Emerging Markets

China's New Freedom For Bond Investors Draws Wealth Manager Welcome

Tom Burroughes Group Editor 29 February 2016

China's New Freedom For Bond Investors Draws Wealth Manager Welcome

China has taken another big step to open up its financial markets - getting a cheer from some wealth managers.

China continues to open its investment doors.

Last week, the People’s Bank of China, the central bank, said it will scrap quota limits on its bond market, seeking to attract more foreign capital and perhaps suggesting concerns about outflows that have pressured the renminbi currency in recent months. The announcement came before the G20 finance ministers and central bank governors meeting last Friday and Saturday, as well as the National People’s Congress gathering (5 March), and the renminbi’s official inclusion in the SDR (October).

Investment house Schroders and AXA Investment Managers have welcomed the move.

“We believe that as operation details (such as the minimum holding period) are spelled out, bond index providers could start including Chinese onshore bonds in global indices. This would also attract global investor interest,” Schroders' Rajeev De Mello, head of Asian fixed income, said in a note.

The world’s second-largest economy has widened investment quotas under its schemes aimed at foreign investors; the Hong Kong/Shanghai Stock Connect link, and the inclusion of China’s renminbi into the International Monetary Fund’s SDR currency basket system are seen as steps of opening up to foreign capital. The country is also privatising state-owned enterprises.

“More recently, the focus has been on measures to limit outflows but this step represents a continuation of the medium-term opening policies. So far, we have seen an increase in quotas for private investors, the removal of quotas for foreign central banks and the inclusion of the renminbi into the SDR basket (an international reserve asset, created by the International Monetary Fund, which member countries can use to supplement their official reserves),” De Mello said.

He said institutional investors will be pleased because lifting quotas gives them a chance to build Asia-related holdings in a large liquid market in addition to Japan; Chinese yields are positive – a rare opportunity when yields in many developed countries are low, zero or even negative. China’s trade surplus and likely move of the currency towards a free float position are also positive factors.
“The Chinese offshore ('dim sum') bond market is suffering from the high implied yields due to expectations of sharper currency depreciation. Issuers do not want to pay high yields and buyers are worried about the volatility. The opening up of the onshore market will further encourage international investors to migrate towards the more liquid domestic market. The higher offshore yields and international legal framework will maintain a certain attraction for the dim sum bond market,” De Mello said.

“Meanwhile, short-term pressures on the currency are still strong and we expect the currency to remain a source of concern until the currency policy becomes clearer to market participants. This may require more time as the changes have been recent. It was only in August that the renminbi moved away from the US dollar and in December that the trade-weighted basket was made more explicit,” De Mello added.

The amount of bonds outstanding in China totaled RMB48.8 trillion ($7.5 trillion) at the end of December, the central bank has said (source: Bloomberg). China’s 10-year sovereign yield of 2.87 per cent compares with 1.69 per cent in the US, and less than zero in Japan (Bloomberg data, other).

At AXA Investment Managers, meanwhile, Aidan Yao, senior emerging Asia economist, was broadly welcoming of the change.

“On the macro side, the move demonstrates a strong and continued commitment to liberalise China’s financial system. But in light of the market turbulence, the government is managing the process carefully to avoid unsettling investor sentiment, by asymmetrically opening the capital account – encouraging more inflows than outflows,” Yao said.

“On the market side, the mix of negative interest rate policies elsewhere in the world and yesterday’s de-regulation has led us to be more constructive on China bonds over time. We think the expansion of foreign access potentially opens the door for index inclusion of renminbi bonds (e.g. Citi’s WGBI), which can support the currency over the medium to long term. However, the near-term market implication (over next three to six months) should be fairly limited, in our view,” Yao said.

China is still determined to liberalise its financial sector and reform external accounts and the bond market move, if it proceeds as stated, “will mark a major step towards integrating China into the global fixed income market,” Yao said.

“It is, therefore, an important demonstration that China is still committed to liberalising, opening, and reforming its financial system."



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