11 March 2016

For China, bond reforms are a vital step towards more efficient markets

Justin Chan, Co-Head of Markets, Asia Pacific, HSBC
(This article was first published on 11 March by Hong Kong Economic Journal)

Early in the Year of the Monkey, the People’s Bank of China announced welcome amendments to the rules governing domestic retail investment in Chinese bonds. The PBoC followed this up with further measures to liberalise global investors’ access to China’s vast interbank bond market. These developments are strong signs that China’s commitment to financial reform remains on track – and that China is serious in its efforts to ensure that the world’s third largest bond market becomes a more effective mechanism for converting domestic and international savings into investment capital.

So what has changed exactly? Firstly, individual investors can now purchase all types of bonds via their banks on an OTC basis. This gives them indirect access to bonds trading in the interbank market, which represent about 95% of the total bond trading volume. All they need is an annual income of more than 500,000 yuan (US $77,000), three million yuan of financial assets (US $460,000) and over two years of securities investment experience. While those parameters clearly restrict participation to wealthier and more experienced retail investors, it’s an important step in expanding retail investment in the Chinese bond market and one that can allow corporates to access a new source of liquidity. Previously, only certificate treasury bonds were available to individuals.

Secondly, the PBoC released a notice on 24 February saying that offshore commercial banks, insurance companies, securities companies, fund management companies and pension funds, are now free to invest in the interbank bond market as well - provided they have a “medium or long-term investment horizon”. It’s now much easier for foreign investors to buy Chinese domestic bonds, as they don’t have to go through the existing Qualified Foreign Institutional Investor (QFII) or Renminbi Qualified Foreign Institutional Investor (RQFII) quota system. Effectively, it removes obstacles to investing in the onshore market and will be welcomed by foreign investors.

These are timely moves in China’s ongoing process of financial reform. The country’s high savings rates means that banks have vast pools of deposits. Allowing greater investment of these savings in bonds has the double benefit of mobilizing capital to support investment in the economy at the same time as encouraging individuals in China’s ageing society to invest in relatively stable instruments that provide a steady income – the traditional choice of retired individuals or those looking to preserve capital when close to retirement.

In the past, China’s rapid economic growth has been fuelled mainly by bank lending. But as the economy matures, the need for stronger and deeper debt capital markets has grown, especially in connection with financing long term projects such as those in the infrastructure sector.

Allowing more retail and foreign investors into the bond market will allow it to become more liquid and  improve the allocation of capital.  By expanding the foreign institutional investors base, China can enhance the mechanism for pricing credit risk. It also helps the financial system to diversify risk, and reduce its over-reliance on the banking sector. 

This also makes perfect sense in the light of China’s ambitious investment plans. First announced in 2013, the “Belt and Road” initiative is just one of those commitments. The initiative entails ploughing billions of dollars into the hardware – railways, highways and ports – that will strengthen links between mainland China and the dozens of countries to its west and south.

Investment in planned and ongoing “Belt and Road” projects could total Rmb1.5tn (roughly $240bn) in the coming years, according to HSBC’s economists. Part of this will come via a US$40bn Silk Road Fund, and the newly-launched US$100bn Asian Infrastructure Investment Bank (AIIB). We believe that the Belt and Road Initiative can be another catalyst for China’s financial reforms, leading to more pro-market changes like the recent ones.

China’s bond market has not traditionally enjoyed the same attention as its stock market, but these reforms make it clear that policymakers are committed to improve the efficiency of China’s capital markets and increase the importance of fixed income to the economy and financial system as a whole. Domestic retail investors and global investors alike should pay close attention.

For China, bond reforms are a vital step towards more efficient markets (3-page PDF 85KB)