China is about to broaden foreign access to its US$10 trillion debt market — but international investors are likely to be wary.
The bond connect with Hong Kong is in the final stages of preparation, Hong Kong Exchanges & Clearing Ltd chief executive officer Charles Li (李小加) said on Monday.
Overseas money managers own less than 2 percent of Chinese debt, leaving plenty of scope for increased inflows.
Still, the new channel for foreigners to access the world’s third-biggest bond market is getting a mixed reception.
E Fund Management (HK) Co (易方達資產管理有限公司) and Shenwan Hongyuan Asset Management (申萬宏源投資管理) see persistent obstacles to international participation. They include capital controls, lack of faith in Chinese credit ratings, and concerns over liquidity — volume in China’s bond market is less than 10 percent of that in the US.
“The trading link will attract a limited amount of additional inflows,” said James Yip, a Hong Kong-based money manager at Shenwan Hongyuan.
“There are still a lack of details and a lot of uncertainties, and issues such as thin liquidity. Foreign investors will most likely wait and watch, and the connect isn’t likely to become a big hit right away,” he said.
Pacific Investment Management Co (Pimco), too, does not see a sudden surge in demand via the connect.
Here are some of the major issues that have been flagged by foreign investors and analysts:
CAPITAL CURBS
China has been working to staunch outflows, going so far as to limit Chinese companies’ overseas acquisitions, curbing money transfers to offshore accounts and increasing scrutiny on citizens’ foreign-currency conversions.
The moves, criticized by global investors and companies, mean foreign funds are worried they will not be able to move proceeds abroad if they use the bond connect to buy onshore securities, said Zhu Qi, a portfolio manager at E Fund Management in Hong Kong.
“Foreign investors still need to re-build confidence in the Chinese government and regulators, which will take more time,” Zhu said.
Due to the curbs and yuan depreciation, “very few overseas funds will use the northbound route at the moment,” he said.
YUAN CONTROL
Beijing appears to be trying to regain some control over the yuan, with officials saying on May 26 that they were considering adding a new factor to the formula used to determine the daily reference rate.
The shift was viewed by analysts as a way for China to keep the yuan stable and dilute the market’s role.
That would be a concern because currency flexibility is becoming an increasingly important factor in investment decisions, Pimco head of portfolio management for emerging Asia Luke Spajic said.
“With a managed currency, the risk premia can be compressed for long periods of time, and when the currency weakens, large volatility and losses can occur,” Spajic said.
“The counter-cyclical factor adds more complexity to currency analysis and valuation,” he said.
THIN TRADING
Trading volumes in China’s bond market are about 7 percent of those in the US, with recent efforts to curtail financial leverage further denting liquidity, data compiled by Bloomberg show.
In China, banks dominate debt trading, and they have less impetus to buy and sell their holdings than money managers do.
That situation has worsened recently as a spike in debt yields prompted Chinese companies to scrap a record 200 billion yuan (US$29 billion) of bond sales over the past two months.
“The market efficiency will be very low when trading is thin,” Yip said.
Fluctuations in liquidity can be wilder in China than in developed nations, as local traders cut positions at the same time, he added.
Foreign investors have long been skeptical about Chinese rating firms, as they tend to give inflated assessments amid fierce competition, said David Qu (曲天石), a markets economist in Shanghai at Australia & New Zealand Banking Group Ltd.
CREDIT RATINGS
Foreign funds probably will not be interested in any debt graded lower than “AA+,” he said.
Local rating firms have said that their Chinese peers are compromising evaluations to win business.
HSBC Holdings PLC has also flagged what it called China’s “relatively tedious” trade settlement procedures, saying the connect should be linked to international settlement systems as a way of luring foreign interest.
For Goldman Sachs Group Inc, the connect has immense potential, but more precise details on exact trading procedures and hedging feasibility are needed.
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