Hong Kong's Swap Connect hailed as 'last important piece of the puzzle for overseas investors entering China'

The continuous opening up of China's interbank financial derivatives market is expected to boost international investors' confidence in the onshore bond market and further internationalise the yuan, according to industry experts.

The Swap Connect mechanism, launched in Hong Kong one year ago, has supported global investors in hedging 4 trillion yuan (US$553 billion) in Chinese bond risk via interest-rate swaps.

Picking up on investors' interests and suggestions, financial regulators in mainland China and Hong Kong on Monday introduced three enhancements that will expand the mechanism's product scope, equip it with ancillary services like compression and clearing of backdated swap contracts, and reduce participation costs.

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"The proposed enhancements will help further support the continued development of onshore financial markets," said Charles Lam, Citi's head of markets for Hong Kong. "As such, we would expect to see an increase in transactions via Swap Connect and a further deepening of liquidity."

Zhaoting Xu, head of China investment banking at Deutsche Bank, said the Swap Connect mechanism is "the last important piece of the puzzle for overseas investors entering China".

The Connect Hall inside the Hong Kong stock exchange in Central. Photo: Jonathan Wong alt=The Connect Hall inside the Hong Kong stock exchange in Central. Photo: Jonathan Wong>

Good hedging tools such as the interest-rate swap under Swap Connect will help encourage international investors to hold more Chinese assets in the interbank market, he added during a media briefing in Beijing.

Interbank bond holdings by international investors in China increased to 4 trillion yuan in March from 3.21 trillion yuan a year ago, according to Deutsche Bank.

As of last month, 20 mainland dealers and 58 overseas investors had conducted more than 3,600 interest-rate swap transactions under the Swap Connect scheme, regulators' data showed. That marked an aggregate notional amount of around 1.77 trillion yuan and an average daily turnover of 7.6 billion yuan.

"As the northbound swap mechanism continues to mature, it is believed that the domestic bond market will develop more steadily and internationally with the participation of diversified international investments," said Tan Yueheng, chairman of Bank of Communications International Holdings and a member of Hong Kong's Legislative Council.

People ride bicycles in business district in Beijing on April 16, 2024. Photo: AFP alt=People ride bicycles in business district in Beijing on April 16, 2024. Photo: AFP>

Tan added that through in-depth participation in China's onshore market, foreign investors can learn more about the country's monetary policy and economic conditions, which will help them participate more in the offshore yuan market and strengthen Hong Kong's role as an offshore yuan centre.

Swap Connect has a synergy with Bond Connect, which was launched in 2017 in Hong Kong to allow investors from mainland China and overseas to trade in each other's bond markets.

The average daily trading volume of northbound trading hit a record high in January this year, reaching 48.7 billion yuan. China government bond trading was the most active, accounting for 65 per cent of the monthly tally.

As international investors grow more familiar with Swap Connect, it will be helpful to "promote the development of mainland China's financial derivatives market and further accelerate the pace of yuan internationalisation", according to John Thang, head of markets for Hong Kong, Greater China and North Asia at Standard Chartered.

Hong Kong Chief Executive John Lee Ka-chiu speaks at the Bond Connect Anniversary Summit & Swap Connect Launch. Photo: Handout alt=Hong Kong Chief Executive John Lee Ka-chiu speaks at the Bond Connect Anniversary Summit & Swap Connect Launch. Photo: Handout>

More financial derivative products from China are expected to roll out to international investors.

Bourse operator Hong Kong Exchanges and Clearing (HKEX) plans to launch China treasury bond futures to help regional and global investors manage their interest rate and investment risks more effectively.

"The domestic treasury bond futures market has a complete trading system, rich trading products, and sufficient liquidity," said Deutsche Bank's Xu. "If domestic treasury bond futures products can be opened to foreign investors and more complete hedging tools can be provided, it will surely further increase foreign investors' enthusiasm for trading in the domestic bond market."

Market participants are widely anticipating the latest enhancements, which include waived fees and using the newly accepted interest rate swap contracts with payment cycles based on the International Monetary Market (IMM) dates. Most futures and options use IMM dates as expiry dates, with termination occurring on the third Wednesday of March, June, September and December.

The Swap Connect's clearing houses - the China Foreign Exchange Trade System, Shanghai Clearing House, and HKEX subsidiary OTC Clearing Hong Kong - will extend the incentive programme to fully exempt interest rate swap transaction fees and contract clearing fees for one year.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2024 South China Morning Post Publishers Ltd. All rights reserved.

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