China Bond Connect regulation: what is it?
Bond Connect complements QFII (Qualified Foreign Institutional Investor), RQFII (RMB Qualified Foreign Institutional Investor), and CIBM Direct Access schemes and is a step further to opening up onshore capital markets to overseas investors. Unlike other schemes, there is no quota requirement or need for investors to identify the intended investment amount.
In late 2017, northbound trading went live, allowing overseas investors to invest directly into the CIBM market through Hong Kong’s market infrastructure. Southbound trading is still to be implemented.
Bond Connect scope
The scope of eligible investors under Bond Connect is the same as the CIBM Direct scheme. Through the scheme, the People’s Bank of China (PBOC) is encouraging into the market mid- to long-term investors such as commercial banks, asset managers, insurers, securities houses, pension funds, charitable funds and other long-term investors.
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Under the Bond Connect scheme, each institution is required to submit an application to the Chinese authorities via the Bond Connect Company Limited (BCCL), which is a joint venture created by the Hong Kong Stock Exchange and the China Foreign Exchange Trading System (CFETS). The PBOC is expected to process and grant approval within 10 calendar days to eligible investors. Once approved, CFETS assigns a unique trading identifier to the investor to begin investing.
Offshore investors must have an appointed a local custodian, who is a “Bond Connect Linkage Participant” in the Hong Kong Central securities depository (CSD) which is called the Central Monetary Unit or CMU. This can be via a direct appointment or through the investor’s appointed global custodian. BNP Paribas Securities Services Hong Kong is an eligible Bond Connect Linkage Participant and can be appointed in this way. The Bond Connect Linkage Participant will assist in opening a segregated CMU sub-account per investor. Unlike the CIBM Direct scheme, investors are not required to open segregated onshore securities accounts or cash accounts.
Offshore investors are able to use offshore trading platforms TradeWeb and Bloomberg for placement of orders with onshore participating dealers. As of the end of 2018, offshore investors are allowed to trade with only the 34 eligible onshore participating dealers (including BNP Paribas). Regulators are expected to open access further to allow trading with both onshore and offshore market participants. Since 31 August 2018, investors have the possibility to book trades in bulk across underlying mandates when placing trades through the offshore trading platforms.
Once the trade is matched, CFETS sends the confirmation ticket for settlement to the China Central Depository and Clearing (CCDC) and the Shanghai Clearing House (SCH). The settlement flow is fully managed through the investor’s Bond Connect Linkage Participant along with CMU, who holds a nominee account with the two onshore CSDs, namely the CCDC and SCH. The settlement cycle can be T, T+1 or T+2; however, most investors opt for T+2 to ensure the cross-border flow of securities and cash, and T+2 provides extra time for funding. Investors can use CNH (offshore renminbi) or foreign currencies for funding. The regulator has also opened the gate for CNO (onshore renminbi) conversion and hedging; however, forex transactions can only be done via the Bond Connect Linkage Participant and should always be directly linked to the Bond Connect activity.
In August 2018, it was announced that activity settled via CCDC is now on a DVP basis. This was a key enhancement necessary for many investors to enter the market and was a pre-requisite for the Bloomberg-Barclays index inclusion in 2019.
BNP Paribas Securities Services’ view
The Bond Connect scheme offers greater access to onshore Chinese bonds, and greater safeguards and cost effectiveness for overseas investors than previous schemes.Continued upgrades will enhance its place as the most comprehensive China access programme.
At the market level, regulators and the market operators are expected to continue to improve the Bond Connect operating model and further align the investment options with global standards. We understand that authorities are discussing the possibility of adding repo trading as an option through Bond Connect. In addition, the market is talking about the possibility of investors directly appointing their own FX bank for CNO FX trading (both for hedging and funding purposes). This will continue to be a focus in 2019 to find the right solution that does not jeapordise the safe settlement of transactions.
As mentioned, 2019 will see the inclusion of Chinese Bonds in a number of global indices starting with the Bloomberg–Barclays Global Aggregate Index planned in April 2019.
- Launch of Bond Connect (northbound trading)
- Real DVP settlement fully implemented across both the Shanghai Clearing House (SCH) and the China Central Depository & Clearing Co., Ltd. (CCDC)
- Block trading capability launched
- 3-year exemption (7 Nov 2018 to 6 Nov 2021) announced on income tax and VAT on offshore institutional investors’ interest income from domestic bonds
- Bloomberg Access is officially launched as the second trading platform for Bond Connect
- Expected inclusion of Chinese bonds into Bloomberg-Barclays Global Aggregate Index