23 June, 2017
On May 31, 2017, the People’s Bank of China (“PBOC”) issued the Interim Measures for Administration of Mutual Access and Connection between Mainland and Hong Kong Bond Markets (Public Consultation Draft) (“Draft Measures”), soliciting public comments with respect to the mechanism and arrangement for domestic and overseas investors, through the connection between the infrastructure institutions of the Mainland and Hong Kong bond markets, to purchase and sell bonds tradable on both markets (“Bond Connect”). Before that, the PBOC and the Hong Kong Monetary Authority (“HKMA”) on May 16, 2017 jointly issued the Joint Announcement (“Joint Announcement”) about the decision to launch the Bond Connect, while the Shanghai Clearing House (“SHCH”) and the Central Moneymarkets Unit of HKMA (“CMU”) released their joint announcement regarding the provision of custody and settlement services for the Bond Connect.
The Bond Connect consists of the “Northbound Link” and the “Southbound Link”. The Draft Measures only apply to the Northbound Link which will be implemented first, and the relevant measures governing the Southbound Link will be separately formulated. According to the previously issued Joint Announcement, the Northbound Link will follow the current policy framework for overseas participation in the China Interbank Bond Market (“CIBM”) and at the same time respect international norms and practices.
The Draft Measures provide that the Northbound Link shall be governed by existing laws and regulations for trade and settlement in both markets, and the relevant trade and settlement activities are subject to the regulatory requirements and business rules of the location where the trading and settlement activities take place. The main contents of the Draft Measures are as follows.
Overview of Northbound Link
The Northbound Link refers to the mechanism and arrangement which enable the overseas investors residing in Hong Kong and other countries and regions (“Overseas Investors”) to invest in the CIBM through the mutual market access and connection of trade, custody and settlement between the Hong Kong and Mainland infrastructure institutions. The targeted bond can be any of the bonds tradable on the CIBM, and there are no investment quota limits imposed thereunder.
Regarding the scope of the Overseas Investors, the Draft Measures describe it as “any Overseas Investor that satisfies the qualification requirements of the PBOC”. Pursuant to the Media Q&A regarding the Bond Connect between Mainland and Hong Kong released by the PBOC on the same day as the Joint Announcement, the scope of the Overseas Investors introduced under the Bond Connect shall be the same as that of the investors permitted to directly enter into the market. The scope of the investors permitted to directly enter into the market are outlined in the PBOC Announcement [2016] No.3, i.e. various qualified financial institutions including commercial banks, insurance companies, securities companies, fund management companies and other asset management institutions duly incorporated outside China, investment products issued to clients by the above financial institutions according to the law, and pension funds, charitable funds, donated funds or other mid-and-long-term institutional investors recognized by the PBOC.
Registration and Depository
The Northbound Link will implement a multi-level custodian pattern, and a bondholder shall set up a bond account with its upper-level custodian to register the bonds it holds. The institutions responsible for registration and custody include the bond registration, depository and settlement institution of Hong Kong recognized by the HKMA (“Offshore Custodian Institution”) and the domestic bond registration, depository and settlement institutions recognized by the PBOC (“Onshore Custodian Institutions”, according to the Joint Announcement, including the China Central Depository & Clearing Co., Ltd. and the SHCH).
The specific mechanism for registration and custody includes:
(i) the Overseas Investors shall open the nominee bond accounts and the proprietary bond accounts with the Offshore Custodian Institution, and the Offshore Custodian Institution shall handle the bond registration and custody for the Overseas Investors;
(ii) any bonds purchased by an Overseas Investor through the Northbound Link shall be registered under the name of the Offshore Custodian Institution, and the Overseas Investor shall be entitled to the rights and interests of such bonds according to the law;
(iii) the Offshore Custodian Institution shall open the nominee bond accounts with the Onshore Custodian Institutions to record the balance of all bonds held under such nominee holding structure, and the Onshore Custodian Institutions shall handle the bond registration and custody for the Offshore Custodian Institution; and
(iv) the aggregate amount of the bonds registered for the bondholders having opened the bond accounts with the Offshore Custodian Institution shall be equal to the balance of the bonds registered for the nominee accounts at the Onshore Custodian Institution.
