China to start Swap Connect with HK in 6 months

CHINA will allow international investors to access its interest-rate derivatives market through Hong Kong, bolstering the city’s status as a financial gateway to Asia’s largest economy while giving foreign funds a new tool to hedge their holdings of Chinese bonds.

The so-called ‘Swap Connect’ will start in six months, pending regulatory approvals, market readiness and the completion of operational arrangements, according to a joint statement by the People’s Bank of China and Hong Kong authorities. It will help investors manage risks for bond investments on the mainland, according to the Hong Kong Monetary Authority.

“By allowing more risk management tools, it makes onshore bonds more attractive to hold,” said Alvin T. Tan, head of Asia FX strategy at RBC in Singapore, “Building up this capability is very important to increase the attractiveness of Chinese fixed income securities.”

The new facility reinforces Hong Kong’s role as a portal to China’s markets, coming after President Xi Jinping visited on Friday to mark 25 years of Chinese rule. The city is also working to introduce quarantine-free travel for Chinese travelers, its chief executive said yesterday, even as the business community calls for broader relaxation of rules that has hurt its hub status.

Overseas investors ramped up their China bond holdings to 4 trillion yuan (US$598 billion) as of end-2021 – about 3.5% of the total outstanding – while total trading volume in onshore interest rate swaps was 21 trillion yuan last year, according to the PBOC.

Offshore traders will find a more accurate tool to hedge investments – one which aligns with currency exposure and onshore repo rates – than the non-deliverable interest-rate swaps they currently use, said Ken Cheung, chief Asia FX strategist at Mizuho Bank.

Only northbound trading will be permitted at the initial stage, which means foreign investors can trade onshore interest-rate swaps but not the other way around. Southbound trading, which enables mainland investors to trade offshore contracts, will be explored in due course.

Other derivatives can also be included as part of the arrangement depending on market conditions, according to the statement. China will also raise its currency swap with Hong Kong to 800 billion yuan from 500 billion yuan, the PBOC said in another announcement.

Meanwhile, more than 80 exchange-traded funds listed in Shenzhen and Shanghai are eligible to be traded by Hong Kong investors starting from Monday, while four Hong Kong ETFs are eligible to be traded by those in China.

“From a global asset allocation perspective, the connect programs have made the Chinese market more investable,” said Xu Meng, executive director of quantitative investing at China Asset Management Co. “These will enhance the attractiveness of Chinese assets.” – Bloomberg