Given that China is the world’s second largest economy (and is expected to be the largest by the end of this decade), it shouldn’t be a huge surprise to learn that it has the world’s second largest bond and equity markets. What may be a surprise, however, is that these markets have grown so large without significant foreign participation?
By June 2020 the size of the Chinese Bond Market passed RMB 97trn ($14trn), but foreign ownership was only at around 2.6%. Contrast this to foreign ownership of US debt at around 30%. I won’t get into all the reasons why this is the case (indeed there are weighty tomes of economic analysis on the topic), but one point to make is this is not from lack of demand: yields and real-returns are significantly higher than across the developed Western markets, performance is considered less correlated than other financial assets (making this a good diversity play) and the credit-worthiness, at least of the Government and Policy Bank debt, is considered solid. Indeed, despite a backdrop of geopolitical tension, investor demand for China has increased steadily over the course of this year. A factor we can point to, however, is that access hasn’t always been easy. China has been cautious with regard to opening its markets, applying controls by creating specific sets of rules and requirements known widely as “Access Schemes”.
Progressively opening up
The first notable scheme was launched in 2002 and is known as QFII (I could spell it all out, but everyone simply refers to it by its acronym, pronounced “kewfee”). Overseas investors were permitted to move capital onshore to invest in equities and bonds (and mutual funds and stock index futures). This was followed in 2011 by RQFII, the primary difference being that investors were also allowed to use offshore RMB, in addition to the domestic CNY.
The rules for overseas investors started off as fairly strict and complex: requirements to establish a local presence in China, applying for licences, moving money into onshore accounts, operating under investment quotas, and lock-up periods on repatriating returns. Gradually these rules have been relaxed over time and demand has increased. In fact, last year even the investment quotas were scrapped (although by this time most investors had moved on to newer, more liberal schemes).
For bonds, the first inflection point for foreign investors came with the launch of CIBM Direct in February 2016. Bond investors were still required to move their funds onshore, but the registration process was simpler, an increasingly wider array of financial entities were permitted access to the onshore bond markets, the use of derivative instruments were permitted (where legitimate hedging purposes could be demonstrated) and no quotas were imposed. The opportunity was gladly taken, and foreign participation greatly increased.
Connecting the world
In 2014, the ‘Stock Connect’ scheme was unveiled. For the first time, overseas investors were allowed to invest in the onshore equity markets via a link between the Hong Kong Exchange and the Shanghai Stock Exchange (adding the Shenzhen Stock Exchange in 2016).
Existing broker and clearing accounts could be used, with no more set-up costs for registering and – significantly – removing the need to move currency onshore in advance of investment. Again, over time, the rules have been adapted and become more accommodative. Investment quotas have been raised significantly (although they do still exist).
In mid 2017, Bond Connect was launched. Overseas investors are simply required to register with the Hong Kong based, Bond Connect Company Ltd (who would manage the onshore requirements on their behalf). Execution takes place via the familiar platforms of Tradeweb and Bloomberg (who in turn connect them digitally to onshore price makers via China’s defacto exchange for FX and Bonds, CFETS). Settlement takes place via the Hong Kong Monetary Authority’s CMU platform (which can manage both the domestic and offshore RMB). Despite the lack of access to derivatives for hedging purposes (so far), the scheme has been a tremendous success, especially for new participants to the market.
What are you scheming?
With five ‘Access Schemes’ out there, it’s now easier than ever to invest in the Chinese markets. Investors have a selection of schemes to choose from. In practice, as new, more accommodating schemes have been launched, users have tended to migrate to the latest scheme – but it’s not always a straightforward choice. CIBM Direct gives investors access to more ‘tools’ to manage their portfolios, as well as potentially cheaper execution fees, by avoiding an offshore middle-man. But there are the costs of setting up onshore and the encumbrance of moving currency in and out of China. Often the older schemes are the first to benefit as China gradually relaxes certain controls: users can now elect up to 3 CNY liquidity providers for their settlement FX requirements on CIBM Direct, but currently still only 1 for Bond Connect.
Whatever the scheme an investor chooses, accessing China from overseas still requires some unique considerations: new rules to comply to, new workflows to be adapted to, new counterparties to onboard… Happily those conditions will evolve too and with the right approach, access will become steadily easier.
ChinaFICC was established to help bridge the gaps between the infrastructures and workflows that overseas investors are familiar with to the requirements of China’s Access Schemes. Whether it’s across execution or settlement, we aim to deliver flexible, centralised products that increase automation, reduce risk, stay compliant and decrease costs. And when rules are relaxed and new opportunities are created, we want to ensure that the benefits can be immediately and seamlessly enjoyed by all participants.
If you are an asset manager that invests in China, let us know what Access Scheme you prefer and why. What restrictions impede you the most? We’d love to hear from you. Drop us a line at firstname.lastname@example.org