Based on the Joint Announcement, we understand that the Offshore Custodian Institution mentioned under the Draft Measures shall mean the CMU, while other overseas custodian institutions at different levels shall open the nominee accounts at their upper-level custodian institutions and ultimately provide the information of the offshore bond registration to the CMU. The Draft Measures, instead of giving any further elaboration, merely require the lower-level custodian institutions to level by level and in a timely manner submit the data of custody and settlement to the upper-level custodian institutions, and to be responsible for the authenticity, accuracy and completeness of such data.
To respond to the possible concern that the overseas investors may have in relation to the beneficiary ownership issue under the PRC law, we suggest that the Draft Measures shall expressly stipulate that a bond beneficiary owner may claim its rights and interests of the bonds and the relevant rights and obligations shall be subject to the terms under the relevant contract entered into between the beneficiary owner and the nominee bondholder.
Trading Procedures
Under the Northbound Link, an Overseas Investor shall send the trading orders through an offshore electronic trading platform recognized by the PBOC, and execute trades with other investors on an onshore electronic trading platform recognized by the PBOC. The onshore electronic trading platform shall send the execution results to the Onshore Custodian Institution for settlement. The onshore and offshore electronic trading platforms and the Onshore and Offshore Custodian Institutions shall timely, accurately and completely record the data of trading, custody and settlement of the Overseas Investors, and establish information sharing and communication mechanisms.
Capital Conversion
Any Overseas Investor may invest with any proprietary RMB or foreign currencies. If an Overseas Investor uses foreign currencies to invest, it may conduct the currency conversion at a Hong Kong RMB business clearing bank of the bondholder and an overseas RMB business participant bank in Hong Kong approved to enter into the China Interbank Foreign Exchange Market (“CIFEM”) for trading (collectively, “Hong Kong Settlement Banks”), and after the bonds so invested are sold or mature, it shall in principle convert the proceeds back into foreign currencies.
It shall be noted that the capital conversion under the Northbound Link will be administrated as a type of RMB purchase and sale business. Therefore, the Hong Kong Settlement Banks shall abide by the relevant provisions regarding the RMB purchase and sale businesses, perform anti-money laundering, authenticity review, information statistics and reporting and other duties, and properly segregate the accounts for the proprietary RMB of the bondholders and the RMB purchased and sold by them.
Foreign Exchange Risk Hedging
In order to hedge foreign exchange risks, an Overseas Investor may, through the relevant bondholder, hedge its foreign exchange risks under the Northbound Link with a Hong Kong Settlement Bank; for any positions arising from handling the businesses of capital conversion, settlement and foreign exchange risk hedging, the Hong Kong Settlement Bank may square them in the CIFEM, provided that it shall ensure that the capital conversion and foreign exchange risk hedging of the relevant Overseas Investor at such bank are based on its real and reasonable needs under the Northbound Link.
It shall be noted that the Draft Measures use the term “bondholder” in a few places but does not provide a definition to it. Our interpretation is that, in the context of capital conversion and foreign exchange risk hedging stipulated under Articles 10, 11, 12 and 13, the “bondholders” therein seems to include any bondholder that may conduct the relevant business with a Hong Kong Settlement Bank, in addition to the bondholders that open accounts with the CMU.
Our Observations
The Bond Connect forges a new investment avenue for overseas institutional investors besides direct access to the onshore bond market, which is conducive to facilitating convenient investment and reducing trading costs of the overseas bond investors. In the long run, it will help to stabilize the exchange rate of RMB and the cross-border capital flow, and further promote the internalization of China’s bond market.
For further information, please contact:
Natasha (Qing) Xie, Partner, Jun He
xieq@junhe.com
