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China opens new channel giving foreign investors access to $4 trillion swap market

BEIJING – Global investors seeking to trade China’s reopening will have a new strategic tool from Monday: onshore interest-rate swaps that had an annual turnover of US$3 trillion (S$4 trillion) in 2022.

The so-called Swap Connect programme between mainland China and Hong Kong provides overseas funds with easier access to the derivatives that will help hedge their exposure to the world’s second-biggest bond market. The scheme also enables them to bet on key money-market rates that are sensitive to China’s monetary policy.

The new programme kicks off just as China’s sovereign bond market puts on a seven-week rally, with traders growing more confident the central bank will ease policy as an economic recovery stutters. The new channel also helps Beijing’s aim of opening up to more global investors after regulatory crackdowns, and rising geopolitical tensions fuelled concern over the nation’s investability even after it scrapped Covid-19 controls and re-opened its borders.

HSBC Holdings said it made Swap Connect trades for several overseas and Hong Kong clients on Monday including Dymon Asia and CSI Capital Management, according to an e-mailed statement.

China has set a 20 billion yuan (S$3.85 billion) daily limit for net trading under Swap Connect. HSBC, Citigroup and JPMorgan Chase & Co are among the 20 banks authorised to structure trades for foreign funds through Hong Kong.

The new programme – which follows Stock Connect started in 2014 and Bond Connect in 2017 – initially only works in the “Northbound” direction, allowing international and Hong Kong investors to access Chinese interest-rate swaps.

Bigger than bonds

“The market share of overseas investors in onshore IRS (interest rate swap) after Swap Connect starts will be bigger than the China bonds holding share for sure,” said Haoao Weng, head of rates trading for onshore China at BNP Paribas, also one of the authorised banks. “Offshore hedge funds are constrained by their balance sheet to participate in the bond market but the enthusiasm for them to participate in the rates derivatives market will be bigger than their appetite for the bonds.”

The new risk-hedging instrument is being introduced just as rising United States interest rates put foreign outflow pressure on China’s bond market, with overseas funds cutting their holdings by US$169 billion over the past five quarters. At the same time, global investors still own 10 times as many of the securities as they did a decade ago.

China currently allows some foreign investors access to onshore interest-rate swaps under the China Interbank Bond Market scheme, but Swap Connect will greatly broaden that ability through Hong Kong.

Swap Connect shows the high priority the People’s Bank of China gives to Hong Kong as a global financial hub and its support for the city’s long-term development and stability, PBOC deputy governor Pan Gongsheng said at a launch ceremony. The Hong Kong Monetary Authority will work with mainland authorities to provide more diversified risk management tools for international investors, according to a statement.

Long view

While Swap Connect may not be able to immediately reverse the recent bond sales by overseas investors, its advantages will become clearer over the longer term, said Hong Hao, chief economist at Grow Investment Group.

“The Chinese authorities hope to woo global investors into the onshore financial market, and Swap Connect is a step forward in that direction,” Mr Hong said. “Swap Connect alone might not be able to deter outflows in the short term, but we do think Chinese sovereign bonds will remain attractive to some foreign investors given their safety and stability.” BLOOMBERG