Reforms spur foreign interest in China's interbank bond market

Foreign investors are fast taking up new opportunities to invest in China's interbank bond market after China's decision in February to further liberalize the sector, investors and analysts said.

The high yields on offer coupled with the ability the market provided to investors to diversify by purchasing more Chinese bonds were key factors that made the market attractive, they said.

With growing evidence of overseas interest, the Bank of China hosted a forum in London on Wednesday to explain to foreign investors how to use this market. The gathering attracted about 50 representatives from global investment companies and institutions.

Jin Mei, chief representative of the People's Bank of China, said at the forum that the liberalization of China's interbank bond market was an important step in China's overall capital account reforms and renminbi convertibility.

Wang Huabin, deputy general manager of Bank of China London Branch, said that the size of China’s inter-bank bond market is anticipated to grow further this year, as the market is anticipating increasing issuance of municipal, panda and green bonds, due to the development of China’s economy and the gradual liberalization of China’s capital account. This growing scale will create further opportunities for overseas investors, he said.

Valued at about $7 trillion, China's inter-bank bond market is currently the third largest in the world, following the US and Japan. Previously the market was only open to foreign investors with Qualified Foreign Institutional Investor (QFII) and Renminbi QFII (RQFII) licences, whose investments were restricted to the amount of their quotas.

As a result foreign participation stands at about 2 percent. In February, however, the PBoC said it would allow certain types of foreign investors to buy bonds in its interbank bond market and would scrap quotas for long-term investors such as pension funds and charity funds.

Andrew Malcolm, a partner and head of capital markets in Asia at the London-based law firm Linklaters, said the attractiveness of China's inter-bank bond market is the yield combined with the relative stability of its economy and currency.

"Long-term this is a very positive development for the Chinese economy as it will further integrate China with global capital markets. Combined with the internationalization of the renminbi, the overall effect is a heightened economic leadership role for China. The renminbi is a key pillar to the global economic order and will become a core currency globally," Malcolm said.

Sean Chang, Head of Asian Debt Investment at the London-based Baring Asset Management, said that due to the large size of China's bond market, Chinese bonds have an estimated potential weighting in major global indexes of about 10 percent. That meant fund managers who wanted to track their portfolios to major global indexes would want to invest in China's bond market. "Therefore access is very important for them," Chang said.

Also, investing in China's bond market means access to China's growth opportunities, which are still significant compared to global norms despite slowing growth rate in recent years, Chang said.

Chang says that whether or not investors globally would be encouraged to invest in China's bond market after the liberalization would depend on three factors: how they perceive the credit risk of bonds in China, the stability of the Chinese currency, and whether the interest rate differential was significant.

"What we have seen in the last few months is that the Chinese currency has become more stable than last year, and the central bank has assured the market there is no good reason for the yuan to have a long term depreciation trend and it is believed that they meant it," he said.

Chang says Barings is keen to invest in China's interbank bond market and is now making preparations to invest in this market.

According to Miranda Carr, a senior analyst at Haitong Securities (UK) Limited cautioned that many players were still new to this market and their unfamiliarity with the market could be a challenge. She also said there was currently limited research material concerning investment opportunities in China's inter-bank bond market available to overseas investors.

She noted that Haitong was preparing to launch research reports on the inter-bank bond market for London investors next month, written by its fixed income team in Shanghai.