China, Hong Kong regulators to launch Swap Connect, give offshore holders of US$553 billion in onshore yuan bonds more tools to hedge risks

Initially, only Hong Kong and overseas investors will be allowed to access China’s interbank derivative market through northbound trade

Swap Connect will bolster international investors’ participation in China’s onshore bond market, HKMA CEO says

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Swap Connect is the latest mechanism designed to augment Hong Kong’s role as an international financial hub, and to further open up the Chinese interbank derivative market. It will kick off with interest rate swaps. Photo: AFP

Published: 4:00pm, 4 Jul 2022

Central banks and regulators in China and Hong Kong will work on launching Swap Connect, a mutual access mechanism that will allow foreign investors to hedge the market risks of the 3.7 trillion yuan (US$553 billion) in onshore yuan bonds held by them.

As the latest mutual access mechanism designed to augment Hong Kong’s role as an international financial hub, and to further open up mainland China’s interbank derivative market, Swap Connect will first debut with interest rate swaps. These are over-the-counter, bilateral contracts that allow holders of a bond to manage their risks by swapping one stream of future interest payments for another, based on a specified principal amount.

At the initial stage, only Hong Kong and overseas investors will be allowed to access the mainland interbank derivative market through the so-called northbound trade, the city’s Securities and Futures Commission (SFC), the Hong Kong Monetary Authority (HKMA), the People’s Bank of China (PBOC), China Foreign Exchange Trade System (CFETS) and Shanghai Clearing House said in a joint statement on Monday. They are targeting the end of 2022 for the launch of this scheme.

The latest development follows a cut in yuan bond holdings by foreign investors this year, as China’s yield advantage over US Treasuries disappeared for the first time since 2010. This has affected even Chinese government bonds, which investors consider risk-free. Foreign investors have been pulling out of yuan bonds since March, bankers said. The yuan has depreciated by about 5.3 per cent against the US dollar year to date.

The Swap Connect scheme is being viewed as a “positive step” that will help foreign investors hedge their yuan bond bets.