now loading...
Wealth Asia Connect Middle East Treasury & Capital Markets Europe ESG Forum TechTalk
Wealth Management
China to lure more foreign bond investors
The bond market becomes more attractive with new hedging rule
Monica Uttam 1 Mar 2017

Another hurdle to investing in the world’s third largest bond market has been removed when China’s State Administration of Foreign Exchange (SAFE) amended its foreign exchange (FX) regulation in February. Asset managers have lobbied SAFE for months to amend the rule.

In its announcement, SAFE says foreign private investors are now permitted to hedge their FX exposure onshore using forwards, swaps, options and cross-currency swaps. The change marks a major step to draw in the active participation of asset managers in China’s US$7.1 trillion bond market.

For institutional investors based in Asia the step has broadened the product suite available when accessing the China market. “We have been using offshore CNH derivatives to hedge FX exposure,” shares Edmund Ng, CIO of Hong Kong-based Eastfort Asset Management. “With the latest relaxation, offshore asset managers like us can deploy FX derivatives onshore, which are cheaper to hedge.” Eastfort is among the managers that are accessing the market via CIBM Direct.

The biggest impact of this move is the positive signal it gives to asset managers for onshore bonds to be included in global benchmark indices such as the Bloomberg Barclays Global Aggregate Index and JP Morgan GBI-EM Index. “It allows (nearly) direct trading of China’s onshore FX market and plays the differential versus the CNH DF curve (which is already fully open),” says Standard Chartered China macro strategist Becky Liu.

If included by main bond indices, China bonds will become part of beta portfolios, according to Ng. “It’s easier (for us) to gain approval from the investment committee. If not included, any investment into China bonds can only be considered as part of an alpha strategy.”

London-based Edwin Gutierrez, who heads emerging market sovereign debt at Aberdeen Asset Management, says the new rule benefits Asian-dedicated funds mostly “where China is a fairly high-yielding country compared to the other Asian fixed income opportunity set.”

“For us, global emerging market investors, Chinese government bonds are currently uninteresting. But, over the medium to long term that could change,” he adds.

The SAFE announcement dictates the hedging should be conducted on a “as per need” basis and that the regulator may still limit the FX hedging instruments to not exceed an amount larger than the underlying bond notional size. Foreign bond investors may also only liaise with their onshore custodian bank or settlement agent for dealing in hedging trades in the over-the-counter (OTC) market.

While a step forward, hurdles for international benchmark index inclusion still loom large. These include the lack of clarification on income tax quotes for the coupon received and whether or not these can be waived.

There is also confusion between the onshore version of a derivatives master agreement and the standard ISDA (International Swaps and Derivatives Association) agreement that foreign investors are used to. For fund managers, if they sign a document that is vastly different to the international standard they might be subject to certain operational risks. Finally, there are issues with the settlement cycle. Foreign investors prefer a T+2 cycle rather than the current T+0 or T+1 that are in place.

Despite these issues, market participants are expected to move quickly. Ng estimates inflow into China’s bond market could range between US$50 billion to US$200 billion within the next one to three years as long as Chinese policy makers continue to open up the market. Standard Chartered expects foreign holdings of China onshore bonds to reach 980 billion yuan to 1 trillion yuan by the end of this year, from 853 billion yuan as of end-2016.

The worry, as Ng sees it, is that some might get left behind. “There might be a situation where global asset owners soon realize they need to step up in allocating to this market since most have underestimated the pace of bond market liberalization. With the current low allocation, moving from zero to some allocation could already be a significant flow given the large AUM (assets under management) globally.” 

Conversation
Victor Cheung
Victor Cheung
director, ETF investment strategist
Mirae Asset Global Investments
- JOINED THE EVENT -
Webinar
Developing strategies supporting sustainable investing
View Highlights
Conversation
Benjamin Diokno
Benjamin Diokno
secretary, department of finance
Republic of the Philippines
- JOINED THE EVENT -
18th Philippine Summit
Bouncing back better
View Highlights