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China Bond Connect Market: What You Need to Know
January 23, 2018
ICI WebinarAgenda» Introductions» Key developments in the China Bond Connect
market»Opportunities in China’s bond market»Operational considerations for regulated funds»Regulatory update and outlook
1
Panelists
2
Lisa MartinezModerator
Assistant Vice President, Network
ManagementCapital Group
Julien MartinGeneral Manager
Bond Connect Company Limited
Barnaby NelsonManaging DirectorStandard Chartered
Patrick WongHead of China Sales
and Business Development
HSBC
CPE Credit
If you are interested in receiving CPE credit for today’s webinar, please enter the following code in the text box now.
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» Patrick Wong» Head of China Sales and Business Development
» HSBC Securities Services
Opening up more opportunities in the world’s third-largest bond marketBond Connect
5
Offshore Hong Kong Mainland China
China-Hong Kong Bond ConnectNorthbound Operating Model
Note:1. Bond Connect Company Limited, jointly owned by CFETS and HKEX, will support and assist admission and registration for Northbound investors, and liaise closely with the international Access Platforms under Bond ConnectSource: HKEx
• International investors trade via global platforms with assets held in custody via a Hong Kong (CMU) nominee structure• Mainland regulators fulfil their requirements for transparency and control
International investors
Global Custodian
Global Access Platforms
HKEX
CMU Members
HKMA CMU
CFETS
CFETS Bond Trading System
CCDC + SCH
Mainland dealers
BCCL1Trading
Settlement
Trading Link
Settlement Link
Existing interface
Existing interface
Nominee structure
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Comparison between Bond Connect North Bound and CIBM Direct ProgramA detailed comparisonAspect Bond Connect North Bound CIBM Direct Eligibility and Market Entry
Quota • No • As per registered amount
Trading platform
• Through HK trading infrastructure, Tradeweb for Day 1, connecting to CFETS.
• Offshore investors to connect with HK trading infrastructures.
• Each investor will maintain a trading account with CFETS in its own name.
• CFETS • Each investor will maintain a trading account with
CFETS in its own name• Trading agent to conduct trade on behalf of investors
Eligible investors• Follow PBOC Notice [2016] No. 3 and Yinfa [2015]
No.220 (i.e. same as CIBM Direct)
PBOC Notice [2016] No.3:• FIs including commercial banks, insurance, securities
companies, asset managers• Products launched by these FisYinfa [2015] No.220: • Foreign central banks, international orgnaisations and
sovereign wealth funds
Market entry/Registration
• Eligible overseas investors may entrust CFETS or registration agents recognized by PBOC to apply for registration to the PBOC Shanghai Head Office. Overseas investors may provide registration documents to the above-mentioned registration agents directly or through their overseas counterparts.Registration could be at product level.
• Bond Connect Co. Ltd, a JV between HKEx and CFETS has been set up to support and assist investors admission
• Onshore account opening• Registration at fund level• Registration process through a Bond Settlement Agent• Central banks may submit registration directly to
PBOC HQ
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Comparison between Bond Connect North Bound and CIBM Direct Program A detailed comparison (cont’d)Aspect Bond Connect North Bound CIBM Direct
Investment Scope and Trading
Investment scope• Cash bonds. Scope same as CIBM Direct• Investors can also access interbank bond market
primary issuance
• Cash bonds. All types of bonds denominated in RMB and traded in the CIBM. Subscription for primary issue are also permitted
Hedging tools available • CNY FX hedging will be provided by “CFETS Direct Members” in Hong Kong
• FX (Spot, Forward, Swap, Options), bond lending, bond forward, IRS, CCS, FRA
Trading• Investors trade by way of RFQ directly with the
onshore Bond Connect Market Makers as counterparty
• Investors trade directly with CEFTS members
Settlement and custodian arrangement
Settlement cycle
• T+0, T+1 and T+2 (Note: the market deadline of 10 am on SD makes it impractical for intermediaries to support T+0 settlement. Investors are requested to negotiate a T+1 or T+2 settlement cycle to avoid settlement failure.)
