As part of China’s efforts to loosen capital controls, increase cross-border flows and giving its mainland investors access to offshore bond markets, Beijing is set to launch the Southbound link to the Bond Connect program. Bond Connect is a breakthrough in China’s mutual market access, where investors from Mainland China and overseas can trade in each other’s bond markets through a market infrastructure linkage in Hong Kong. Trading via the Northbound link/Connect began in July 2017, giving access to the China Interbank Bond Market (CIBM) to a broader group of international investors. Holdings in the onshore debt market rose to a record 11% from 4% before the Northbound link was launched.
The new Southbound Connect will now offer a mechanism for mainland investors to buy offshore bonds that were otherwise available to offshore investors only. Domestic investors can now diversify their portfolios, and Chinese banks have a new avenue to park surplus dollars whilst also deepening the domestic FX swap market. Official details are not published yet, but Bloomberg notes that different types of USD notes, offshore yuan (CNH) debt and other foreign-currency bonds that are accessible in Hong Kong may be included.
Bloomberg adds that the new system can help reduce the pace of increase in the Yuan with the USDCNY moving from the 7 handle a year ago to a low of ~6.35 and currently at 6.46. With the Southbound Connect, domestic traders will need to sell CNY to buy other currencies to purchase bonds. This would also help reduce the need for the PBOC to directly intervene in controlling the currency and allow it to be more free floating. On the other hand, for Hong Kong, the Southbound Connect would boost its role as the conduit to the mainland market. Currently, the southbound link is available for stocks and is one of the biggest sources of flows for the HK market as per Bloomberg with ~HKD 3.7bn ($477mn) of average daily trading volumes in the last year. As per Bloomberg, mainland investors currently have very limited access to offshore bonds with limited control over selecting the bond type.
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