Bond Connect is therefore an on-going job. As Mainland bonds take up an increasing portion of international investors’ portfolios, the need to manage related exchange rate risk, interest rate risk and liquidity risk will be more prominent. Our priority would therefore focus on the provision of diversified risk management tools in the next stage of enhancements to Bond Connect. We will join hands with Mainland authorities to explore the introduction of repo and other derivatives (such as interest rate swap) to Bond Connect, as well as optimise the existing foreign exchange hedging arrangements. More importantly, the success of Northbound Bond Connect has laid a solid foundation for us to study a Southbound channel. In future discussions with our Mainland counterparts to upgrade mutual market access arrangements, launching Southbound Bond Connect at a suitable juncture will be one of our focal points.
Hong Kong Monetary Authority
28 September 2020
1According to the latest estimates by the index providers, after the inclusion process is completed, the weighting of Mainland bonds in the Bloomberg-Barclays Global Aggregate Index and the J.P. Morgan Government Bond Index will be around 6% and 10% respectively.