• T+0, T+1 and T+2
Settlement account structure
• SCH/CDC are the ultimate central securities depository (CSD)
• HKMA CMU will be the nominee holder of the bonds• Investors will need to open a segregated CMU sub-
account via its Global Custodian or directly via a CMU member. Remarks: Bond Connect Application requires investor to provide such CMU sub-account number
• Investors need to open relevant accounts with PBOC (Special RMB account), CCDC, SCH and CFETS
Settlement method• DVP for SCH and Delivery-against-Payment for CDC.
Settlement on gross basis with the relevant Bond Connect Market Makers as counterparty
• Delivery-versus-Payment (DVP) and settlement on gross basis with the relevant CFETS member as counterparty
7
Comparison between Bond Connect North Bound and CIBM Direct ProgramA detailed comparison (cont’d)Aspect Bond Connect North Bound CIBM Direct
Others
Fund remittance
• CNH funding or foreign currencies exchanged into
CNH or CNY
• For investor, conversion of foreign currency to CNY
can be conducted via their Global Custodian or directly
via a CMU member who will execute it through its
connected “CFETS Direct members” in Hong Kong
region
• If investors use FCY to invest in onshore bonds, they
could keep the RMB for reinvestment or otherwise
convert to FCY after they sell down the bond positions
or when the bonds mature
• CNH funding or foreign currencies exchanged into
CNH or CNY
• Conversion of foreign currency to CNY can be
conducted through Bond Settlement Agent only
• Injection/Repatriation should be done in the same
currency either in CNH or FCY
Fees
• Same as tariff structure of CIBM for the onshore
portion. Customary service fees will collected for
trading, infrastructures and settlement by the offshore
service providers
• Fees to Bond Settlement Agent including the third
party fees charged by CFETS, CDC and SCH
Documentation
• Bond Connect application form, account opening form
for CMU sub-account (from global custodian/local
custodian) and documentation in relation to trading
platform, etc
• PBOC registration documents, service agreement with
Bond Settlement Agent and CFETS and
documentations required for qualification examination
carried out by settlement agent.
Repatriation
• Zero balance to be maintained onshore. Surplus RMB
will be repatriated back to HK automatically on a daily
basis
• The ratio of FCY and RMB in the accumulated
outward remittance shall basically be in-line with that
of the accumulated inward remittance, and the
fluctuation should be within +/-10%
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Comparison between Bond Connect North Bound and CIBM Direct Program
Aspect Bond Connect North Bound CIBM Direct
Others
Account Opening
• Investors need to onboard with Bond Connect market maker as trading counterparty
• As mentioned in settlement account structure above, investors will need to open a CMU sub-account via its Global Custodian or directly via a CMU member
• Bond Settlement Agent assists investors to open relevant accounts with PBOC (Special RMB account), CCDC, SCH and CFETS
Taxation • CGT exempted. No withholding mechanism for VAT and CIT
• CGT exempted. No withholding mechanism for VAT and CIT
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Comparison between Bond Connect North Bound and CIBM Direct ProgramAdvantages and disadvantages
Bond Connect North Bound CIBM Direct
Advantages
• Trading through offshore trading platform(s) that investors
are familiar with
• Investors are registered as direct CFETS member
• Bond coupons and repayment will be automatically
repatriated back to HK on the date of payment
• Nominee account structure: Bonds will be held through
sub-custodian in the CMU account. No need to open
accounts with CDC/SCH
• CNY FX conversion and derivatives can be traded with
offshore CFETS FX settlement bank. Offshore
documentations are used for derivative hedging
transactions
• OTC trading with all CFETS members
• Dedicated service from the Bond Settlement Agents
• Wider scope of hedging tools are available including FX
(Spot, Forward, Swap, Options), bond lending, bond
forward, IRS, CCS, FRA
Disadvantages • Only FX hedging tools are available
• Trading with Bond Connect Market Makers only
• Except for Central Banks, investors need to trade bonds
and hedge through their appointed Bond Settlement
Agents (“BSAs”)
• Onerous documentation including service agreement with
BSAs, account opening with CFETS/CDC/SCH
• Onshore documentation for derivatives hedging
transactions
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» This document does not necessarily deal with every important topic relating to Bond Connect or cover every aspect of the topics with which it deals. Certain clearing and trading rules and regulations are not yet completely promulgated by the relevant authorities, regulatory bodies and/or exchanges and therefore their understanding might be subject to changes in the future. HSBC is under no obligation to keep current the information in this document. Clients are advised to pay close attention to any rules, regulation and announcement published by the relevant authorities, regulatory bodies or exchanges.
