Bond Connect a win-win for mainland and Hong Kong

The introduction of the long-awaited Bond Connect scheme was timed with celebrations of the 20th anniversary of Hong Kong’s return to China. It is an important step in the city’s long and frustrating efforts to create a credible bond market to rival its world-famous stock exchange. The scheme offers an immediate boost to the city’s financial services as it provides a streamlined platform for global investors to access China’s 69 trillion yuan (HK$79.2 trillion) bond market, the third largest after the United States and Japan.

Perhaps more importantly, it marks another step forward for China’s decades-long efforts to open its capital markets. It is a win-win for Hong Kong and the mainland, part of a long-running series of mainland “gifts” such as the Shanghai Stock Connect scheme in November 2014 and the Shenzhen Stock Connect last December.

Brisk trade marked the launch of the new bond scheme, with foreign investors purchasing 4.9 billion yuan worth of bonds on its opening day. As the People’s Bank of China has been tightening monetary policy – and causing bond yields to be higher than those in many developed economies – it’s no surprise that many outside investors are attracted.

Financial stocks advance in Hong Kong as Bond Connect opens for business

The Chinese bond market is expected to double in size over the next five years. Yet foreign investors own less than 2 per cent of the market total. The average foreign ownership of a mature bond market in the developed world is about 10 per cent. By liberalising the market, China has a chance to lift foreign ownership. The recent inclusion of A shares in the widely followed MSCI indexes came after the Shanghai and Shenzhen Stock Connect links. Depending on the popularity of the latest scheme, Chinese bonds should expect similar global recognition.

Bond Connect is part of the country’s efforts to encourage the opening of its capital account. In place of heavy-handed capital controls, the inflow of foreign capital will help create a better market mechanism to determine the yuan’s value. Chinese sovereign financial bodies and private commercial entities can better access international capital.

Last year saw the inclusion of the yuan in the International Monetary Fund’s basket of currencies. The ongoing reform of the bond market will boost usage of the yuan and its recognition as an international currency. And, as more foreign investors are exposed to borrowings from state and commercial entities, they will demand greater transparency.

In time, a virtuous cycle of transparency and price discovery may develop in an internationalised bond market with Hong Kong benefiting in the middle.