Unlocking the Potential of China's Onshore Bond Market: Swap Connect Collateral Expansion Boosts Global Investor Access

In a move that promises to enhance cross-border connectivity and cooperation, regulators from Hong Kong and mainland China have announced that international investors can now pledge their holdings of Chinese domestic bonds as margin collateral for Northbound Swap Connect trading. This significant development aims to vitalize global investors' 4.22 trillion yuan (US0 billion) holdings by reducing their liquidity cost and improving capital efficiency in their interest-rate swaps.

Unlocking the Doors to China's Vast Bond Market

Expanding Collateral Options for Swap Connect

The decision to allow the use of onshore bonds as Swap Connect collateral is a game-changer for global investors. Previously, they were restricted to using only cash and certain offshore securities as collateral. This new development will "not only improve the efficiency of capital management for foreign investors, but also increase the willingness of holding China's onshore bonds," according to Julia Leung Fung-yee, CEO of Hong Kong's Securities and Futures Commission (SFC).The Hong Kong Monetary Authority (HKMA) and the SFC are expected to announce the details of this service later this year, paving the way for its implementation by the end of 2023. This move is a significant step towards the internationalization of China's onshore bond market, which currently accounts for only 3% of foreign investor holdings, a stark contrast to the 14% and 25% seen in Japan and the United Kingdom, respectively.

Strengthening Hong Kong's Position as an Offshore Yuan Hub

The usage of onshore bonds as collateral for Swap Connect will not only expand the applications of these yuan-denominated securities but also strengthen Hong Kong's position as the world's leading offshore yuan center. According to HSBC's William Shek, head of markets and securities services for Hong Kong, this step "further contributes to the internationalisation of onshore bonds and strengthens Hong Kong's position as the world's leading offshore yuan centre."The HKMA's CEO, Eddie Yue, echoed this sentiment, stating that the usage of onshore bonds as Swap Connect collateral will benefit the internationalization of the yuan. This move comes at a time when the offshore yuan bond, or "dim sum" bond, market in Hong Kong has seen a significant surge, with issuance reaching 540 billion yuan in 2022, a 3.5-fold increase from 2020.

Deepening China-Hong Kong Financial Cooperation

The announcement of the Swap Connect collateral expansion is a testament to the deepening cooperation between Hong Kong and mainland China's financial authorities. The People's Bank of China (PBOC) has expressed its commitment to elevating its "pragmatic cooperation" with Hong Kong and supporting the city's development as an international financial center.SFC's Leung highlighted the significant impact of the Bond Connect scheme, which has "hugely promoted Hong Kong's status as a centre for fixed income, currencies and commodities." This has led to many foreign institutions setting up subsidiaries and deploying workforce in Hong Kong to collaborate on the development of Bond Connect services.

Catering to Global Investor Demand

The demand for Chinese government bonds among foreign institutions, particularly pension funds, wealth funds, and central banks, is high, accounting for about 70% of overseas investors' holdings in sovereign debt. This underscores the growing appetite for exposure to China's bond market, which is the world's second-largest, yet still underrepresented in global investor portfolios.The expansion of Swap Connect collateral options is poised to further unlock this demand, as it will improve the efficiency and capital management for foreign investors, making it more attractive to hold Chinese onshore bonds. This move aligns with China's broader efforts to internationalize its financial markets and strengthen its position as a global financial powerhouse.