Among the three global flagship bond indices, Citi’s and Bloomberg Barclay’s have introduced parallel indices to include Chinese government bonds. The biggest among all, JP Morgan GBI-EM Index, with about $210bn tracking it, has yet to make any announcements.
However, a decision to include China bonds on the above major indices could happen by the end of this year, according to a report by StanChart and China consultant Z-Ben Advisors. If so, the asset class could see capital inflows in excess of $200bn, it noted.
So far, foreign investor interest in China bonds has been lukewarm.
Regulators opened the interbank bond market to qualified foreign investors in mid-2016, but few foreign managers took advantage due to the depreciating RMB, said Harwood-Jones. The currency has somewhat stabilised since and investor interest picked up in Q1, she added.
“Given the fact that you can still get yield, and given that chasing yield is a challenge in other parts of the world, Chinese bonds are attractive to investors,” Harwood-Jones told FSA.
Ten-year Chinese treasury bonds have seen yields rise to 3.7% as of yesterday, a level that presents buying opportunities, according to Fidelity.
Bond concerns
Investors have been concerned about the lack of transparency of Chinese companies, which makes it difficult to determine the quality of the bond offering. China also uses a domestic bond rating system, which uses different criteria for credit assesment than the global ratings agencies.
Another issue is hedging tools. The Chinese government has only allowed foreign investors to hedge currency exposure using futures, a tool that is not actively used by domestic banks, as reported earlier.
Harwood-Jones expects more tools to be made available.
“We expect access to bond forwards and interest swaps could be extended to foreign managers, not just central banks, as early as this year.
“While FX hedging alone may be adequate for passive managers, the lack of interest rate hedging will likely be a sticking point for many active managers as they have a much greater need to hedge interest rate exposure in their portfolios,” the report noted.
Capital controls have become less of a worry, the report said.
China’s foreign exchange reserves rose the past three months after the regulators imposed stricter measures to curb capital outflows.
According to the report, outbound restrictions will likely be relaxed in 2017.
Reviving QDLP?
The QDLP programme, which allows foreign managers to sell overseas products to non-retail investors onshore under designated quota, has had no new quota issued since October 2015.
But according to the report, authorities have plans to revive it.
“Talk of a restart of Qualified Domestic Limited Partner picked up steam in the second half of 2016 and regulators gave a major signal when it was explicitly included in foreign manager investment guidelines in early 2017.
“This would allow global managers access once again to China’s HNWIs and, at the margins, some institutional investors. However, QDLP is a small and niche program and its restart could only make a dent in pent-up offshore demand.”
