Development in China’s Bond Market
The PRC has effectively two bond markets:
- The inter-bank bond market, regulated by the People’s Bank of China (PBoC); and
- The exchange bond market, regulated by the China Securities Regulatory Commission.
However the inter-bank market is much larger than the exchange market, accounting for more than 95% of total trading volume. Foreign investors currently only hold about 2% of all Chinese bonds, PBoC data shows.
There are four main types of bonds in the Chinese market:
- Government bonds issued by the Ministry of Finance to finance government spending and those issued local governments which are similar to municipal bonds in the US.
- Central Bank notes are short-term securities issued by the PBoC for implementing monetary policy. These notes are often used in money market and liquidity management portfolios due to their short maturities.
- Financial bonds are the most actively traded bonds in China and are issued by policy banks (such as the China Development Bank, the Export-Import Bank of China and the Agriculture Development Bank of China), commercial banks and other financial institutions and are backed by the central government.
- Non-financial corporate bonds include a wide variety of bonds but the largest sectors are enterprise bonds and medium-term notes. Enterprise bonds are issued by institutions affiliated to Central Government departments, enterprises solely funded by the State, state-controlled enterprises and other large-sized state-owned entities. Private companies of any size can issue corporate bonds. Companies can also issue short-term financing bills (or commercial paper) and medium-term notes which are the most liquid non-financial corporate bonds.
China currently has two programs that allow foreign investors access to the bond market.
The first program is the Qualified Foreign Institutional Investor (QFII) program, which since 2012 has allowed foreign investors access to both the exchange bond market and the inter-bank bond market. RQFII funds can also trade in these markets. European regulators concluded in 2014 that the China interbank bond market was a regulated market for UCITS investments which increased the interest in this area.
Another pilot program was launched in 2010 to allow three types of offshore institutions to invest in the inter-bank bond market. The qualified institutions include foreign central banks, lenders in Hong Kong and Macau that were already conducting RMB clearing and overseas banks involved in RMB cross-border trade settlement. These qualified investors were permitted to trade on the inter-bank market either via direct access (only available for Hong Kong or Macau based institutions) or agent access.
For direct access the investors are required to open a trading account with the Chinese clearing house and connect trading terminals to the inter-bank trading center. Such investors trade directly on the market and conduct all daily operations including trade settlement and confirmation. For agent access the investor appoints a qualified agent bank in China as proxy which then trades on the market on behalf of the central banks and takes care of all the operations.
In July 2015 the PBOC announced major changes to the process of accessing the interbank bond market:-
- Foreign central banks, international financial organisations, and sovereign wealth funds will no longer have to seek prior approval to invest in the interbank debt market and will only have to file a one-page registration form of their investment plan with the PBoC;
- Foreign institutions can decide the scale of their investments at their own discretion rather than be assigned a quota; and
- The investment scope is broadened to trading forward contracts, interest rate swaps, and bond repurchases.
At present however foreign commercial banks, pension funds, hedge funds etc. are not included in the direct access scheme yet and must still go through the QFII / RQFII route.
This new move is being seen in China as an important step in the internationalisation of the RMB : -
“The move is a big step for the RMB 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 debt market is an important step.”
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 reserve especially as yields on Chinese currency fixed-income products remain high compared with what is on offer in dollar, euro, yen, and sterling bond markets.
Philippa Allen, CEO at ComplianceAsia