» This document is issued by The Hongkong and Shanghai Banking Corporation Limited (HSBC). The information contained herein is derived from sources we believe to be reliable, but which we have not independently verified. HSBC makes no representation or warranty (express or implied) of any nature nor is any responsibility of any kind accepted with respect to the completeness or accuracy of any information, projection, representation or warranty (expressed or implied) in, or omission from, this document. No liability is accepted whatsoever for any direct, indirect or consequential loss arising from the use of this document. Any information (including market date, prices, values or levels) contained here are indicative only and any examples given are for the purposes of illustration only and may vary in accordance with changes in market conditions. The opinions in this document constitute our present judgment, which is subject to change without notice. We are not obliged to enter into any actual trade with you based on the any information contained herein. This document does not constitute an offer for, or advice that you should enter into, the purchase or sale of any security, commodity or other investment product or investment agreement, or any other contract, agreement or structure whatsoever. This material is intended for distribution to, or use by, Professional Investors only, as defined in the Hong Kong Securities and Futures Ordinance. The document is intended to be distributed in its entirety. Unless applicable laws permit otherwise, you must contact a HSBC Group member in your home jurisdiction if you wish to use HSBC Group services in effecting a transaction in any investment mentioned in this document. This document, which is not for public circulation, must not be copied, transferred or the content disclosed, to any third party and is not intended for use by any person other than the intended recipient or the intended recipient's professional advisers for the purposes of advising the intended recipient hereon.
» HSBC does not provide legal, tax, accounting, regulatory or other specialist advice and you should make your own arrangements in respect of such matters accordingly. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient, you should conduct relevant due diligence and analysis, and seek necessary independent professional advice. You are responsible for making an independent assessment and obtaining specialist professional advice in relation to the merits of the proposals contained herein. In particular, this document may contain certain references to regulation. HSBC makes no representation that the references to regulation, if contained herein, are exhaustive. There could be other references to regulation that may also be relevant to the proposals. HSBC does not give advice on regulation. You should consult your own advisers on regulation.
» Copyright. The Hongkong and Shanghai Banking Corporation Limited 2017. ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of The Hongkong and Shanghai Banking Corporation Limited.
» For additional information, please contact your local sales or trading representative.
Disclaimer
12
Questions
If you have questions for the panelists,please submit them using the text box.
12
CPE Credit
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2018 ICI BOND CONNECT WEBINAR
23 JANUARY 2018
Julien MartinGeneral Manager
Bond Connect Company Limited
DisclaimerThis document and the information contained herein may not be used other than by the person to whom it is addressed or distributed to and may not be reproduced in any form or transferred to any person. The information contained in this document is for general informational purposes only and does not constitute an offer, solicitation, invitation or recommendation to buy or sell any securities or to provide any investment advice or service of any kind. This document is not directed at, and is not intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation or which would subject any of Hong Kong Exchanges and Clearing Limited (“HKEX”), China Foreign Exchange Trade System & National Interbank Funding Centre (“CFETS”), Bond Connect Company Limited (“BCCL”), China Central Depository & Clearing Co., Ltd (“CCDC/ChinaBond”) or Shanghai Clearing House (“SHCH”) (together, the “Entities”, each an “Entity”), or any of their affiliates, or any of the companies that they operate, to any registration requirement within such jurisdiction or country.
No section or clause in this document may be regarded as creating any obligation on the part of any of the Entities. Rights and obligations with regard to the trading and settlement of any securities effected on the CFETS, including through the Bond Connect, shall be set out solely in the applicable rules of the Entities, as well as the applicable laws, rules and regulations of Mainland China and Hong Kong in effect from time to time.
