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3 August, 2017
On July 2, 2017 the People’s Bank of China (“PBOC”) and the Hong Kong Monetary Authority (“HKMA”) jointly announced that they had approved the launch of the “mutual bond market access between Mainland China and;Hong Kong (Bond Connect) by the China Foreign Exchange Trade System; National Interbank Funding Centre (CFETS), the China Central Depository; Clearing Co., Ltd. (CCDC), the Shanghai Clearing House (SHCH),together with the Hong Kong Exchanges and Clearing Limited and the Central Moneymarkets Unit (“CMU”). trial operations of northbound trading (Northbound Trading) commenced on July 3.
In their announcement, the PBOC and the HKMA indicated the execution of the Memorandum of Understanding between the People’s Bank of China and Hong Kong Monetary Authority on Strengthening Supervisory Cooperation under the Bond Connect (“MoU”), which lays out the basic principles for regulation of the Bond Connect. The relevant interim administrative measures and their detailed implementation rules are set out below:
| Issued by | Rule or Regulation |
| PBOC |
Interim Measures for the Administration of Mutual Bond Market Access between Mainland China and Hong Kong (“Interim Measures”) |
| PBOC | Media Q&A on the Interim Measures (“Media Q&A”) |
| PBOC Shanghai Head Office (“PBOC Shanghai”) |
Guide on Registration of Overseas Investors for Northbound Trading of Bond Connect (“Investor Registration Guide”) |
| CFETS |
Guide on Market Entry of Overseas Institutions (Bond Connect) (“Market Entry Guide”) |
| CFETS |
Bond Connect Trading Rules of National Interbank Funding Center (Trial Implementation) (“Trading Rules”) |
| SHCH |
Detailed Operation Rules for Registration, Custody, Clearing and Settlement of Bond Connect Cooperation between the Mainland and Hong Kong (Trial Implementation) (“SHCH Rules”) |
| CCDC |
Registration, Custody and Settlement Business Rules for Northbound Trading of Bond Connect (“CCDC Rules”) |
The Media Q&A, the Investor Registration Guide, the Market Entry Guide, the Trading Rules, the SHCH Rules, and the CCDC Rules are collectively referred to as the “Implementation Rules”. Below is a summary of the key aspects of the MoU, the Interim Measures and the Implementation Rules.
Comparison between the Interim Measures and its Consultation Draft
The PBOC released a consultation draft (“Draft Measures”) of the Interim Measures on May 31, 2017. Compared with the Draft Measures, the final Interim Measures remain largely the same and have very few revisions. The main revisions are: (1) The Draft Measures provide that no investment quota limits apply to Northbound Trading. Such provision is deleted in the Interim Measures. On the other hand, back in May 16, 2017, the PBOC and the HKMA issued a joint announcement on Bond Connect indicating that there will be no investment quota limits for Northbound Trading. Therefore, in spite of such revisions to the Draft Measures, investment quota limits should not be imposed on Northbound Trading unless otherwise announced by the PBOC and the HKMA. (2) Regarding the custody arrangement, the Interim Measures clarifies that a lower-level custodian institution shall contract with its upper-level custodian institution to specify each party’s obligations. Please see our detailed analysis below in the “Custody Arrangement” section.
Scope of Overseas Investors
As confirmed in the Investor Registration Guide, overseas investors for Northbound Trading refer to eligible overseas investors which satisfy the requirements for entry into the China Interbank Bond Market (“CIBM”). The requirements are specified in the PBOC Announcement [2016] No.3 and the PBOC Notice on Issues Concerning Investment of Foreign Central Banks, International Financial Institutions and Sovereign Wealth Funds with RMB Funds in the Inter-bank Market (Notice No.220 [2015]). Eligible overseas investors include:
- 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 in accordance with the relevant laws and regulations, and pension funds, charitable funds, donated funds or other mid- and long-term institutional investors recognized by the PBOC; and
- foreign central banks, international financial institutions and sovereign wealth funds.
Scope of Trading
Under Northbound Trading, the trading vehicles cover any of the bonds tradable on the CIBM. However, currently overseas investors may engage in the trading of physical bonds only, and in the future it may be expanded to bond repurchasing, bond lending, bond forwarding, interest rate swaps, and forward rate agreements.
