With Chinese government bonds and policy bank bonds now included in a widely tracked global bond index, China’s bond market has taken an evolutionary leap. Have investors leapt, too?
On April 1, 2019, the first batch of yuan-denominated securities was added to the Bloomberg Barclays Global Aggregate Bond Index.
A total of 356 Chinese securities met the two key eligibility requirements on the day, with at least US$5 billion in outstanding debt and more than one year to maturity. Going forward, all China bonds in the Index and the wider China market will be assessed on the last day of every month to recapture those that meet the Index eligibility criteria.
Initially, each eligible bond was included in the Index at a 0.05 factor of its outstanding amount. This factor will increase by 0.05 each month for 20 months to allow for a gradual phase-in of the China securities. This will see full inclusion for China bonds in November 2020 as the culmination of an effort that began in 2016.
Nicholas Gendron, Fixed Income Index Product Manager at Bloomberg, explained, “Throughout the past three years, we’ve been on a journey in terms of gathering client feedback, working through our governance process, and engaging with policymakers in China. In the end, we felt that a very gradual but consistent phase-in would be the best overall solution for investors and the China bond market, since it avoids the sudden inclusion of the equivalent of US$3 trillion of debt in the Index, which would have put a lot of stress on the marketplace.”
Even though the China bond inclusion process is still at an early stage, Bloomberg has noted that most foreign investors are already moving ahead with the standard benchmarks that include China bonds.
“Foreign investors are definitely at varying degrees of readiness, but the majority have decided that China is investable and understand that they have to work through a few obstacles at this initial phase,” Mr. Gendron said.
On the other hand, some foreign investors have opted to exclude China bonds for now and some have decided to proceed more cautiously and include China in their investment process through customized benchmarks instead of the standard Index.
Obstacles to participation in China’s bond market range from investor concern about overall liquidity and transaction costs to challenges around getting set up to use Bond Connect or China Interbank Bond Market (CIBM) Direct. From an entry perspective, burdensome documentation and complex processes are hurdles that will need to be relaxed in the future.
“For example, it currently takes more than two weeks to open the necessary segregated accounts with the Chinese Central Depository and Clearing and the Shanghai Clearing House. Our clients are telling us that a shorter and simpler process for opening these local market accounts would be very helpful,” said Patrick Ludden, BNY Mellon’s Cash, Foreign Exchange and SWIFT Product Manager, Global Product Management, Asset Servicing.
“Additionally, as all investors are aware, we have to deal with the co-existence of CNY** and CNH** without an official ISO currency code for both. This puts a lot of pressure on foreign investors and providers to create funding procedures to support and segregate offshore CNH and onshore CNY funds,” he continued. “Plus, from a CIBM Direct perspective, there is a requirement to ensure that the ratio of foreign currency to Renminbi (RMB)** in terms of accumulated outward and inward remittance stays within a range of plus-or-minus 10% of each other.”
Even so, these obstacles can be overcome, and the market is gradually moving toward greater efficiency.
Following Bloomberg’s decision to include China bonds in its Aggregate Index, this year is also likely to see FTSE Russell considering whether to add China bonds to its World Broad Investment-Grade Bond Index. JPMorgan has also placed China bonds on watch for inclusion in its JPM GBI-EM Diversified and EMBI Global Diversified indexes.
As to whether Bloomberg will add corporate bond issuers to its indexes, Mr. Gendron pointed out that Bloomberg has been tracking the wider market via its China Aggregate Index since 2004 and it continues to analyse the full market as it evolves with an eye on its liquidity and the accessibility of these other issuers. “It is a matter of when, not if, but it is a longer-term process for the rest of the market to be included in a broader-based index,” he said.
BNY Mellon’s plans include extending FX services to provide an end-to-end solution for clients accessing the China’s bond market. “For Bond Connect, we offer a full suite of FX and funding services for both CNH and onshore CNY. For CIBM Direct, we support CNH for FX and funding. For CNY, we support funding only as CNY has to be done through local custodian. As we look ahead, we plan to offer onshore CNY in the offshore market”, Mr. Ludden revealed.
1Regulation 159 permits foreign investors to execute onshore CNY in offshore market via RMB clearing or participating banks. BNY Mellon is reviewing the FX and funding processes.
2Restricted to local custodian and direct arrangement between the local custodian and client for FX dealing relationship.
3FX Direct Dealing. Client must instruct BNY Mellon to move cash from their relevant offshore CNY account to the onshore CNY.
4Sovereign entities can transfer CNY from another onshore commercial bank.
5Strictly prohibited for onshore CNY trading due to market requirements.
** The ISO code for Renminbi (which may also be used for yuan) is CNY, (an abbreviation for Chinese Yuan), and also used for CNH which is CNY traded in offshore markets such as Hong Kong.
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APAC Custody Product Manager, BNY Mellon Asset Servicing
Magdalene Tay is the APAC Custody Product Manager for Asset Servicing based in Singapore. In her current role, Magdalene is responsible for core custody related product development and key market initiatives in the region. Magdalene is a specialist on the China market and is currently developing a China access roadmap for BNY Mellon clients.View Profile