Swap Connect scheme to allow global investors to use Chinese bond holdings as margin collateral

International investors can pledge their holdings of Chinese domestic bonds as margin collateral for Northbound Swap Connect trading later this year, regulators from Hong Kong and mainland China announced at a summit on Tuesday, in an enhancement of cross-border connectivity and cooperation.

The financial authorities of Hong Kong and the mainland will soon launch this service in a move that will help vitalise global investors' 4.22 trillion yuan (US$580 billion) holdings by reducing their liquidity cost and improving capital efficiency in their interest-rate swaps.

Another risk management tool - China treasury bond futures - will be launched "in the near future", regulators said at a function organised to commemorate the connect scheme's seventh anniversary. Launched in 2017, the mutual access scheme allows global investors to buy mainland China-listed bonds, while the southbound channel caters to mainland China-based investors who wish to buy Hong Kong products.

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Allowing the use of onshore bonds as Swap Connect collateral will "not only improve the efficiency of capital management for foreign investors, but also increase the willingness of holding China's onshore bonds", said Julia Leung Fung-yee, CEO of Hong Kong's Securities and Futures Commission (SFC).

"The Hong Kong SFC, along with the financial infrastructure institutions including OTC Clearing Hong Kong, strives to launch the service by the end of the year," she said.

Julia LEUNG Fung-Yee, Chief Executive Officer of Securities and Futures Commission, speaks virtually at Bond Connect Anniversary Summit at HKEX Connect Hall in Central. Photo: Xiaomei Chen alt=Julia LEUNG Fung-Yee, Chief Executive Officer of Securities and Futures Commission, speaks virtually at Bond Connect Anniversary Summit at HKEX Connect Hall in Central. Photo: Xiaomei Chen>

The Hong Kong Monetary Authority (HKMA) and the SFC are expected to announce details later this year.

Leung added that foreign investors' holdings only accounted for about 3 per cent of China's onshore bond market - the world's second-largest. This is dwarfed by the corresponding proportions of 14 per cent and 25 per cent prevailing in the developed economies of Japan and the United Kingdom, respectively.

"Foreign capital has much space to get involved," Leung said. "According to the World Economic Forum data, China's bond market is 1.1 times the domestic GDP, which is lower than other advanced economies such as the United States' 2 times and Japan's 2.3 times."

Market analysts said this was a significant step.

"Once this is launched, they can post these onshore bonds as eligible collateral for swaps under the Swap Connect scheme, which was previously restricted to just cash and certain offshore securities," said William Shek, head of markets and securities services for Hong Kong at HSBC. "This step further contributes to the internationalisation of onshore bonds and strengthens Hong Kong's position as the world's leading offshore yuan centre."

The usage of onshore bonds as collateral for Swap Connect will expand onshore yuan bonds' applications and benefit the internationalisation of yuan, said Eddie Yue, CEO of the HKMA, the city's de facto central bank.

Dim sim bonds, as offshore bonds denominated in yuan are known, issued in Hong Kong last year totaled 540 billion yuan, 3.5 times larger than in 2020, Yue said.

The People's Bank of China is looking to elevate its "pragmatic cooperation" with Hong Kong and support the city's development of an international financial centre, said Huifen Jiang, deputy director general for the financial market department at the central bank, via a video address to the summit.

"We found that Bond Connect has hugely promoted Hong Kong's status as a centre for fixed income, currencies and commodities," said SFC's Leung. "Many foreign institutions have set up subsidiaries and deployed workforce in Hong Kong to cooperate with the development of Bond Connect services."

She added the demand for Chinese government bonds was high among foreign institutions, especially pension funds, wealth funds and central banks, who accounted for about 70 per cent of overseas investors' holding in sovereign debt.

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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