Bond Connect a one-way street until southbound trade opens
Hong Kong’s bond market won’t feel the benefits of the new cross-border link until southbound trading is enabled
The much anticipated Bond Connect scheme was finally launched on Monday, giving international investors access to China’s US$9 trillion debt market and marking a key milestone in the gradual opening up of the country’s capital markets.
By 9.20am more about 3.3 billion yuan in mainland bonds had been snapped up in what is referred to as “northbound trade”.
But it may be a while before Hong Kong benefits from southbound flow, in which mainland investors will eventually buy and sell bonds in the city.
Newly appointed Chief Executive Carrie Lam Cheng Yuet-ngor came to the Hong Kong Exchanges and Clearing headquarters to host the Bond Connect launch ceremony, demonstrating the importance of the scheme for her government. Indeed, it was her first official financial event since taking office on Saturday.
The reasons for the connect scheme’s importance are obvious: it will allow international investors to easily trade in the world’s third biggest bond market.
But there are a number of setbacks.
The most important one is that the scheme for now only allows northbound buying and selling of mainland bonds via HKEX.
There is no southbound access for mainlanders to trade Hong Kong bonds.
As a result, the trade is currently just one-way traffic and not yet a mutually beneficial system.
This is different from the two stock connect initiatives that tied up Hong Kong and Shanghai’s stocks markets in 2014 and then the Hong Kong and Shenzhen bourses two years later. In the case of both stock connects, northbound and southbound trade capabilities were launched together.
Without southbound trade activated, Hong Kong is only acting as a channel to let international funds flow to mainland bond markets, something which is likely to boost the attractiveness of panda bonds – onshore yuan-denominated bonds.
The current bond connect scheme is thus not much help in boosting Hong Kong’s bond market as it will not bring any money in from the mainland.
Mainlanders are an important source of turnover for many Hong Kong financial products, from insurance to stocks. Mainlanders’ trading now represents 10 per cent of Hong Kong stock market turnover via the southbound activity enabled by the two stock connects.
Mainlanders also purchased 37 per of all life insurance products in Hong Kong last year.
These figures strongly suggest that if there were southbound trading available for mainlanders to buy bonds in Hong Kong, the potential is huge.
At the launch ceremony this morning, both People’s Bank of China deputy governor Pan Gongsheng and HKEX chief executive Charles Li Xiaojia said the southbound strand of Bond Connect will be launched when there is sufficient market demand.
Low interest rates and bond yields has meant Hong Kong’s dim sum bonds have lacked appeal for investors.
But this is a chicken and egg scenario: if there were investors from the mainland who wanted to trade bonds in Hong Kong, more good quality companies would consider issuing bonds here.
There are few bond products listed in Hong Kong now. If the southbound bond connect gets up and running, perhaps more issuers will opt to issue debt via HKEX.
If this happens, it will help HKEX to diversify its income source away from stocks.
It could also benefit Hong Kong as an international fundraising centre by attracting more mega infrastructure projects of the Belt and Road Initative to issue bonds here.
This is why Carrie Lam’s government should fight for the southbound leg of the bond connect to start trading as soon as possible.