The Chinese bond market opens

Co-authored with Zouhoure Bousbih

The Chinese bond market is becoming more international and opening up to foreign investors. Coinciding with the 20th anniversary of the handover of Hong Kong to China, the Chinese authorities are displaying their aim of shaping world affairs, acting directly on the largest and most important financial market worldwide.
The Chinese bond market is the third largest worldwide after the US and Japan, with assets of $9,000 billion (source FT) if we combine sovereign bonds, agencies and corporates.
Foreign investors only account for 1.5% of this market, which is ridiculously small for an economy the size of China’s. The magnitude of the Chinese economy in the world and the proportionate weighting of its bond market are not yet comparable. But this is set to change, and this shift in balance will mark a lasting transformation compared to the current situation.  

This new mechanism will have investors operate via Hong Kong, which is already a well-developed financial market place. The Chinese market itself is less efficient, which makes it less attractive, but investing via Hong Kong through Bond Connect will provide access to the Chinese market, while avoiding the very high administrative costs involved in investing directly there.
Investors will not have full access to the market: only institutional investors will be able to access the market to begin with, and retail investors will not be able to invest the way they do in other bond markets. The market balance itself will also be asymmetrical. Foreign investors will have access to the Hong Kong platform to invest in Chinese securities, but Chinese investors will not be able to use this point of entry to buy bonds traded in Hong Kong. The Chinese authorities do not want to encourage capital outflows.

This is a potentially attractive market for investors as the 10-year bond currently carries yield of 3.6% as compared with 2.3% on the 10-year T-note. The Chinese authorities will need to stabilize the country’s currency if they are to keep their bond market attractive, and avoid disruption in the event of sharp volatile shifts on the Yuan exchange rate. Opening up the bond market to the world should make the currency more stable with potentially more frequent interventions.
This market is set to attract investors due to its size and also on the back of the strength of the Chinese economy. However, the real boost will come from the inclusion of Chinese securities in bond indices. This stage, which should happen a bit later, would provide the market with more transactions and greater depth as it would be traded by all investors who want to track the bond benchmark.

China has previously used this Hong Kong strategy to open its equity market, with Shanghai in 2014 and Shenzhen in 2016.
After the inclusion of Chinese A-share stocks (222 stocks) in the MSCI emerging markets and world benchmarks around ten days ago, China is now hitting a fresh milestone by opening up its bond market.

In view of the size of the Chinese market, this change marks a shift that will make the zone a major component of the world bond markets in the future.
Almost 20 years ago, in December 2001, when China joined the World Trade Organization (WTO), its manufacturing products were seen as being of poor quality. The Chinese manufacturing sector now rules the world, so it is worth bearing that in mind. The Chinese bond market is set to remain in its infancy with insufficient oversight for a short while, but the watershed moment is happening now.
Imagine, in a just a few years, our institutional investors looking at the Chinese bond market as a source of arbitrage opportunities with the Bund, OAT, Japanese JGB, or US T-note markets… we should not be surprised. Opening of the Chinese economy must now involve a new financial dimension to balance its growth and its economy. And this is the breakthrough we are now seeing, just 20 years after Hong Kong was handed over to China.

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