Although the information contained in this document is obtained or compiled from sources believed to be reliable, none of the Entities guarantee the accuracy, validity, timeliness or completeness of the information or data for any particular purpose, and none of the Entities or the companies that they operate or their respective affiliates, agents, nominees, representatives, officers and employees shall accept any responsibility for, or be liable for, errors, omissions or other inaccuracies in the information or for the consequences thereof. The information set out in this document is provided on an “as is” and “as available” basis and may be amended or changed in the course of implementation of Bond Connect. It is not a substitute for professional advice which takes account of your specific circumstances and nothing in this document constitutes legal advice. If you are in any doubt about the contents of this document, you should seek independent professional advice. None of the Entities or any of the companies that they operate or their respective affiliates, agents, nominees, representatives, officers and employees shall be responsible or liable for any cost, expense, loss or damage, directly or indirectly, howsoever caused, of any kind, arising from the use of or reliance upon any information provided in this document, or in the presentation given.
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Structural Growth of China’s Bond Market
0
2
4
6
8
10
'08 '09 '10 '11 '12 '13 '14 '15 16 '17
Mar
Credit Bonds Rate Bonds
China’s bond market is now the third largest in the world, and is predicted to double in size in the next 10 years
Growth of China’s Bond market
Amount Outstanding, USD
trillions
CAGR 20%
US$10.1tn
Bank Assets Equities Bonds
USD28 tn
USD8.5tn
USD10.1 tn
~90% Interbank
~10% Exchange55% SSE
45% SZSE
Outstanding, USD tn Relative to GDP
20
40
US JP China DE FR UK
212%
87%249% 146% 171% 157%
China’s Domestic Funding Markets
Sources: WIND, CBRC (Jun 2017), IMF, SIFMA
Jun
17
USD28 tn
Relative to GDP
Foreign Participation in China’s Bond Market
Sources: ChinaBond, Bloomberg, BIS
Foreign participation still only ~2%, well below the international average for large bond markets
68%64%
46%41% 39% 38%
29%
13%8%
2.6%
DE FR AU UK IT CA US RU JP China
International Bond Market ComparisonForeign Participation in the CIBM
Average: 38.5%
15%
Achievable target
Foreign Ownership %
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
-
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
Aug-
16
Sep-
16
Oct
-16
Nov
-16
Dec
-16
Jan-
17
Feb-
17
Mar
-17
Apr-1
7
May
-17
Jun-
17
Jul-1
7
Bond Holdings,RMB trillions
As % of total
2.6%
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Foreign Holdings in CIBM after Bond Connect launchChina Central Depository & Clearing (CCDC) and Shanghai Clearing House (SCH)
Source: (1) SCH: http://www.shclearing.com/sjtj/tjyb/ (2) CCDC: http://www.chinabond.com.cn/Channel/19012917?BBND=2017&BBYF=6&sPageType=2*Published by CFETS: https://mp.weixin.qq.com/s/8QFke9PtmXyLyi3UtD0iyw** Data as of November 2017: CCDC + SCH*** Note: Dec 2017 Shanghai Clearing House (SCH) data to be announced
824 839 897 921 937 974
41108
165 184 171
0
200
400
600
800
1,000
1,200
Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17
RMB (bn)
CCDC – Foreign Holdings SCH – Foreign Holdings
+28% (Jul 2017 to Nov 2017)
Total Number of Bond Connect Accounts Approved as of 31 Dec 2017: 247*Average Bond Connect Account Opening: 10 ~ 12 days from submission to Bond Connect
Company Limited (BCCL)
SCHTBA***
19
Questions
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19
10th January 2018
China - Hong Kong Bond Connect
Regulatory Update and Outlook
Overview
• Regulatory requirements
• Market requirements
Key Developments
• Luxembourg• Ireland• Other markets
Regulatory approvals • JPMorgan
• Bloomberg / Barclays
• WGBI
Index Inclusion
22
Bond Connect and UCITS:What are the key considerations?
Key Considerations Status Conclusion
Are Bond Connect transactions settled on a
simultaneous DvP basis?
SHCH – Simultaneous DvP
CCDC – Linked DVP (cash before bond delivery at all times)
Are Bond Connect assets segregated?
