China expands overseas access to swaps after $130bn bond selloff

China has opened the door for more foreign investors to access its prized $5 trillion interest rate swap market, a move Beijing hopes could help prevent long selling of local debt as US rates rise. Is.

The market link-up, known as Swap Connect, launched on May 15 and is similar to existing programs in Hong Kong that allow offshore investors to trade bonds and stocks in Shanghai and Shenzhen.

Eddie Yue, chief executive of the Hong Kong Monetary Authority, said during a meeting in Beijing that allowing foreign investors to hedge interest rate risk on their renminbi bonds could “prevent a massive selloff for bonds, resulting in market volatility”. may be reduced and financial stability may be improved”.

“The most direct impact is access to a liquidity pool that was previously untapped,” said Enrico Bruni, head of Europe and Asia trading at bond trading platform TradeWeb.

But while investors have welcomed the new channel for trading onshore derivatives, few expect it to turn the tide as the US Federal Reserve continues an aggressive monetary tightening campaign.

Foreign investors using Hong Kong’s Bond Connect program have given up nearly Rmb220bn ($31bn) worth of Chinese government debt this year, bringing total outflows since the beginning of 2022 to more than Rmb903bn ($130bn).

The outflows have accelerated because of repeated rate hikes by the Fed, pushing US Treasury yields higher than their Chinese counterparts.

“The outflow from the China market is not because (investors) have access to a certain scheme,” said a senior analyst with a bond market data provider in Asia. “It’s (caused by) central bank interest rate divergence.”

Data released by the China Foreign Exchange Trade System (CFETS), a central bank affiliate that runs the country’s interbank market, said 27 offshore investors – including HSBC, Deutsche Bank, BNP Paribas, Amundi, Citigroup, Bank of Malaysia , DBS and Standard Chartered. – About Rmb8.3bn worth swapped on the first day of the event.

This was less than half of the plan’s total daily quota of Rmb20bn, which is divided among participating financial institutions. But the head of Hong Kong financial markets for a large European lender said initial demand was encouraging and his team was already close to meeting its daily quota after conducting transactions for about half a dozen clients.

A Shanghai-based banker at the European lender said trading had been “sluggish” since the day of the launch. He warned that there were “a lot of operational issues to deal with and straighten out”, describing early trading as still being in “test mode” with technical glitches and clearance snags.

Despite such early issues, there was broad agreement that the new business plan was central to the continued integration of Chinese and global finance.

“The swap is an important step for the (Chinese central bank) to connect and for China to open up its financial market,” said Chen Xinquan, an economist at Goldman Sachs.

Chen said the new plan was important for foreign investors using Hong Kong’s popular Bond Connect scheme, which accounts for about 60 percent of the market’s foreign exposure in renminbi-denominated government debt.

While there was ample liquidity in interest rate swaps with shorter maturities, he said, trading activity for swaps with maturities between 5 and 10 years was thin, making it difficult for offshore investors to hedge longer-term interest rate risk.

International investors, Chen said, “certainly have exposure to both short- and long-term bonds, with only a lot of interest and real money in long-term debt”.

Still, he said 10-year government bond futures, not yet included in the program, were a “more effective hedging tool” for investors with longer maturities.

The head of a financial industry group was more blunt: “Investors really want access to bond futures.”

Beijing has been reluctant to give foreign traders greater access to its onshore government bond futures, fearing they could disrupt the market, which while more liquid than offshore bond futures, is relatively shallow in absolute terms.

However, some traders believe that China will soon open its bond futures market after the launch of the swap connect scheme.

“Our expectation is that it will not be difficult (for the program) to expand over longer periods, 7 to 10-year buckets, where liquidity is deeper than offshore,” said the Hong Kong finance chief at the European Investment Bank.

In addition, analysts expected the swap connect to facilitate more flows to China’s renminbi debt market once Chinese bond yields climbed back above US Treasuries.

“Demand for the swap scheme is likely to increase in the future, especially as the rate environment encourages more inflows into Chinese government bonds,” said Chen Jianheng, head of fixed income research at brokerage group China International Capital Corporation.

