Foreign investors are becoming more interested in Bond Connect given its efficiency, though are concerned about settlement methods, the credit rating system and defaults. The number of transactions via Bond Connect hit 1,959 in the first four months of 2018 to reach 224.7 billion yuan (US$35 billion). Nearly 300 investors have been approved to enter the market, per the Hong Kong Stock Exchange.
Bond Connect has room to improve the settlement system. "The specialty of Bond Connect is that international investors can invest in the primary market through the scheme," says Ren Qing, deputy head of the international cooperation department, National Association of Financial Market Institutional Investors. But the commonly used delivery versus payment (DvP) system is only available in the secondary market under Bond Connect.
DVP is a securities industry settlement procedure in which the buyer's payment for securities is due at the time of delivery. "The People's Bank of China has urged the implementation of DvP in the primary market, but the infrastructure is not fully in place," says Liu. "China Central Depository & Clearing (CCDC) and Shanghai Clearing House (SHCH) have consulted investors on DvP. In terms of technology and system, there is not much of an obstacle," says Liu.
Although SHCH supports settlement on a DvP basis for overseas investors investing in the China interbank bond market (CIBM) via Bond Connect, CCDC, which is providing custody for popular products such as government bonds and policy bank financial bonds, is not supporting DvP. "This is one of the reasons that foreign investors are not trading a lot under Bond Connect in the primary market," says Liu Youhui, general manager of treasury department, Agricultural Development Bank of China
Foreign investors have some concerns about China's bond market, reducing enthusiasm for investing in CIBM via the Bond Connect, according to Ren. "In terms of the corporate credit bond market, many of the bonds are issued by local companies. But foreign investors are not familiar with these names. They are willing to invest in big names," says Ren.
China's credit rating systems are another concern. "As these were developed to serve the local industry, foreign investors find it hard to understand Chinese ratings," says Ren. China is assuaging these concerns by gradually opening up the application of overseas ratings and improving rating systems. Defaults are another concern. "But the average default rate of China's corporate credit bonds is between 0.15% and 0.2%, lower than the average NPL ratio of China's banks, and regulators are tightening up on supervision," notes Ren.
Bond Connect provides easier access and better efficiency to foreign investors. So we can expect more foreign investors in the CIBM via the Bond Connect. "We did a consultation and found that it takes six to nine months to get ready for CIBM. With Bond Connect, it only takes a few weeks," says Li Zhanying, director, The Yield Book and Fixed Income Indexes, FTSE Russell, noting that she is seeing many investors in the APAC region (particularly Hong Kong, Singapore, and Thailand). "We still need to see more US/Europe based investors," she adds.
"Foreign investors have a wide range of choice. The CIBM market is appealing. Foreign investors can get access to all the Chinese bonds, worth 60 trillion yuan, via Bond Connect. This is far more appealing than the bonds issued overseas," Liu says. "I am disappointed not to see a big appetite from global investors outside of China and Asia post the MSCI inclusion announcement," says Brad Gibson, senior vice president and portfolio manager for Asia-Pacific fixed income, AllianceBernstein. "If we can address foreign investors' concerns, I believe that foreign investors will be more willing to participate in Bond Connect," says Ren.
Cover photo: Bond Connect