Assets are distinctly segregated into three levels including both at the onshore
and offshore level - further mandatory segregation is required at the offshore
level for each beneficial owner
How are beneficial ownership rights enforced
at the investor level?
CMU is only responsible as a nominee holder. The end investors are the
beneficiary owners who have bondholder rights, enforcement rights and rights
to take legal actions – including onshore.
Is CMU deemed a CSD in HK under UCITSV (in
the Bond Connect operating model)?
Since the responsibilities of CMU under Bond Connect perform similarly with
HKCSS under Stock Connect, we anticipate, CMU will issue a guidance note to
confirm they should be recognized as a CSD under the Bond Connect Scheme
Are there any provisions for quota and capital
repatriation controls under the Bond Connect
scheme?
No quota and capital repatriation controls under Bond Connect scheme
Does the Bond Connect model provide
investors with the ability to meet their best
execution requirements under MIFID2?
Under Bond Connect, Tradeweb creates a higher pricing transparency and a
more efficient pricing mechanism. Therefore, achieving the best execution
requirements under MIFID2.
1
2
3
4
5
6
23
Bond Connect and UCITS:What are the key considerations?
Key Considerations
Are Bond Connect transactions settled on a simultaneous DvP basis?
Are Bond Connect assets segregated?
How are beneficial ownership rights enforced at the investor level?
Is CMU deemed a CSD in HK under UCITSV (in the Bond Connect operating model)?
Are there any provisions for quota and capital repatriation controls under the Bond Connect scheme?
Does the Bond Connect model provide investors with the ability to meet their best execution requirements under MIFID2?
1
2
3
4
5
6
Real Time DVP
• Currently SHCH settles in RVP mode• CCDC settlements are not currently RVP• CCDC has implemented CIPS in order to be able to support RVP• This will be based on the BIS model 1•We understand that testing has been successfully completed•We are pending final sign off from PBOC immimently
FAQ
• A single FAQ document has been drafted to summarise the range of operational and legal elements of the Bond Connect• This is based largely on the Stock Connect template• It covers Beneficial ownership (3); CMU as a CSD (4) amongst other issues• A second working draft has been shared with key regulators and publication is expected shortly
Est. Q1 2018 Est. Q1 2018
24
TBC
Key DevelopmentsMarket Requirements
CNY funding
Tax
Additional trading platforms
Failed trades
Change of custodians
Hedging
CNY Repos and IRS
Fully available but variable across different FX banks
Same as CIBM Direct
Pending confirmation of Bloomberg
Roles and responsibilities for reporting to be included in FAQ
Completed: only for investors who have not yet traded
Fully available but variable across different FX banks
Widely expected in early 2018
Market data Trade data is available for SHCH, not yet for CCDC
Block trading May be available at end of Q1 (dependent on CFETS)
Extended trading hours Under consideration by Chinese authorities
Expe
cted
in Q
1/Q
2Co
nfirm
25
Regulatory Approvals
Luxembourg
• A small number of funds have been approved to use the Bond Connect for less than 10% of AUM
• A small number of funds have been approved to use the Bond Connect as a core part of their investment strategy (ie >10% of AUM): on the condition that they dont start using the Bond Connect until a suitable solution to the counterparty risk issue is put in place.
• Will approve funds for large scale participation in Bond Connect once counterparty risk issue is fully resolved
Ireland
• Currently gathering information on the Bond Connect
• CBI is pending a formal submission from IFIA on the Bond Connect
• Once received, CBI wil review the submission and consult the industry for any specific points
• At the end of the consultation, CBI will issue their own FAQ on the Bond Connect: detailing how depobankscan begin to use the mechanism
Others
• Key regulators (Japan, Hong Kong, etc.) remain focused on real time DVP point
• No other issues identified by other regulators to date
Est. Q1 2018 Est. Q2 2018 Est. Q1 2018
26
Bond Index Inclusion• On 30 November 2015, the Executive Board of the International Monetary Fund (IMF) completed the regular five-
yearly review of the basket of currencies that make up the Special Drawing Right (SDR), and decided to include the RMB into the currency basket of SDR. The new basket will become effective on October 1, 2016.