Registration with the PBOC Shanghai
To engage in trading under Northbound Trading, qualified overseas investors shall apply for registration with the PBOC Shanghai. The registration may be applied through one of the following registration agents:
- CFETS (CFETS has issued a complete set of registration forms, which are attached to the Market Entry Guide. The forms are downloadable at http://www.chinamoney.com.cn/fe/Info/38765913);
- domestic bond custodians recognized by the PBOC, i.e. the CCDC and the SHCH;
- CIBM settlement agents (see the PBOC website for a complete list of the settlement agents);
- other institutions recognized by the PBOC.
Upon receiving the registration application, the PBOC Shanghai will complete its review of the application and issue a registration notice within three business days.
Opening Accounts with the CFETS
After registered with the PBOC Shanghai, a qualified overseas investor may open a trading account with the CFETS. The name of the trading account should be consistent with that on the registration notice issued by the PBOC Shanghai.
Trading Procedure
Overseas investors shall deliver trading orders via overseas electronic trading platforms (including Tradeweb, and other platforms may be approved later). Then the orders will be transferred to the CFETS, where transactions with counterparties are consummated.
The CFETS will organize quotation institutions to provide ongoing quotations for overseas investors. Overseas investors may send requests for quotations to one or multiple quotation institutions. Such requests shall specify trading direction, bond code, face value, request valid period (one hour maximum), and settlement speed, but not prices. Quotation institutions may respond to the requests with price quotations. If the quoted prices are accepted by overseas investors, transactions will be executed at the CFETS.
Custody Arrangement
The Interim Measures and the Implementation Rules provide the following clarifications on the custody arrangement as summarized below: (1) When applying for registration with the PBOC Shanghai, an overseas investor shall disclose all custodians between the Tier 1 custodian and the CMU. The Tier 1 custodian shall refer to the custodian with which an overseas investor directly signs a custody contract and opens a bond account. (2) Custodians at each level shall sign a custody contract with its upper-level custodian. (3) The final overseas custodian is the CMU. Any bonds purchased by an overseas investor through Northbound Trading shall be registered under the name of the CMU, and the overseas investor shall be entitled to the rights and interests of such bonds. (4) The CMU shall open nominee holder accounts with the two onshore custodians, i.e. the CCDC and the SHCH, to record the balance of all bonds held in such nominee accounts. The aggregate amount of the bonds registered for the overseas bondholders having opened bond accounts with the CMU shall be equal to the balance of the bonds registered under the nominee accounts at the CCDC and the SHCH.
Nominee Holder and Beneficiary Owner
According to the MoU, the PBOC and the HKMA shall oversee the custodians to ensure that the custodians’ proprietary assets are segregated from clients’ assets held in the nominee accounts, and clients have the ownership of the assets held on their behalf in the nominee account. The method for an overseas investor, as an actual beneficiary owners to the rights and interests of bonds, exercises its rights of creditors shall be arranged according to the laws of Hong Kong with respect to beneficiary ownership. Beneficiary owners to the rights and interests of bonds under Northbound Trading shall exercise their rights against bond issuers via the nominee holder, i.e. the CMU.
In our June 7 Client Briefing on the Draft Measures, we suggested that the Interim Measures shall expressly stipulate that a beneficiary owner may directly claim its rights and interests to the bonds based on the relevant contract entered into between the beneficiary owner and the nominee bondholder. While not expressly addressing this issue in the Interim Measures, the PBOC explained in the Media Q&A that, first, overseas investors shall prove their beneficiary ownership under the Hong Kong law and relevant rules; second, as long as the Hong Kong law and relevant rules recognize that the bond holding certificates issued by the CMU and its participants are the legal proof of overseas investors’ securities beneficiary ownership, the PBOC will respect such arrangement; third, an overseas investor may initiate a lawsuit in its own name before a PRC court pursuant to law, if it proves that it is a beneficiary owner and its direct interests are concerned therein.
Capital Conversion
Rules on capital conversion remain basically the same as those in the Draft Measures. 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 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, unless it uses the proceeds for re-investment, it shall in principle convert the proceeds back into foreign currencies and transfer the foreign currencies abroad through Hong Kong Settlement Banks.
It shall be noted that the capital conversion under Northbound Trading 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 RMB purchases and sales, 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
Rules on foreign exchange risk hedging remain the same as those in the Draft Measures. In order to hedge foreign exchange risks, an overseas investor may, through the relevant bondholder, hedge its foreign exchange risks under the Northbound Trading 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 Northbound Trading.
For further information, please contact:
Natasha (Qing) Xie, Partner, Jun He
xieq@junhe.com
