China bond market set to open up to foreign investors

China’s interbank bond market is expected to further open up to foreign investors this year, following on from the central bank's expansion of access in recent days

Further reforms are likely to see faster approvals given for access to the market, introduction of a registration regime, and fewer restrictions on repatriation and lock-up periods.

The opening up of the interbank bond market is part of China’s bid to liberalise its capital account, which is one requirement for inclusion in the IMF’s Special Drawing Rights (SDR) basket of currencies.

Last Thursday the People’s Bank of China (PBoC) announced it had given 32 foreign institutions permission to trade in the onshore interbank bond (IBB) market. The figure included 11 holders of qualified foreign institutional investor (QFII) licences, 11 of its renminbi-denominated equivalent (RQFII) and 10 foreign financial institutions, according to Shanghai Clearing House, China’s clearing house for the interbank market.

A total of 211 foreign firms had permission to access the onshore IBB market at the end of 2014, and of this number 73 gained approval last year, according to the PBoC’s annual report on financial market development. Shanghai-based consultancy Z-Ben Advisors estimated that only 24 QFII holders and 86 RQFII holders had previously received permission to enter the IBB market; but the actual number could be higher since Chinese regulators have not regularly announced approvals.

“The 32 approvals at once is still material. I do believe the onshore bond market will open up in a material way in the coming quarters,” said Becky Liu, Hong Kong-based senior rates strategist at Standard Chartered Bank.

“It will likely remain a quota-based system but with much easier approval, or no approval at all [but] just registration.” Other aspects of IBB reform could be fewer restrictions on the lock-up period and repatriation, she added.

Charles Salvador, director of investment solutions at Z-Ben, said that applications were becoming speedier.

“Another indicator of further opening is that the application process with PBOC has become more streamlined for foreign investors compared to the past, which was lengthier,” Salvador said. He added that many QFII applications had been made in the past “with no movement until recently”.

The further opening of the IBB market is one of the tasks facing China’s policymakers as they attempt to liberalise the capital account. This liberalisation is one critical requirement for the renminbi’s inclusion in the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) basket of currencies.

PBOC governor Zhou Xiaochuan called in March for the further opening-up of the onshore bond market. In addition to his bond liberalisation call, Zhou also said the QFII scheme was not flexible enough and that reforms were being planned. He added that a series of policy changes would be unveiled to make it easier for foreign investors to invest in China's financial assets.

In January, the China Central Depository & Clearing Company’s annual report made three suggestions for IBB liberalisation, including a shorter approval process with more foreign firms allowed to access the IBB market. It also recommended further liberalisation of foreign investors’ activities in the IBB market to allow repurchase agreements to boost secondary market activities. Finally, it said eligible foreign investors should be allowed to qualify as Class B investors in the IBB market, giving them the same status as domestic non-financial institutional investors such as brokers, mutual fund managers and insurers.

The IMF will decide in the fourth quarter of this year whether to include renminbi in the SDR basket, and one key criteria is for China to further liberalise its capital account or have a fully convertible currency. Since Zhou’s declaration in March about China’s determination to open up, policymakers have implemented various reforms to the QFII and RQFII schemes.

“We believe it is the right time to open up the China capital account further and at a faster pace. The success of Stock Connect suggests cross-border investments can be conducted in a controllable manner,” said Liu.

“Beyond the RMB liberalisation story, we believe that regulators are opening the IBB market to further develop the operational infrastructure and transparency, as well as the quality of the credit itself,” said  Z-Ben’s Salvador. He predicted that the onshore bond market could reach $10 trillion by 2020.

China’s bond market is the third-largest in the world and was worth Rmb36.7 trillion ($5.9 trillion) at the end of March, while the IBB market accounts for 95% of trading volumes.

Foreign institutions were given access to the IBB market in 2010 for the first time through a PBOC pilot programme, but only three types of offshore institutions (central banks, lenders in Hong Kong and Macau which have renminbi clearing business, and overseas banks involved in renminbi cross-border trade settlement) were allowed to invest in it.

Foreign investors with RQFII quotas were given access to the IBB market after the scheme launched in late 2011. However, QFII investors were not allowed to access the IBB market until March 2013 – prior to a rule change they could only access the exchange bond market.

In total, foreigners held Rmb672 billion of onshore bonds at the end of 2014, of which Rmb572 billion was in the IBB market and Rmb100 billion in the exchange market, according to the PBOC. Standard Chartered has predicted that foreign holdings of China onshore bonds will increase to Rmb972 billion this year.