Inclusion of RMB into the currency basket of SDR
• The potential inclusion of China debt instruments in Global Bond Indices could have a significant impact on investors in benchmarked fixed-income strategies, as they would need to restructure their portfolios to reflect the indices’ realignment.
• Bloomberg Barclays Fixed Income Indices: On 24 January 2017, Bloomberg announced that 3 new indices including CIBM would be enacted with effect from1 Mar 2017o Combining Global Aggregate Index and the government and policy bank component of the China Aggregate
Indexo A new EM Local Currency Government + China Indexo A new EM Local Currency Government + China Index (with 10% cap per country)
• Citi Fixed Income Indices: On 06 March 2017, they announced the inclusion eligibility of Chinese onshore bonds to its Emerging Markets and Regional Government Bond Indices. o China is eligible to join three existing government bond indices, Emerging Markets Government Bond
Index(“EMGBI”), Asian Government Bond Index(“AGBI”) and Asia Pacific Government Bond Index(APGBI”). For EMGBI and AGBI, announcement will be made on June to see whether indices will be available in February 2018. For APGBI, China will enter in February 2018.
o China is also eligible to join one new related index – World Government Bond Index – Extended (“WGBI-Extended”), which will be available in July 2017.
Bond Index Inclusion
Bond Connect • Bond Connect is formally launched on 3 July 2017.• Only Northbound Trading is allowed in the initial phase.• This scheme compliments the existing China market access channels, QFII, RQFII and CIBM Direct. Currently,
foreign participation in China bond market still remains low (less than 2%)
26
China Bond Index Inclusion Related Potential Inflows
• Recent industry research estimates passive inflows to China onshore bonds may reach USD 286 billion
• Main outflows from G3 (USD 222 billion) and other developed markets (USD 36 billion)• Inflows likely to account for 14% of outstanding Chinese Government Bonds vs RMB 1.1
trillion* foreign holdings
Source: Standard Chartered Global Research China Bond Index Inclusion: Prospects and Implications 5 December 2017. Focus on the JP Morgan GBI-EM Global Diversified Bond Index, Citi World Government Bond Index (WGMI) and Bloomberg-Barclays Global Aggregate Indicex* Data as of November 2017: CCDC + SCH
28
Inclusion Criteria in Major Emerging Market Bond Indices
Source: Standard Chartered Global Research China Bond Index Inclusion: Prospects and Implications 5 December 2017
ü Onshore Accessibility, Tradability and Convertibility
ü Absence of Capital Control
ü FX hedgeabilityHard Criteria
Soft Criteria
? Settlement Risk - Lack of True Delivery vs Payment (DVP) settlement
? Full services offering by global custody banks and local settlement banks
? Further clarification on tax
? FX operational Issues
Soft criteria are subject to resolution in 3 to 6 months pending regulatory approval
29
Index Inclusion: SCB Research ViewCore index providers
JPMorgan• September 2017 review: China not eligible but remains on Index watch• Re-assessment in Q2/Q3 2018• Likely impact USD20bn
Bloomberg-Barclays• Pending confirmation of 2017 review• Next review in Q4 2018•Likely impact USD107bn
World Gov’t bond Index • Next review in Q4 2018• Likely to be most conservative index provider (no new inclusions since 1984)• Likely impact USD159bn
80% chance for China bonds to be included in one of the major global bond indices in the 2018 governance review, with actual inclusion starting
in 2019
China has met ‘hard’ inclusion criteria, but still gaps to meet ‘soft’ criteria
Our analysis showed that some Asia LCY markets already included in the indices have more
restrictive FX access than China
Potential inflows to China is significant, at USD 286bn, which is about 14% of outstanding CGBs
or government budget deficit in 2017
The bulk of the outflows will likely to come from G3 and other developed markets, instead of EM
LCY bond markets
Key Deliverables
‘Must Haves’• Settlement Risk / DVP• Global Custodians’ readiness (on CNY)• Tax • FX Operational issues
Nice-to-have’s• Harmonisation of schemes• CNY access via multiple banks• Block trading
30
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