For the past twelve years, since China first allowed investment in the China Interbank Bond Market (“CIBM”) by foreign central banks, monetary authorities and RMB clearing banks, etc., China has been making efforts to further open the bond market and facilitate the participation of foreign institutional investors by adopting a series of measures. On May 27, 2022, the People’s Bank of China (“PBoC”), the China Securities Regulatory Commission (“CSRC”), and the State Administration of Foreign Exchange (“SAFE”) jointly issued the Circular on Matters Concerning Further Facilitating Foreign Institutional Investors to Invest in China’s Bond Market (“Circular No. 4”) to unify the different thresholds and the entry procedures for foreign investment. Circular No. 4 follows the principle of “one set of rules, one integrated bond market”, and further facilitates foreign institutional investors’ investments in the bond market.
We have summarized below the key points of the circular which concern foreign institutional investors.
Thresholds for Foreign Institutions
Qualified foreign institutional investors under Circular No. 4 include:
(1) Foreign central banks or monetary authorities, international financial organizations and sovereign wealth funds (“Sovereign-type Institutions”);
(2) Various types of foreign financial institutions legally registered and incorporated overseas, including foreign commercial banks, insurance companies, securities companies, fund management companies, futures companies, trust companies and other asset management institutions; and
(3) Other medium- and long-term institutional investors including pension funds, charity funds, endowment funds ((2) and (3) collectively “Commercial-type Institutions”).
The qualification requirements for the foregoing Commercial-type Institutions to invest in China’s bond market under Circular No.4 are in line with that enumerated in PBoC Circular (2016) No. 3. The scope of foreign institutional investors is consistent with the “qualified foreign institutional investors” under the Measures for the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors issued by the CSRC on September 25, 2020.
Procedures and Investment Methods for Foreign Institutions to Invest in China’s Bond Market
At present, a foreign investor can invest in the CIBM via (a) QFII/RQFII, (b) direct investment in the CIBM (“CIBM Direct”) and (c) Bond Connect. Via the QFII/RQFII method, a foreign investor can also invest in the exchange bond market (“Exchange Market”). A foreign investor investing in the CIBM through CIBM Direct or via QFII/RQFII is required to enter into a settlement agency agreement with a domestic settlement agent or a domestic custodian bank (“Settlement via Agency Model”), and file with the PBoC’s Shanghai Head Office via a settlement agent or custodian bank.
Since the further opening-up of the CIBM to admit qualified Commercial-type Institutions in 2016, the entry procedures for foreign institutions have been further simplified. In March 2021, the PBoC simplified the filing requirements for foreign institutions’ entry into the CIBM. It clarified that the same foreign investor just needs to apply a new filing form and file it once in its own name if it uses different unincorporated products to invest in the CIBM via different channels. In addition, the PBoC’s Shanghai Head Office no longer requires a foreign investor or its settlement agent or custodian bank to submit the settlement agency agreement for filing. Circular No. 4 further provides that foreign Commercial-type Institutions applying for entry to the CIBM may submit documents to the PBoC’s Shanghai Head Office electronically, while Sovereign-type Institutions may submit documents directly to the PBoC, which further facilitates foreign institutions’ participation in the CIBM.
Pursuant to Article 4 of Circular No. 4, qualified foreign institutions in the CIBM may trade in the Exchange Market either directly or through the intra-market connect scheme. Foreign institutional investors shall comply with the relevant business rules of the different financial market infrastructures (such as trading and settlement institutions) and the financial institutions concerning account opening, trading, custody, and settlement. This means, other than QFII/RQFIIs that are already permitted to directly trade in both the CIBM and the Exchange Market, qualified foreign institutional investors under CIBM Direct may also invest in the Exchange Market either directly or through the intra-market connect scheme. Detailed rules for account opening, trading, custody and settlement for such foreign institutions investors’ directly trading in the Exchange Market are expected to be formulated by the CSRC, the exchanges and the China Securities Depository and Clearing Corporation Limited. If a foreign investor under CIBM Direct trades on the Exchange Market through the intra-market connect scheme, they shall comply with the Interim Measures for Businesses of Interconnection Scheme between the Interbank Bond Market and the Exchange Bond Market (which were issued in January this year) to participate in the “Connect to the Exchange Market”, and trade bonds with other investors via their agents. It should be noted that under the intra-market connect scheme, only cash bonds are permissible to trade on the Exchange Market. Further clarification is needed from the regulators as to whether foreign investors trading in the CIBM via Bond Connect are permitted to participate in the intra-market connect scheme.
