On 24 September 2020, China Foreign Exchange Trade System (CFETS), the operator of the trading system of the China Interbank Bond Market (CIBM), issued a notice relating to a new arrangement under which Northbound Bond Connect investors may choose to engage up to three designated settlement banks in Hong Kong to conduct currency conversion and FX hedging for their RMB exposure in respect of their Bond Connect investments (referred to here as “Enhanced CNY Conversion Service”). Prior to such arrangement (and when Bond Connect first launched in July 2017), a Bond Connect investor can only engage one settlement bank in Hong Kong (typically by the investor’s CMU member on its behalf) to handle settlement and to conduct currency conversion and FX hedging. The new arrangement presents new opportunities to settlement banks in Hong Kong as overseas investors investing in the CIBM via Bond Connect are given more choices in their selection of banks for the provision of foreign exchange services.  
 

Further to CFETS’ notice, the Hong Kong Monetary Authority (HKMA) issued a circular1 to all “Hong Kong FX Settlement Banks” on 5 March 2021 setting out the regulatory requirements that banks are expected to comply with in offering the Enhanced CNY Conversion Service in order to maintain access to the onshore interbank foreign exchange market to conduct position squaring transactions.
 

Under the new arrangement, an overseas investor eligible to participant in Northbound Bond Connect is allowed to appoint up three settlement banks in Hong Kong: one as its “Primary FX Settlement Bank” to handle the money settlement of its Northbound Bond Connect transactions with the Central Moneymarkets Unit (CMU) and to provide currency conversion and FX hedging services (i.e. the role performed by the sole settlement bank in the existing arrangement), and up to two as its “General FX Settlement Banks” for the provision of currency conversion and FX hedging services. General FX Settlement Banks do not handle settlement so any CNY funds arising out of the relevant Bond Connect transactions should be transferred to/from the investor’s designated Bond Connect settlement account at its Primary FX Settlement Bank.  
 

Enhanced monitoring responsibilities and reporting requirements
 

Hong Kong FX Settlement Banks wishing to offer the Enhanced CNY Conversion Service should be mindful of the monitoring responsibilities and reporting requirements that the HKMA expects of them as set out in the HKMA circular. Banks are expected to put in place proper internal controls to ensure that the currency conversion and FX hedging transactions arise from an investor’s genuine and reasonable needs from Bond Connect investments. Investors confirmations should be obtained for such purpose. Since fund flows under Northbound Bond Connect operates on a closed-loop basis, banks should implement proper ring-fencing arrangements to monitor fund flows. Hong Kong FX Settlement Banks should also note the new FX risk management information services offered by CFETS under the Bond Connect scheme which allows them to, with the authorization of the relevant investors, access certain investor data relating to their Bond Connect investments.  
 

While the HKMA does not expect Hong Kong FX Settlement Banks to share transaction data relating to the Enhanced CNY Conversion Service with each other in order to discharge the above monitoring responsibilities, they are required to report certain investor-level data to the HKMA. In particular, the banks are required to notify the HKMA if the amount of CNY converted or hedged exceeds certain thresholds which may suggest that the Enhanced CNY Conversion Service is used for purposes other than in connection with Northbound Bond Connect investments. Hong Kong FX Settlement Banks also have to fulfil certain reporting requirements as set out in the HKMA circular.  
 

The HKMA said in its circular that Hong Kong FX Settlements Banks may start to provide the Enhanced CNY Conversion Service after they have the necessary control and system in place to discharge the regulatory requirements set out in the circular.  Existing settlement banks are advised to revisit their contractual terms with clients including their account terms and conditions, settlement bank agreements and FX hedging terms to ensure that the terms are appropriate and sufficient for the new service. For example, whether the existing documentation reflects the new arrangement as to fund flows if more than one settlement bank is involved and whether the documentation contains the necessary provisions to enable the banks to conduct the monitoring they are required to do. Banks hoping to offer the Enhanced CNY Conversion Service as “General FX Settlement Banks” may wish to establish new sets of client documentation. In either case, provisions such as client representations and warranties and confidentiality waivers may be required.
 

Linklaters Zhao Sheng has extensive experience in advising banks and financial institutions on a wide spectrum of China Connect-related work (including stock connect, bond connect and funds connect). We have assisted our clients in developing China Connect trading terms and conditions, structured and repackaging transactions and related collateral arrangements. We are also currently advising on GBA PWM Connect schemes for a number of clients. We would be happy to discuss with you any questions you have on the Enhanced CNY Conversion Service.
 

 

For further information, please contact:

 

Karen Lam, Linklaters

karen.lam@linklaters.com  

   

1 “Enhanced Currency Conversion Arrangement Involving Onshore RMB (CNY) under Northbound Bond Connect” issued by the HKMA on 5 March 2021 (with Annex I and Annex II)