Short-term buying through Bond Connect may prompt policy measures

Foreign holdings of negotiable certificate of deposits up by 231pc this year

PUBLISHED : Friday, 10 November, 2017, 8:02am
UPDATED : Friday, 10 November, 2017, 11:28pm

Trading by offshore investors through China’s Bond Connect scheme is picking up amid this year’s strength in the yuan, but interest has been focused mainly on short-term money market instruments, with a tenor of less than one year.

Policymakers, however, may want to obtain more foreign inflows into longer term bonds and extend the maturity of its yield curve, helping provide long-term funds to public and private projects rather than for short-term speculative purposes, analysts said.

Foreigners have been buying short-term debt such as super short and short-term commercial paper, and especially negotiable certificate of deposits (NCDs). Their holdings of NCDs surged 231 per cent this year to 79.3 billion yuan (US$12 billion) in October, according to data from the Shanghai Clearing House, one of China’s two bond-settlement systems.

Meanwhile, foreign holdings of Chinese bonds has only grown by 16 per cent this year to a peak of 396.8 billion yuan in September before it slipped back to 387.3 billion yuan in October, according to China Central Depository and Clearing.

“There is a drive to expand the yield curve and get more investments at the longer end of the yield curve. The Chinese government will ensure policies and measures to encourage that,” said Christy Tan, the head of markets strategy at National Australia Bank.

The Bond Connect kicked off in July, allowing foreigners to access China’s US$9.3 trillion bond market through Hong Kong. NAB predicts funds coming to China to amount to US$1 trillion in the near term.

Institutional investors have been attracted to China’s NCDs, which are simply a fixed deposit that is negotiable, because they are low risk given the credit standing of the bank issuer and since they are short tenor. More importantly, NCDs are offering attractive interest rates of as high as 3.70 per cent to 4.25 per cent for a one-month tenor, compared with a rate of only 2.75 per cent paid on a 28-day central bank reverse-repurchase agreement, another type of money market instrument.

At the same time, investors have been avoiding long-term bonds because of a sell-off in the market amid easing concerns over China’s economic growth and the given expectations for the US Federal Reserve to continue raising interest rates.

Reflecting a worsening sentiment especially in long-term debt, China’s 10-year government bond yield breached 3.9 per cent, a level that has not been seen since the end of 2014.

But the People’s Bank of China is curbing the sharp growth in the NCD market in an apparent effort to curb risky lending behaviour in the financial system. For example, in its quarterly monetary policy report in August, it said it would start to include NCDs issued by banks with assets of more than 500 billion yuan in its quarterly macro-prudential assessment from the first quarter of 2018.

Indeed, NCD issuance has started to shrink since then, falling to 200 billion yuan in October from 247 billion in September.

“The sharp growth in the NCD market has created some concerns for policymakers and banks are now switching to the issuance of financial bank bonds to raise funds,” said David Qu, a market economist at ANZ Bank.