More than four years after the northbound leg of the Bond Connect Programme was launched in July 2017, Chinese policymakers have now given the all-clear for the implementation of the southbound leg, which came into effect on 24 September.
The ability by Mainland-based investors to tap into Hong Kong’s debt market will help spur interconnection in the Greater Bay Area (GBA) and further develop the two-way opening-up of the financial industry.
Under the latest arrangement, Mainland institutional investors will have access to the Hong Kong bond market, and effectively, global bond markets. Around 40 Mainland banks, as well as participants in China’s Qualified Domestic Institutional Investor (QDII) and RMB QDII schemes, will be eligible to participate in the new scheme.
There are quotas for outflows from Mainland China to Hong Kong’s bond market, set at 20 billion RMB (HK$24 billion) per day and 500 billion RMB per year. However, there are no restrictions on the denominated currency, meaning that all bonds traded in the city, regardless of currency, can be potential targets for investors from the Mainland.
The platform’s expansion to a two-way connection represents the latest move by Beijing to liberalize capital flows, with the objective of promoting the internationalisation of the RMB. The move was unveiled shortly after the official launch of the Wealth Management Connect, a scheme which aims to enable residents in Hong Kong, Macao and Guangdong Province to carry out cross-boundary investment in wealth management products distributed by GBA banks.
These developments will allow Mainland investors to diversify their portfolios by encouraging more outbound investment, while also providing more options to hedge against currency risk and rising global interest rates relative to Chinese rates.
Beijing also wants to send a signal to the market that it is optimistic about the stability of the country’s financial system. The launch of the southbound leg of the Bond Connect Scheme – which essentially facilitates capital outflows – comes at a time when international investors are rethinking their investment strategy on China.
The primary concerns of overseas investors are China’s high levels of debt, as well as the regulatory clampdowns on certain sectors that have recently led to market sell-offs.
It is unlikely, however, that China’s appeal as an investment hotspot will wane, so long as the potential returns from the world’s second largest economy continue to outweigh the risks. In fact, China overtook the United States as the world’s top destination for new foreign direct investment last year with inflows of US$163 billion, compared to US$134 billion into the U.S.
Over the past year, China’s strong GDP growth has continued to outpace most major economies due to its early success in reining in the coronavirus, which in turn boosted capital inflows and market confidence in the RMB. The Northbound Bond Connect, which carries no quota, has become a major conduit for foreign investors to buy Mainland bonds, with an average daily turnover of 26 billion RMB in August, up 35% from a year earlier.
At the same time, the RMB has strengthened nearly 5% against the U.S. dollar over the past 12 months, reaching its strongest level in three years at the end of May. This prompted intervention by the People’s Bank of China to moderate the currency’s rally by raising the foreign exchange reserve ratio for financial institutions.
Allowing Chinese investors access to Hong Kong’s bond market will obviously have a positive impact on the city’s financial market and its status as the premier international financial centre within the region, as well as the leading offshore RMB hub.
Hong Kong’s bond market has long been regarded as underdeveloped thanks to the city’s robust public finances, and consequently, the reduced need to raise funds through debt instruments. The broadening of investor access could enliven the local bond market – which has almost doubled in size to HK$2.3 trillion by the end of 2020 compared to HK$1.2 trillion 10 years ago – by attracting more bond offerings to the city and increasing market liquidity.
The fully operational bond connection framework between the Mainland and Hong Kong, together with the kick-off of the long-awaited Wealth Connect Scheme and the latest announcement of the expansion of the Qianhai Economic Cooperation Zone in Shenzhen, are indicators that cross-border financial integration will continue to accelerate going forward.
Wilson Chong, firstname.lastname@example.org