Foreign investors dream of a world with China bond futures

By BLOOMBERG

SINGAPORE • Foreign fund managers are pretty clear about what they want now that China’s bonds are joining a key global index: A better way to manage risk.

While hedging products like interest rate swaps are available to some overseas firms through the onshore interbank market, most instruments either aren’t accessible to foreigners or are rarely traded.

The dearth of hedging tools is a deterrent for many global pension funds, insurers or banks that need them to manage risk when they take positions.

Some US$100 billion (RM414 billion) is expected to flow into the world’s third-largest bond market in the year after China’s sovereign and policy-bank notes joined the Bloomberg Barclays Global Aggregate Index. Most onshore bonds are currently bought and held by banks, rather than traded in a liquid secondary market. Developing a better hedging market onshore is one way of addressing that issue.

Opening access to the existing onshore government bond futures market would be ideal, fund managers said, though it’s unclear whether they’ll get their wish any time soon.

Contracts on five-year and 10-year sovereign notes are among the most liquid hedges, with 910 billion yuan (RM564.2 billion) traded in March.

Bond futures were launched less than six years ago and remain unavailable to foreign investors and domestic commercial banks. Trading is limited to securities firms and futures companies.

The yield on China’s 10-year government bond was little changed at 3.39%, near the highest level since November, after first-quarter economic data exceeded analyst estimates.

Here’s what fund managers say they need to manage risk as they buy China’s bonds:

1) AMP Capital Investors Ltd(Nader Naeimi). There are challenges like the lack of liquidity and lack of a liquid derivatives market; the lack of hedging ability makes it hard for us to allocate significantly. The toolkit to manage interest rate risks is also limited: As a start for a macro investor, futures will be the most useful tool. Onshore is preferred, but Hong Kong Exchanges and Clearing Ltd will be a good start, as long as they track the onshore bonds.

2) Fuh Hwa Securities Investment Trust Co Ltd (Huang Yuanchun). The main demand for hedging tools will come from actively managed funds. Overseas institutional investors definitely want to participate in the bond futures market to actively manage interest rate risks. For overseas investors, it’s just not as convenient as hedging risks with bond futures would be.

3) China Securities (International) Brokerage Co Ltd (Gary Zhou). We would be more willing to participate in the onshore market if the access to products like derivatives and repos was liberalised. Trading the cash bond market itself has comparably low returns, and investors usually use leverage to increase yields; that’s not convenient without interest-rate swaps (IRS) to manage related risks. There’s still definitely a gap between non-deliverable IRS available in Hong Kong and interest rate hedging products in the domestic market; the participants, price trends and volatility are all different. — Bloomberg