China has opened the door for more foreign investors to access its prized $5 trillion interest rate swap market, a move Beijing hopes could help prevent long selling of local debt as US rates rise. Is.

The market link-up, known as Swap Connect, launched on May 15 and is similar to existing programs in Hong Kong that allow offshore investors to trade bonds and stocks in Shanghai and Shenzhen.

Eddie Yue, chief executive of the Hong Kong Monetary Authority, said during a meeting in Beijing that allowing foreign investors to hedge interest rate risk on their renminbi bonds could “prevent a massive selloff for bonds, resulting in market volatility”. may be reduced and financial stability may be improved”.

“The most direct impact is access to a liquidity pool that was previously untapped,” said Enrico Bruni, head of Europe and Asia trading at bond trading platform TradeWeb.

But while investors have welcomed the new channel for trading onshore derivatives, few expect it to turn the tide as the US Federal Reserve continues an aggressive monetary tightening campaign.

Foreign investors using Hong Kong’s Bond Connect program have given up nearly Rmb220bn ($31bn) worth of Chinese government debt this year, bringing total outflows since the beginning of 2022 to more than Rmb903bn ($130bn).

The outflows have accelerated because of repeated rate hikes by the Fed, pushing US Treasury yields higher than their Chinese counterparts.

“The outflow from the China market is not because (investors) have access to a certain scheme,” said a senior analyst with a bond market data provider in Asia. “It’s (caused by) central bank interest rate divergence.”

Data released by the China Foreign Exchange Trade System (CFETS), a central bank affiliate that runs the country’s interbank market, said 27 offshore investors – including HSBC, Deutsche Bank, BNP Paribas, Amundi, Citigroup, Bank of Malaysia , DBS and Standard Chartered. – About Rmb8.3bn worth swapped on the first day of the event.

This was less than half of the plan’s total daily quota of Rmb20bn, which is divided among participating financial institutions. But the head of Hong Kong financial markets for a large European lender said initial demand was encouraging and his team was already close to meeting its daily quota after conducting transactions for about half a dozen clients.

A Shanghai-based banker at the European lender said trading had been “sluggish” since the day of the launch. He warned that there were “a lot of operational issues to deal with and straighten out”, describing early trading as still being in “test mode” with technical glitches and clearance snags.

Despite such early issues, there was broad agreement that the new business plan was central to the continued integration of Chinese and global finance.

“The swap is an important step for the (Chinese central bank) to connect and for China to open up its financial market,” said Chen Xinquan, an economist at Goldman Sachs.

Chen said the new plan was important for foreign investors using Hong Kong’s popular Bond Connect scheme, which accounts for about 60 percent of the market’s foreign exposure in renminbi-denominated government debt.

While there was ample liquidity in interest rate swaps with shorter maturities, he said, trading activity for swaps with maturities between 5 and 10 years was thin, making it difficult for offshore investors to hedge longer-term interest rate risk.

International investors, Chen said, “certainly have exposure to both short- and long-term bonds, with only a lot of interest and real money in long-term debt”.

Still, he said 10-year government bond futures, not yet included in the program, were a “more effective hedging tool” for investors with longer maturities.

The head of a financial industry group was more blunt: “Investors really want access to bond futures.”

Beijing has been reluctant to give foreign traders greater access to its onshore government bond futures, fearing they could disrupt the market, which while more liquid than offshore bond futures, is relatively shallow in absolute terms.

However, some traders believe that China will soon open its bond futures market after the launch of the swap connect scheme.

“Our expectation is that it will not be difficult (for the program) to expand over longer periods, 7 to 10-year buckets, where liquidity is deeper than offshore,” said the Hong Kong finance chief at the European Investment Bank.

In addition, analysts expected the swap connect to facilitate more flows to China’s renminbi debt market once Chinese bond yields climbed back above US Treasuries.

“Demand for the swap scheme is likely to increase in the future, especially as the rate environment encourages more inflows into Chinese government bonds,” said Chen Jianheng, head of fixed income research at brokerage group China International Capital Corporation.