China 2020 – a fixed-income market structure review

This article originally appeared in FinanceAsia here.

OPINION: From major changes to QFII and all the way down to a wide range of micro adjustments, 2020 was a period of significant progress for fixed-income markets in China.

As we approach the end of the year, it is clear that 2020 has been a period of significant progress for China’s fixed-income market. Despite the unpredictable situation that has characterised financial markets over the past twelve months, Chinese regulators have continued to push ahead with measures that increase connectivity between the world’s second-largest bond market and the rest of the world.

Market structure is an especially important topic for China as international investors have only had streamlined access to onshore bonds for a few years – ever since the launch of China Interbank Market (CIBM) Direct and Bond Connect.

Indices – Major Inclusions

These entry programs are constantly evolving to meet the needs of international investors, and it is improvements in areas like market liquidity, trading rules and clarifications on taxes that have resulted in Chinese bonds being included in major international indices. Most recently, FTSE Russell announced that Chinese government bonds would be conditionally added to its flagship World Government Bond Index starting in October 2021.

Along with the 2019 inclusion in the Bloomberg Barclays Global Aggregate Index, China is now represented in the main debt indices that active investors use to benchmark their performance and passive funds track to determine what to invest in. Chinese bonds are now so much a part of the mainstream international investment universe that investors who decide not to allocate capital to China could be seen as taking a position on the market.

QFII revamped

The biggest changes in Chinese market infrastructure have taken place in the Qualified Foreign Institutional Investor programme. The programme, which launched in 2002, is the original route for foreign investors looking for exposure to Chinese onshore securities. A renminbi version (RQFII) was introduced in 2011, but both channels were overshadowed by Bond Connect – in part because the newer initiative required onboarding via registration, which was much faster than the license that was required to take part in QFII.

The first significant change to QFII took place in May this year, when regulators removed the quota that capped how much individual QFII holders could invest in the market. This harmonises it with CIBM Direct and Bond Connect, which impose no limits on inbound investment.

The more recent move took place at the beginning of November, as QFII and RQFII were merged into a single entry point. Going forward, not only will both programs be governed by the same rules and regulations, but also investors will enjoy a faster application procedure, along with access to a broader range of securities, including government bond futures, with exact details to be announced by the relevant exchange.

They will also have access to both the exchange-traded and the interbank market, which the regulators intend to link together. This broader, easier-to-access QFII will likely see increased interest from investors in the future, as it removes the need for multiple accounts, but also results in a more unified and streamlined trading, clearing and settlement process.

Closing in on International Practice

Beyond the larger structural changes to the market, there have been many smaller modifications to how investors can trade onshore China bonds. Seen individually, they appear to be incremental improvements, but taken together they mark a substantial step towards international standard practice – meaning that investors can trade onshore China debt in a way that feels very much like any other market.

We can see this kind of improvement in the introduction of electronic trading on CIBM Direct. Although electronic request-for-quote (RFQ) has been available on Bond Connect since its inception, CIBM Direct still required traditional phone-based pricing until August 2020, when it introduced an electronic RFQ trading overlay.

Other upgrades to the foreign investor user experience include increasing the number of allocating sub-accounts from 50 to 99. This helps increase efficiency and save execution time, as the ability to trade with a larger number of sub-accounts means that the order does not need to be split up.

T+N trading for onshore bonds is also now supported, following a decision by China Foreign Exchange Trading System (CFETS) and the clearing houses to extend the settlement cycle. The result is that global investors are less likely to be caught out during settlement due to differences between holidays in Mainland China and the investor’s home country. In addition, as of September CIBM trading hours were extended to 8pm from 5pm China Standard Time, in an effort to boost the market’s appeal to overseas institutions.

Looking Ahead

By rounding up all the infrastructure changes we have seen in 2020, we can see that it is a year that has left China’s fixed income markets more connected, accessible and efficient than ever before for global investors.

Going forward, on the regulatory side, it is likely the policy direction will remain firmly in the direction of further opening up, while among investors, it is clear that foreign participation in China’s bond market will only increase.