Explainer: what is Bond Connect?

What is Bond Connect?

Bond Connect is a new mutual market access scheme that allows investors from mainland China and overseas to trade in each other’s respective bond markets.

Northbound trading commenced on July 3 in the initial phase, allowing overseas investors from Hong Kong and other regions to invest in the China interbank bond market through mutual access arrangements in respect of trading, custody and settlement. There are no quota limits imposed on the northbound investment. Southbound trading will start at a later date.

What are the advantages of Bond Connect?

Under the Bond Connect programme foreign investors are able to buy debt trading on China’s interbank bond market directly through the Hong Kong exchange. Eligible investors are mainly institutions, such as banks, insurance companies, brokerages and asset management firms.

Prior to the Bond Connect, foreign investors needed to go through a lengthy process of opening an account, applying for yuan quotas and finding a clearing agent with international settlement.

China’s bond market is now valued at 65 trillion yuan (US$9.57 trillion) and foreign investors hold about 800 billion yuan, or 1.3 per cent of the total.

Foreign investors bought more Chinese bonds than they sold for 10 straight months through the end of 2016. By the end of 2015, a total of 407 foreign were participating in the inter bond market.

What is the expected market size of Bond Connect at the initial stage?

The initial impact could be limited as there is uncertainty facing the yuan’s exchange rate, and bond yields are likely to rise further amid China’s economic recovery, according to China International Capital Corp.

Deutsche Bank estimates an inflow of 300 billion yuan into China’s onshore bond markets this year and cumulative inflows of as much as US$800 billion over the next five years.

Ping An Asset Management says that capital inflows can be expected in the long term. Foreign ownership of Chinese bonds is much lower than that of other developing countries, indicating potential increase in the foreseeable future, Ping An said.

The firm predicts that China will attract US$250 billion, once its bond market is added to global debt indexes.

What types of bonds are foreign investors likely to buy?

The main scope of focus of foreign investors is still on government bonds and policy financing bonds, according to Ping An Asset Management. With an improving understanding of the Chinese market, their interest may expand to include credit bonds, it said. Once the basic problem of domestic credit ratings is resolved, credit bond investment will become a more viable option to investors, the firm said.