Bond Connect launched in July this year to allow eligible institutional investors in Hong Kong and abroad to invest in onshore bonds. It was meant to help China win faster inclusion in global bond indices. But the scheme’s development remains at an early stage and interest is low, leaving quick inclusion in doubt, according to Stephen Chang, head of Asian fixed income at JP Morgan Asset Management.
“Bond Connect is doing something like a beta testing mode as not all features are available,” Chang said during a panel discussion at the Asia Securities Industry and Financial Markets Association (Asifma) conference held in Hong Kong in late November.
He predicted that the inclusion of China’s bonds in the JP Morgan Government Bond Index-Emerging Markets might occur in late 2018 at the earliest, but added that a well-functioning Bond Connect scheme might accelerate the process.
In the meantime, asset management firms tend to adopt a wait-and-see approach. Chang said that while JP Morgan AM was involved in several China cross-border programmes, such as Qualified Foreign Institutional Investor (QFII), Renminbi Qualified Foreign Institutional Investor (RQFII) and China Interbank Bond Market (CIBM) Direct, it had not yet come on board for Bond Connect.
One other aspect that adds to the reluctance of asset managers to use Bond Connect is the inconvenient settlement process among the different platforms, Chang noted.
In particular, foreign investors are unable to set up a universal account for buying and selling bonds. “If you hold something in the RQFII programme, you cannot sell it on the CIBM platform, nor can you do it via Bond Connect, so it remains a challenge to us as bond buyers,” he said.
The issue leads to inefficiency in the programme’s operation, he added.
Index inclusion
Despite the issues, some fixed income indices have moved ahead with inclusion of Chinese bonds.
In March, Citi announced that its EM and regional government bond indices would include China, following a similar move by Bloomberg Barclays in the same month. However, Citi’s announcement did not include China’s sovereign bonds in its widely-tracked World Government Bond Index (WGBI).
Not all fixed income portfolio managers are keen on the inclusion of China’s bonds in the large benchmarks, Chang noted. “Some portfolio managers, particularly those farther away from China, would prefer the decision of China’s exclusion [from the key indices] as they are still rather skeptical about the market,” he said. “Another challenge for them is replicating the [China-included] index across the time zones,” he said.
To resolve this, instead of including China in the existing indices, some index providers had created new ones that track the old components plus China’s bonds, Chang noted. This approach aims to temporarily harmonise different expectations from the market.
While China’s bond market is now worth RMB 60trn ($9.10trn), foreign investor participation is small, accounting for only 2% in the first three quarters of 2017, according to data from the China Central Depository and Clearing Company.
Earlier, Value Partners’ chief investment officer Gordon Ip argued that Citi’s decision to exclude sovereign bonds may be based on unsatisfactory liquidity in the onshore bond market.
“Certainly, it would be a big statement if China’s bonds could make it into the WGBI, but the liquidity issue endures in China’s bonds, which are traded in a ‘buy-and-hold’ market,” he said.
Although China is encouraging money to go in, at this early state, the foreign fund managers who are now participating in the market merely want “a seat at the table” and are not yet primarily interested in returns, he added.
