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Swap Connect program enables global investors to use Chinese bonds as margin collateral

Swap Connect program enables global investors to use Chinese bonds as margin collateral
Swap Connect program enables global investors to use Chinese bonds as margin collateral

International investors will be able to pledge their holdings of Chinese domestic bonds as margin collateral for Northbound Swap Connect trading later this year, regulators from Hong Kong and mainland China announced at a summit on Tuesday, in a move aimed at improving cross-border connectivity and cooperation.

The financial authorities of Hong Kong and mainland China will soon launch the service, which aims to help revitalize global investors’ 4.22 trillion yuan ($580 billion) of holdings by reducing their liquidity costs and improving the capital efficiency of their interest rate swaps.

Another risk management tool – futures on Chinese government bonds – will be introduced “in the near future,” regulators said at an event marking the seventh anniversary of the Connect program. Launched in 2017, the mutual access program allows global investors to buy bonds listed in mainland China, while the southbound channel serves mainland investors looking to buy Hong Kong products.

Allowing domestic bonds to be used as swap connect collateral will “not only improve capital management efficiency for foreign investors, but also increase the willingness to hold Chinese domestic bonds,” said Julia Leung Fung-yee, CEO of Hong Kong’s Securities and Futures Commission (SFC).

“The Hong Kong SFC, together with financial infrastructure institutions, including OTC Clearing Hong Kong, aims to launch the service by the end of the year,” she said.

Julia LEUNG Fung-Yee, Chief Executive Officer of the Securities and Futures Commission, speaks virtually at the Bond Connect Anniversary Summit at the HKEX Connect Hall in Central. Photo: Xiaomei Chen

The Hong Kong Monetary Authority (HKMA) and the SFC are expected to announce details later this year.

Leung added that foreign holdings accounted for only about three percent of China’s onshore bond market – the second largest in the world. This share is dwarfed by the corresponding shares of 14 percent and 25 percent in developed markets Japan and the United Kingdom, respectively.

“Foreign capital has a lot of room to get involved,” Leung said. “According to World Economic Forum data, China’s bond market is 1.1 times the size of domestic GDP, which is lower than other developed countries, such as the United States (2 times) and Japan (2.3 times).”

Market analysts called this a significant step.

“Once this is rolled out, they will be able to post these onshore bonds as eligible collateral for swaps under the Swap Connect program, which was previously limited to cash and certain offshore securities,” said William Shek, head of markets and securities services for Hong Kong at HSBC. “This move further contributes to the internationalization of onshore bonds and strengthens Hong Kong’s position as the world’s leading offshore yuan center.”

Using onshore bonds as collateral for Swap Connect will expand the application of onshore yuan bonds and promote the internationalization of the yuan, said Eddie Yue, CEO of the HKMA, the city’s de facto central bank.

Dim sim bonds, as offshore yuan bonds are called, issued in Hong Kong last year totaled 540 billion yuan, 3.5 times more than in 2020, Yue said.

The People’s Bank of China wants to expand its “pragmatic cooperation” with Hong Kong and support the city’s development into an international financial center, said Huifen Jiang, deputy director general of the central bank’s financial market department, in a video address at the summit.

“We have found that Bond Connect has greatly promoted Hong Kong’s status as a centre for fixed income, currencies and commodities,” said SFC’s Leung. “Many foreign institutions have established subsidiaries and stationed staff in Hong Kong to help develop Bond Connect services.”

She added that demand for Chinese government bonds was high among foreign institutions, especially pension funds, wealth funds and central banks, which held about 70 percent of foreign investors’ government bonds.

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