SPONSORED FEATURE: Accessing China’s onshore bond market

Bing Li, from the European asset management unit of the world’s largest bank, is hopeful that European investors will favour its bond funds.

Initiatives such as the Shanghai-Hong Kong Stock Connect have drawn a lot of attention recently by making it easier for foreigners to buy mainland-listed stocks. But while equities have hogged the headlines – for these good reasons and for bad ones, such as stock price volatility – it is the Chinese bond market that is perhaps more promising, and less understood by outsiders.

It is no wonder that foreigners are intimidated by the Chinese bond market. About 95% of Chinese bonds are traded in the quote-driven interbank bond market that can seem opaque to those not involved. Accordingly, it is no surprise that foreign investors account for just 2% of the overall market.

But there are great changes underway. The Chinese authorities are making it easier than before for foreign institutions to buy onshore bonds, even allowing some institutions, such as central banks and sovereign wealth funds, to buy them directly without pre-approval. 

For other investors, the qualified foreign institutional investor (QFII) programme and its offshore renminbi version, RQFII, offer a means of accessing these onshore assets.

The result, says Bing Li, head of the asset management department at ICBC Europe, is sure to be an increase in foreign participation in China’s onshore bond market.

Li, who is based in Luxembourg, hopes his firm can play a role in exposing European investors to Chinese fixed income assets. Last year, the firm launched a Ucits that invests in China’s onshore bond market through the RQFII scheme. This year, the firm launched a specialised investment fund (SIF) targeting the same market.

In the coming months and years, Li hopes to add new sub-funds to its Luxembourg Ucits and SIF umbrella, both to cater to Europeans wanting to invest in China and, ultimately, to Chinese investors who want to invest in Europe.

The firm certainly has good credentials. ICBC is the largest bank not only in China but in the world, and the largest player in  China’s interbank bond market, which gives it a level of expertise that is hard to match.

Not only that, but Li says his funds offer better returns than comparable European bond funds, thanks to the dynamism of China’s growing economy. The question is simply one of explaining to European investors what the opportunities are.

“In our experience, European investors have a demand for China-focused products,” he says. “The question is educating them.”


Education is especially important at present, when volatility in China’s stock market and the surprise devaluation of the renminbi have unsettled European investors, who are uncertain about the future course of events in China. 

Li concedes that the changes in foreign exchange policy have led to some negative views among clients. However, he sees the Chinese central bank’s move in the context of a wider strategy: the internationalisation of the renminbi. China wants its currency to become a global reserve currency, and a key step in achieving it is to gain inclusion into the special drawings rights (SDR) basket, which the International Monetary Fund (IMF) uses as a global currency reserve.

“My personal view is that the renminbi’s inclusion in the SDR is a question of when rather than if,” says Li. “The new renminbi daily fixing mechanism in mid-August is a good step for the IMF to discuss adding renminbi into the SDR in the future, perhaps next year.”

The long-term trend that could see the renminbi ultimately reach a status comparable to the dollar or the euro is only going to increase demand for Chinese onshore bonds, he says. As the renminbi becomes more of an international currency, all sorts of institutions, from central banks to pension funds, will seek to increase their holdings in renminbi-denominated assets. It is natural that many of them will look to the onshore bond market to satisfy their needs.

There are still challenges ahead. One of the obstacles ICBC Europe faces are the quota limits on the RQFII scheme, which mean the firm cannot buy as many Chinese onshore bonds as it would like.

“The fund size for our Ucits is not very large yet, due to quota control,” he says. “We are still using the Hong Kong quota, which has been fully used up. We are seeking opportunities to expand our fund size.”

Another hurdle is the cautious attitude taken by European investors to China in light of the recent market uncertainty, an attitude Li hopes to change through education.

There are solutions, however. The RQFII scheme was recently extended to Luxembourg, where ICBC Europe is based, and the firm is in talks with the Chinese authorities to allow it to gain additional access to Chinese onshore assets via the Luxembourg quota. 

Financial regulation is developing fast in China, with the central bank bringing in a range of measures to make onshore bonds more accessible to foreigners.

One of the rumoured developments is a so-called Bond Connect, a system similar to the Shanghai-Hong Kong Stock Connect that would link fixed income instruments on the mainland with investors in other territories, such as Hong Kong.

Li says such a development would be interesting for the market, however, given that less than 5% of Chinese onshore bonds are traded on exchanges, it would be difficult to see such a system having a significant effect, unless it were extended to interbank transactions too, which presents technical challenges.

“I don’t think Bond Connect could be realised in the short-term period,” he says. “Most investors trade in the interbank market and the new initiatives are focused there.”

There is plenty going on besides rumours of a Bond Connect. Chinese authorities have recently sought tie-ups with financial centres elsewhere in the world, for instance the UK, which is hoping to strengthen financial links between London and China. The UK and Chinese governments recently collaborated on a research paper that sought to explain the characteristics of China’s onshore bond market for the benefit of international investors.

All these schemes help to create publicity for China’s onshore bond market, which will help build demand for bond funds from firms such as ICBC Europe. It seems that foreign participation rates are sure to rise.

©2015 funds europe



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