3 July, 2018
JunHe, together with some of the key players of Bond Connect including overseas custodian banks and domestic market makers, was invited to attend a closed seminar (“Seminar”), to mark the first anniversary of the Bond Connect scheme. The Seminar provided profound insights into the current status of Bond Connect and an understanding of the expectations of market participants. We provide here a brief summary for your reference.
I. Review
Northbound trading of Bond Connect (“Northbound Trading”) was launched on July 3, 2017. Since that time, according to data provided by the Bond Connect Company Limited as of May 31, 2018, a total of 315 overseas investors have tapped into the China Interbank Bond Market (“CIBM”) through Northbound Trading. Jurisdictions in which overseas investors are registered currently include almost 30 countries and regions, including, amongst others, Hong Kong, Taiwan China, Singapore, the United States and the Cayman Islands.
Bond Connect is a mutual market access scheme that allows investors from Mainland China and overseas to trade in each other’s bond markets through connection of the bond trading and settlement systems between mainland China and Hong Kong. It allows overseas investors to invest in the CIBM without changing the types of practices that are common in mature markets, for example, market making schemes and a multi-tier custodial structure. Under the Bond Connect scheme, overseas investors with existing Hong Kong accounts may access the CIBM directly without the need to go through a local settlement agent.
It seems, overall, that Bond Connect has been successful in being able to offer overseas investors an easier and more convenient way for accessing the CIBM.
During the course of the Seminar, there was discussion of some common issues.
(i) Improve efficiency of settlement
Many foreign custodian banks and investors have commented that there is scope to improve settlement efficiency and thereby reduce the fund occupancy cost.
(ii) Clarify tax policies
Various tax related issues, including the tax calculation basis, collection method and matters related to tax recourse are still pending clarification. Besides, it seems that the relevant authorities have initiated an analysis of the feasibility of introducing the method of tax withholding, and the market eagerly awaits further information on clarity of tax policies.
(iii) Expand ways to hedge foreign exchange risks
Pursuant to the current rules, overseas investors may only hedge their foreign exchange risks with a Hong Kong settlement bank, making it an expensive exercise. Overseas investors are hoping that in the future they will be able to hedge their foreign exchange risks onshore, for example initially being allowed to manage their foreign exchange risks through onshore market makers.
(iv) Expand the scope of products available for trading
Northbound Trading investors look forward to the opportunity to expand the scope of trading to include bond repurchasing, foreign exchange derivatives and exchange-traded bonds. However, there is recognition that, due to the overall plan of China’s regulatory authorities on the opening up of financial markets, there might be some time before this expansion occurs.
II. Prospects
Given the differences between the bond markets of mainland China and that of Hong Kong or international bond market, there is recognition that establishing the rules, mechanisms and systems of Bond Connect will be an ongoing process. There may well be short-term solutions to some of the aforementioned concerns about the Bond Connect scheme, for example by bringing in improvements in efficiency and clarifying rules. Other issues relating, for example, to the discrepancies between legal systems and the overall plan to open up China’s financial markets, may require a longer time to resolve and will therefore require patience on the part of market participants.
There are currently multiple channels available to the foreign investors looking to invest in China’s bond market, including QFII and RQFII, Direct Access to China Interbank Bond Market and the Bond Market. We believe that in the long run, the co-existence of these multiple options may continue to be the norm. Each channel has its own distinctive benefits and disadvantages.
We recommend that overseas investors should choose their channel according to their specific needs. We will continue to pay close attention to this area and share all relevant updates and advice with our clients.
For further information, please contact:
Natasha (Qing) Xie, Partner, Jun He
xieq@junhe.com
