China widens foreign access to domestic bond market

China has approved HSBC, Morgan Stanley and 30 other foreign institutions to invest in its $5.9tn domestic bond market, a big step towards opening its capital markets to foreign investment.

China has significantly expanded foreign access to its stock market in recent years, but liberalisation of the domestic bond market — the world’s third-largest, behind the US and Japan — has proceeded more slowly.

Economists say loosening restrictions on bond investment is crucial if China wants to persuade international investors to store their savings in renminbi. Heavyweights such as central banks, sovereign wealth funds, insurers and pension funds have portfolios heavily weighted towards fixed income.

The approvals also come as China’s slowing economy and falling domestic interest rates spur capital outflows. Expanding inbound bond investment could help hedge against this.

Standard Chartered estimates that more than 50 central banks already hold some renminbi bonds among their foreign currency reserves.

Many of these hold “dim sum” bonds traded in Hong Kong, which do not require Beijing’s approval, but foreign holdings of onshore bonds are also on the rise. Offshore institutions held Rmb579bn ($93bn) in interbank bonds by the end of March, up 44 per cent from a year earlier, according to data from China’s two main bond clearing houses.

The People’s Bank of China issued rules in 2013 allowing institutions that had already been approved to buy into domestic stock exchanges to apply for access to the interbank bond market, where more than 90 per cent of all Chinese domestic bonds are traded.

That created an opening for the several hundred institutions approved under the Qualified Foreign Institutional Investor (QFII) programme and a related scheme for offshore renminbi (RQFII) to diversify into bonds. The approvals come with quotas restricting the amount that can be invested, but Beijing does not disclose them.

Prior to the latest 32 approvals, 24 QFIIs, 86 RQFIIs, and an unknown number of foreign central banks and renminbi trade settlement banks had been previously approved.

A separate programme allows foreign central banks that have signed bilateral currency swap agreements with the PBoC, as well as overseas banks involved in cross-border renminbi trade settlement and clearing, to apply for access to the interbank bond market.

In recent days, the PBoC approved 32 new foreign investors under these two programmes, including HSBC, Morgan Stanley, Société Générale, BNP Paribas and ING Bank, according to statements published by Shanghai Clearing House.

In addition to hedging against capital outflows, the latest approvals may be an attempt to maintain the relevance of QFII following the launch of a rival programme that also allow foreign investors to buy mainland stocks.

The Shanghai-Hong Kong stock connect, launched in November, created a new channel for foreign investors to buy large-cap stocks traded in Shanghai, up to a quota of Rmb300bn ($48bn), with no preapproval required.

Indeed, even before the stock connect launched, investor demand for QFII appeared tepid. About half of the $150bn QFII quota and 60 per cent of the Rmb300bn RQFII quota remained unused by the end of April, according to figures from China’s foreign exchange regulator.

Additional reporting by Ma Nan in Shanghai

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