Outlining the market impact of the latest changes in the Chinese bond market, Tony Shaw, Head of Institutional Sales APAC at HSBC, discusses the challenges faced by the buy-side desks, and how the latter can optimise their access and trading efficiencies in China.
How has investors’ appetite for Chinese bonds changed over the past year?
There has been a notable increase in demand for investments via different channels over the past 12 months, including both the Chinese Interbank Bond Market (CIBM) and Bond Connect.
At the end of July 2019, 2,085 overseas investors had entered the market; 951 had registered via CIBM Direct and 1,134 through Bond Connect. Over 800 of these accounts had been added during the past 12 months alone.
CIBM Direct remains the most highly utilised investment channel for china bonds by institutional investors, particularly banks, central banks and asset owners.
In H1 2019 institutional investor volumes via CIBM Direct were UCNY1.3tn verses CNY0.8tn via Bond Connect. [Source CFETS]
Having said that, there has been a significant increase in investors registering to invest via the Bond Connect channel – particularly asset managers. The number of investors registered to execute via Bond Connect is higher than CIBM (1028 for BC vs 923 for CIBM) [Source CFETS]. The US and Hong Kong account for 32% and 25% respectively of the overall investor base; this scheme has on-boarded 59 of the top 100 global asset managers with many more in the pipeline.
The main reason for this, particularly for asset managers, is that the trading infrastructure used in the Bond Connect programme, initially Tradeweb and latterly also Bloomberg, looks and feels much more like a global bond market. Another key contributing factor was the resolution of a number of key investor concerns relating to the Bond Connect platform prior to the BBG Barclays inclusion, specifically; bulk trade allocations and tax treatment.
What were the overall activities in the Chinese Bond Market in the past year?
At the end of July 2019, the total trading volume on Bond Connect was RMB991 billion, while the average daily turnover was RMB6.93 billion. This equates to 11,854 transactions over 143 trading days.
During H1 2019, CFETS reported that offshore investors did 21,786 deals in CIBM. Total turnover was CNY2.1tn – a 31% increase YoY – weighing 2% of the whole market turnover.
In terms of what we saw at HSBC, August was HSBC China’s highest monthly trading volume ever as an onshore bond broker in the China Interbank Bond market. Since the inclusion of the Bloomberg Global Aggregate index in April 2019, HSBC’s monthly average volumes are up over 100% versus the beginning of 2018. For the CIBM Direct channel, in H1 2019 HSBC China was ranked #1 in trading volume amongst foreign banks and 2nd among all market makers.
The increase of these volumes is predicated by new investments and new developments.
The BCCL, the primary market information platform, disclosed pre and post issuance information on 194 bonds in July; this will allow investors to get greater transparency on new issuer’s information across policy, financial bonds, NCDs, asset backed securities and commercial paper, and will in turn facilitate investors’ participation in the market.
As of July 2019, Bond Connect’s scope has expanded beyond secondary market trading. A total of 47 onshore dealers, both Chinese and international, are now set up in Bond Connect to provide market liquidity, with 15 new dealers added on the second anniversary of Connect. Live streaming of indicative prices has been introduced on Tradeweb and Bloomberg, helping investors to get a wider sense of dealers’ quotes. Bloomberg also launched pre and post trade allocation functionality and support for ABS trading, levelling its service offering to e-trading platforms on Bond Connect. In addition to that, Tradeweb also started to provide iDeal chat, a messaging tool developed by CFETS to allow investors to communicate with dealers. The limit of the RFQ size was reduced from RMB100,000 to RMB10,000.
Such developments have gone hand in hand with a very supportive macro environment and subsequently creating fast growing demand and allowed easier adoption.
What effect does index inclusion, and therefore passive investment tools, have upon market liquidity?
Index inclusions are certainly helping international investors to make their debut in the onshore Chinese Bond Market. Big news this month is of course that China government bonds will be included in JP Morgan’s various bond indexes, including the widely followed GBI-EM Global Diversified, beginning 28 February 2020 (Bloomberg 4 Sep 2019). A similar inclusion announcement from FTSE Russell appears likely, the company is due to announce the results of its semi-annual WGBI review on 26 September 2019 (Bloomberg, 4 Sep). We estimate that the entire index inclusion process will bring USD320bn of bond inflows into China. (Important to note that this is from passive index tracking funds only and does not include the broader universe of funds that use the indices as a reference).
The effect on liquidity is not perceptible at the moment, but as more parties get involved, we will probably see a natural reduction in volatility, as market participants become less prone to trade tactically on news and short-term triggers, similar to what we have seen in the equity environment. 364 securities have been included, covering RMB64.1tn of the debt covered by the index. The demand for government bonds and financial bonds from passive investors should encourage onshore players to act as market makers for off-the-run bonds, effectively improving market liquidity in off-the-runs overall.
The challenge will be to replicate the index fully, but we believe the authorities will enhance liquidity going forward by increasing the size of the primary auction and frequency of taps.
When clients approach you regarding access to the Chinese mainland market, what are their main challenges?
The foreign exchange process is one of the major challenges for clients. Firms trading the index prefer to manage the FX process using the CNY rate, as the bonds they trade are marked to market in CNY. They also prefer to hedge their positions using a deliverable CNY forward, not through CNH. The PBOC has relaxed regulation to allow foreign banks to offer CNY spot and forward to offshore investors; however, as this is still a new development, the process is not yet fully mature. HSBC has been offering various solutions to investors in CIBM and Bond Connect channels, from trade execution, FX, to custody. To date, we have done billions in CNY FX deals to settle clients’ bonds.
The other challenge that clients have is the choice of scheme. From QFII, CIBM Direct to Bond Connect, HSBC has provided clients with optimal solutions as they navigate each channel. By collaborating with our custody business, we continue to support investors in making the right choice of scheme to enter the market, based upon their needs.
Liquidity is also another key challenge for investors. HSBC ranks number two according to CFETS data on most active counterparty for foreign investors and as of the first half of the year we were number one. We can therefore trade in competitive sizes as well as making markets in odd lots, which is a challenge for many other banks. We provide onshore and offshore FX derivative hedging, especially with implementation of rule 159; which we were the first to implement.
Finally, the timely dissemination and translation of regulation is also an issue faced by many clients. It is important to ensure that the clients understand new regulations and how the latter impact their investments. At HSBC, we help clients understand the issues at stake by facilitating access to regulators and authorities, with face-to-face discussions of current issues in the market. We recently hosted a tri-party call between PBOC and investors to discuss market entry barriers and operational requirements.
What should buy-side desks do to optimise their access and trading efficiencies in China over the next 12 months?
Lines of information flow, efficient front-to back execution, and access to the regulators are all critical components. The last element is particularly true for foreign investors, whose trading functions are becoming more segregated from portfolio management, and proximity to the market therefore becomes key for them. HSBC has had a very long history in the region, with its presence dating back over 150 years.
One of the most crucial steps for the buy-side desks to make themselves more efficient would be to choose a reliable partner. At HSBC, we have worked with several buy-side desks to increase their connectivity, facilitate their transactions, and support them to obtain a greater understanding and a faster deployment in the Chinese Market. We have also engaged local regulators, and allowed the assimilation of best practices over time. We are doing a lot with those buy-side desks not only on the manner in which they execute their trades, on-the-run vs off-the-run, primary vs secondary, but we are also helping them as a custodian with the biggest challenge they face in joining the various schemes in terms of aligning internal systems, getting regulatory approval, understanding the documentation and processes; which will ultimately lead to greater efficiencies.