Investment Scope
We set forth below the permissible investment products that foreign investors can trade in the CIBM via the three channels.
| CIBM Direct | Bond Connect | QFII/RQFII |
| Sovereign-type Institutions:Cash bonds, bond repos, bond lending, bond forwards, forward rate agreements, interest rate swaps, etc. Commercial-type Institutions:Cash bondsBond lending, bond forwards, forward rate agreements and interest rate swaps traded for hedging purposes | Cash bonds only | Cash bondsBond lending, bond forwards, forward rate agreements and interest rate swaps traded for hedging purposes |
Circular No. 4 allows foreign institutional investors to trade cash bonds, bond lending, related derivatives for risk management purposes, open-end bond-index securities investment funds, and other products recognized by the PBoC and the CSRC in the bond market. Our observation is that there is no change in the permissible investment products for foreign investors in the CIBM. In other words, foreign investors are still only allowed to trade bond lending, bond forwards, forward rate agreements and interest rate swaps for hedging purposes. In recent years, foreign institutions have shifted more asset allocation to RMB bond assets. With the rapid increase in their investment size in China’s bond market, their needs for managing the interest rate risk increases accordingly, bringing a growing demand for trading treasury bond futures and other related interest rate derivatives. At present, the China Financial Futures Exchange (“CFFEX”) has listed 2-year, 5-year and 10-year CGB futures, which could be used to manage short-term, medium-term and long-term interest rate risks respectively. It remains to be seen whether Circular No. 4 paves the way for foreign investors to trade bond treasury futures by allowing foreign investors to trade related derivative products for risk management purposes. We also note that the CSRC has provided in the Provisions on Issues Concerning the Implementation of the Administrative Measures for Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors that qualified foreign investors may invest in the financial futures contracts listed and traded in the CFFEX. However, it remains unknown when such a provision will be implemented.
Custody and Settlement Arrangements
Pursuant to Circular No. 4, in addition to the current Settlement via Agency Model (i.e., directly opening bond accounts at bond registration and settlement institutions), a foreign investor may, directly or via its global custodian bank, entrust a qualified local custodian bank to exercise custody over its bonds. The bonds purchased by a foreign institutional investor in the CIBM via its local custodian bank will be registered in the name of this custodian bank and the foreign investor will have the interests in the securities according to laws. Circular No. 4 introduces a multi-layered custody arrangement, whereby the nominee holder mechanism adopted by such arrangement is not new to foreign investors. Currently, the financial infrastructure institutions of both the CIBM and the Exchange Market adopt the nominee holder mechanism to conduct cross-border custody and settlement with the Hong Kong market, to achieve the interconnection of stock and bond trading between the Hong Kong market and the Exchange Market or the CIBM, and so does the intra-market connect between the CIBM and the Exchange Market. Circular No. 4 adopts a globally followed model of “Global Custodian Bank + Local Custodian Bank”, so that foreign investors can invest in the CIBM without needing to adjust their trading customs. Despite the lack of explicit provisions on the nominee holder mechanism, we believe the current legal framework and judicial practice in China can provide protection for the legitimate rights and interests of foreign beneficial owners under a multi-layered custody arrangement.
The multi-layered custody arrangement in Circular No. 4 also imposes requirements on local custodian banks. Circular No. 4 requires local custodian banks to establish and optimize the relevant mechanisms to strictly segregate the assets of foreign institutional investors from its proprietary assets and other assets under custody and effectively implement the requirement of independent custody. Under the model of a “Global Custodian Bank + Local Custodian Bank,” the local custodian bank shall enter into an agreement with the global custodian bank to clarify their respective responsibilities. In addition, both local and global custodian banks shall record the trading, custody and settlement information of foreign institutional investors in a timely, accurate and complete manner, and report the same to the regulators on a regular basis pursuant to the relevant reporting requirements.
Outlook
In recent years, China’s regulators have issued a number of policies to facilitate the participation of foreign institutions in China’s bond market. The promulgation of Circular No. 4 further deepens and broadens the opening-up of China’s bond markets. In October 2021, the Executive Meeting of the State Council extended the terms of a policy for an exemption of enterprise income tax and value-added tax derived by foreign institutional investors’ investing in China’s bond markets until the end of 2025, which consolidates the confidence of foreign institutions in investing in the CIBM. In addition to Circular No. 4 which allows foreign investors to trade domestic bond ETFs, on May 27, 2022, the CSRC and the Hong Kong Securities and Futures Commission jointly issued an announcement to include in principle qualified ETFs by mainland and Hong Kong exchanges in the Stock Connect, thereby allowing mainland and Hong Kong investors to trade eligible stocks and ETFs listed on the other exchange. At present, domestic stock exchanges are soliciting comments on the relevant implementation measures for the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect to clarify the investor qualification requirements, permissible investment products, investment methods and other rules related to the inclusion of ETFs under Stock Connect.
For further information, please contact:
XIE, Qing (Natasha), Partner, Junhe
xieq@junhe.com
