China-Hong Kong bond connect: not what is seems but rather a second attempt to attract foreign investors
China has stepped up the effort to attract capital inflows since 2015, but the result is hardly very successful. Only 2% of onshore bonds are held by foreign investors and there is virtually no increase since the further opening. And here comes the second attempt to attract capital inflows. Although not much detail has been unveiled yet, there is enough to confirm that this is another entry door (but not exit) to China’s fixed income market.
The announcement makes it very clear that only the Northbound connect (from Hong Kong to China) will be opened for the time being. Furthermore, no quota will be applied – same as the current access to the interbank market – although only institutional investors can access. Furthermore, the exchange market is not included and there is nothing new in terms of the available bonds.
At first instance, it seems there is no material difference between the current system and the new Bond Connect. There is, of course, a very good reason to bother, which is China’s need to attract inflows, still today. This is why Chinese authorities are still very keen on finding stable sources of capital. This second attempt, through Hong Kong, may look similar but has a key differentiating feature. Investors deal with Hong Kong authorities, and there could additional incentives which may still be introduced as the preliminary date of opening of the Bond Connect is around July 2017.
In a nutshell, Hong Kong may again prove useful for China to achieve its goals. The establishment of Bond Connect – especially if enough incentives are put on the table – could help China attracting the much needed capital inflows and Hong Kong strengthening the existing role as port into and out of China’s financial markets. However, it is hard to say whether the strategy will be successful as it will very much hinge on the details and, in particular, how quick and easy it is for investors to undo their positions. The relevant implications will not only be on China’s portfolio flows, but also for Hong Kong as the financial centre, in terms of opportunities and risks. China’s USD 9 trillion bond market looks massive for Hong Kong to intermediate in the case of a successful outcome.