China opens southbound leg of Bond Connect, allowing mainland investors to trade offshore bonds via Hong Kong

Mainland China’s investors will be allowed to trade offshore bonds through an expansion of the Bond Connect scheme linking mainland and Hong Kong markets.

The so-called southbound leg of the Bond Connect will take effect from September 24, according to a joint announcement released by the People’s Bank of China and the Hong Kong Monetary Authority (HKMA).

“The launch of southbound trading of Bond Connect marks another milestone of mutual access between Hong Kong and mainland. The southbound trading will deepen the two-way opening up of the mainland financial markets and promote the vibrant development of the Hong Kong bond market and hence strengthen Hong Kong’s status as an international financial centre,” said Eddie Yue Wai-man, the CEO of HKMA.

The long-awaited move comes only a few days after the launch of the cross-border Wealth Management Connect scheme on September 10.

“Launching southbound trading under Bond Connect to complete the two-way connection of the bond markets will promote further mutual access between the two financial markets,” Hong Kong Chief Executive Carrie Lam Yuet-ngor said. The scheme will “reinforce Hong Kong‘s status as an international financial centre.”

The Bond Connect was first launched in July 2017 for overseas investors to buy China’s onshore bonds through Hong Kong. As many as 2,733 foreign institutional investors have been approved to use the northbound trading to access China’s $17.5 trillion bond market. Average daily trading turnover reached 26.5 billion yuan ($4.11 billion) in the first eight months of this year, according to the Hong Kong Exchanges and Clearing (HKEX).

“The launch of southbound trading will further underline the unique function of Hong Kong in connecting mainland capital and the wide range of products in the international market,” Financial Secretary Paul Chan Mo-po, said. “Not only would this enhance the attractiveness of Hong Kong as a bond issuing platform and the liquidity of the bond market in Hong Kong, but also further facilitate the progress of renminbi internationalisation.”

As the operator of Asia’s third-largest capital market, HKEX scrapped the trading and settlement fees of fixed-income index funds traded in Hong Kong on May 31 to boost the local bond market, in preparation for the expansion of the Bond Connect scheme.

The southbound Bond Connect is likely to begin by enabling offshore yuan-denominated debt, known as dim sum bonds, said market participants.

The issuance of dim sum bonds rose to 172 billion yuan in the first seven months of 2021, just shy of the 185 billion yuan record in the same period in 2014, according to research by Standard Chartered. Total outstanding dim sum bonds stood at 607 billion yuan at the end of July.

The launch of the southbound led came after successful development of the northbound trading in the past four years, which saw the number of overseas investors increase from 150 to now more than 2,700, while the average daily turnover has increased by 17 times, from 1.5 billion yuan per day in 2017 to 26 billion yuan a day now.

Unlike the northbound that has no quota, the southbound trading caps the daily net outflow at no more than 500 billion yuan per year and up to 20 billion yuan a day.

Only mainland institutional investors who have Qualified Domestic Institutional Investors (QDII) status or can invest through the yuan denominated QDII scheme can invest, according to Edmond Lau, HKMA’s deputy CEO. “These restrictions will ensure a stable launch of the new scheme,” he said.

The trading and settlement of the southbound route will be processed through the China Foreign Exchange Trade System and HKMA’s Central Moneymarkets Unit. The PBOC has appointed 41 banks, including the Chinese units of HSBC and Citibank, as well as mainland players such as ICBC and Postal Savings Bank of China to act as primary dealers to ensure liquidity.