HKEX Report丨The Inclusion of China into Global Bond Indices

北大汇丰金融研究院

Editor's Note
On April 1, 2019, Bloomberg announced that 356 RMB-denominated Chinese government bonds and policy bank bonds were officially included in the Bloomberg Barclays Index. This is the first time that Chinese bonds have been included in the international mainstream bond index, and it is also a milestone in the orderly opening of China's bond market. It marks another substantial step in the opening up of China's financial market.

In recent years, China has taken a number of steps to reduce the entry barriers for foreign participation in its domestic bond market. In particular, the Bond Connect scheme was officially launched in July 2017, which has largely removed the entry barriers to China’s bond market and eased restrictions on foreign investors’ trading in the market. Large global institutional investors, such as global banks, pension funds, insurance companies, central bank reserves and sovereign wealth funds, are prone to choose a widely used index as a benchmark, or take positions away from the benchmarks within a certain risk budget to achieve excess returns.

Author: Chief China Economist's Office, Hong Kong Exchanges and Clearing Limited

REPORT SUMMARY

China’s bond market has experienced a rapid expansion and become the third largest in the world. However, it is much under-represented in global bond indices, compared to the size of its economy and bond issuance. In recent years, China has taken a number of steps to reduce the entry barriers for foreign participation in its domestic bond market. In particular, the Bond Connect scheme was officially launched in July 2017, which has largely removed the entry barriers to China’s bond market and eased restrictions on foreign investors’ trading in the market. This has enhanced China’s eligibility to meet the stringent criteria of widely-used global bond indices. However, certain operational issues remain constraints on foreign participation in China’s bond market. These include the settlement arrangement in existing channels being not fully on delivery versus-payment (DVP) basis, unclear taxation policy on foreign investment in bonds, the difficulty in repatriating funds, and the ability to hedge currency risk through liquid foreign exchange markets.

China’s inclusion into widely-used globalbond indices appears inevitable and the impact will be significant in the foreseeable future. Once China is admitted to and assigned larger weights in global bond indices, and more exchange traded funds (ETFs) tracking these global bond indices increase their holdings in China’s bond sectors accordingly, the availability of hedging instruments would become important to reduce the sensitivity of China’s domestic bond market to international market volatility. Moreover, maintaining a solid sovereign rating is essential for attracting global large institutional investors and for remaining included in global bond indices. Domestic financial deepening, including expanding the local investor base, deepening banking sectors and capital markets, and improving institutional environment, will help strengthen the domestic financial market and mitigate the adverse impact of global financial shocks on domestic asset prices.