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Moody’s sees slow, eventful opening of China’s bond market

The inclusion of RMB-denominated bonds in leading global indices will be a turning point for the onshore bond market, following the pattern of the Stock Connect, said Ivan Chung, an associate managing director at Moody's Investors Service.
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The inclusion of RMB-denominated onshore bonds will support recognition of China as a more transparent market, Chung told FSA.

Chung expects that China bonds will gradually be included on key indices, especially after the Bond Connect was launched in July. He likens the situation to the Stock Connect, which has prompted major indices, such as the MSCI Emerging Market Index, to include China’s A-shares next year.

“The Connect scheme plays a vital role in the MSCI’s decision as the scheme has improved market transparency and convenience in trading. Bond Connect is likely to work the same in [supporting] future bond index inclusion.” Chung said.

He believes China bonds will be tracked by the top indices, but he declined to give a timeframe.

Northern Trust Capital Markets is also optimistic. In a note to clients it quotes Mark Cudmore, macro strategist at Bloomberg:  “Foreign investors only account for about 2% of China’s bond markets, so there’s huge upside as international exposure catches up with the country’s financial and economic relevance.”

Little foreign interest

Currently, foreign investors can access onshore bonds through the China Interbank Bond Market, which opened last year to foreign investors, and through quota programmes, such as the Qualified Foreign Institutional Investor and the Renminbi Qualified Foreign Institutional Investor programmes.

Foreign participation in the onshore bond market is small. In the first three quarters of 2017, foreign investors accounted for about 2% of China’s RMB 60trn ($9.10trn) bond market, according to Chung, citing data from the China Central Depositary and Clearing Company.

Foreign investors have been  focusing on low-risk sovereign bonds, with the 10-year government bond yield climbing up to 4% for the first time since September 2014, Chung said.

However, currency volatility remains a risk for investors. As many overseas investors convert their onshore bond investments into US dollars or other currencies, the attractiveness of RMB-denominated bonds might erode when the renminbi depreciates.

Chung added that as the regulatory crackdown continues on shadow banking products, such as the risky “wealth management products” that typically offer “guaranteed” returns, investment appetite will shift to publicly-traded bonds.

More foreign issuance

On the issuance side, Chung believes that the PBOC is taking meaningful steps to entice foreign companies set up in China to issue bonds to raise RMB. Steps include accepting US accounting standards of issuers. Previously, it only allowed Chinese and European accounting standards.

Chung added that companies may find it more attractive to issue onshore bonds in China rather than issuing offshore renminbi bonds in Hong Kong.

The increasing cross-market activities in China has diminished Hong Kong’s role as an offshore renminbi bond market, according to Chung. In the first nine months, new issuance in the offshore RMB bond market continued to decline, falling to RMB 27bn, which is only 21% of the full-year issuance in 2016.

However, Stephen Chang, head of Asian fixed income at JP Morgan Asset Management, said onshore and offshore bond markets have no strong connection as their target investors differ. Onshore Panda bonds have mainly domestic investors and most dim sum bonds are bought by international investors, Chang told FSA in a previous interview.

Part of the Mark Allen Group.