China’s onshore capital markets have proven relatively resilient to the disruption caused by the Covid-19 pandemic. While China was not immune from the sell-off that tanked markets globally in March, foreign inflows into Chinese A-shares rebounded strongly, showing net buying of around $4 billion in the period from late March to mid-April, while yield differentials spurred record inbound foreign fund flows into Bond Connect of 478.2 billion yuan in the month of March.
While global uncertainty leaves the door open to further sell-offs to cover exposures elsewhere, the overall trend remains encouraging, with experts suggesting the Chinese onshore capital market is likely to continue attracting foreign funds, particularly with more global indices increasing China’s weighting in their equity and fixed income benchmarks.
“We have seen a lot more foreign investment activity in Chinese equities and fixed income recently. More and more institutions look at China as a long-term investment opportunity, something that has been amplified by the low interest rates everywhere else,” says Jason Lui, Head of East Asia Strategy and Head of APAC Equity Derivative Strategy at BNP Paribas. “The relatively robust trading operations during the global sell-off should enhance investors’ confidence in the Stock Connect and Bond Connect channels. In addition, recent index inclusions have helped facilitate greater investor flows into China,” he adds.
At the same time, schemes designed to promote investment into China such as Stock Connect, Bond Connect, the China Interbank Bond Market (CIBM) along with the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII), have simplified and changed processes to make it easier for international investors to participate in China’s onshore fixed income and equity markets.
Teething issues
While investors have welcomed moves like allowing CIBM investors to use onshore derivatives tools to hedge risk, Jacqueline Rong, Senior China Economist, Global Markets at BNP Paribas China concedes there are still some infrastructure issues impeding derivatives trading for foreign investors.While investors can make use of multiple channels in order to get the best solution, it requires a greater level of understanding of the different nuances before determining their investment approach.
Gary O’Brien, Head of Clearing and Custody Product, APAC at BNP Paribas Securities Services
“Access to the
repo market continues to be heavily restricted for certain types of bond
investors. This is a major hurdle for asset managers,” says Rong.
In addition, the
sheer number of access channels and conflicting rules around them can create
challenges for investors, says Gary O’Brien, Head of Clearing and Custody Product,
APAC at BNP Paribas Securities Services.
“Each of the
different schemes has their own unique requirements. For example, an investor
cannot use onshore CNY for hedging and funding via Stock Connect in the same
way they could if they went through QFII. Similarly, Bond Connect investors
cannot trade bond forwards repos, but in contrast organisations leveraging
onshore schemes can,” says O’Brien.
“While the
differences between the schemes can allow investors to make use of multiple
channels in order to get the best solution, it requires a greater level of
understanding of the different nuances before determining their investment
approach and an ongoing focus as schemes continue to evolve,” he adds.
Reform amid Covid-19
The intention, however, is clear and Chinese regulators have forged ahead with a slew of positive reforms. Rong points to the relaxation of foreign ownership restrictions on brokerage and securities businesses announced last October as another positive reform.
The Global Equity Segment (GES), also announced in October 2019, is expected to help the troubled London-Connect Scheme with Shanghai, providing investors with a mechanism to obtain exposure to depository receipts of actively-traded and highly-liquid US and Shanghai-listed securities on a venue operated by the London Stock Exchange. However, O’Brien concedes that Covid-19 has been a distraction for participants involved in London-Shanghai Stock Connect, adding that trading volumes are largely muted.
Other regulatory initiatives are also facing inevitable delays as a consequence of Covid-19. “The removal of the QFII/RQFII investment quotas and repatriation restrictions – which were announced in 2019 – have yet to be implemented. Similarly, the roll out of the Stock Connect Master SPSA (special segregated account) solution, which will allow for omnibus trading to take place, is being pushed back too. However, we expect this will be launched in May 2020,” explains O’Brien.
China 2020
With Bond Connect’s anniversary fast-approaching, a number of investors are agitating for further improvements to be made to the programme. These include access to third party onshore FX hedging and funding; the ability to use repos and bond futures; the introduction of longer trading hours to accommodate the US and European markets; and widening the scheme to incorporate more investors such as private banks. China’s willingness to address such concerns will prove crucial in upcoming decisions from other index providers to include Chinese bonds in their global indices, potentially spurring even more foreign inflows.