The Sleeping Dragon Opens Her Doors For Business
In China, change has slowly taken place in many ways over many years. But the current pace of change in Chinese capital markets seems greater than ever.
It’s no longer true to say that Asian capital markets begin and end in Hong Kong. Hong Kong is now the starting point. Thanks to changes in legislation enacted by the People’s Bank of China, mainland China is open to foreign investment. For the first time in history, Chinese equity and fixed income markets are welcoming money from overseas.
Isolationist China has remained resolutely outside global markets and regulation for many years, concerned what effect expansion and an open-border policy would have on the strength of its currency, national identity and morale. Restrictions on money flowing in and out of China have remained tight, with the Communist government keen to keep money generated inside its borders, inside its borders.
But over the past few years, this attitude changed, led by the government’s want for the Yuan to play a wider role in the world. Given the astonishing growth that its infrastructure-led economy has enjoyed, the US, Europe, and the rest of the developed world have repeatedly knocked at the Chinese door, wanting access to trade the world’s second-largest economy. At last, China is letting them in.
Last year, a scheme called Stocks Connect created an equity trading link between Shanghai and Hong Kong. Significantly, following strong initial demand, Chinese equities won inclusion onto an international stocks benchmark — MSCI’s Emerging Markets Index. It was a statement of intent: China was open to the world. And the world was keen to participate. Equity markets led. Fixed income markets followed.
A month ago, Bond Connect opened China’s bond market, worth $9 trillion and the world’s third largest, to overseas institutions, allowing investment into government, agency and corporate debt without the need for an onshore account. At present, overseas investors own 2% of the market. This figure is set to rise dramatically.
Since launch, foreign institutions have taken up ¥1.5 billion of short-term corporate debt and another ¥2 billion of secondary transactions. Given an expected rise in issuance, analysts are predicting it won’t be long before China’s debt market races past Japan’s to become the second largest in the world.
Considering the strength of the Chinese economy – now the world’s second largest – and a strong currency – rallying in 2017 versus the dollar – Chinese yields are still offering investors a premium. A 10yr treasury yields about 3.5%, the highest among the world’s biggest economies, with the US 10yr yielding a paltry 2.3% in comparison. So another reason for optimism is the investment case.
A significant step will be the inclusion of Chinese debt on a global bond index. This move would divert hundreds of billions of dollars toward mainland Chinese markets. Only time – and market sentiment – will tell whether this next step occurs and how quickly. Like equities, demand exists and indices seem keen to satisfy.
So we can be confident that Bond Connect is a major step forward for an increasingly liberal China. But ‘liberal China’ remains a relative measure.
It’s worth noting that Bond Connect only permits ‘northbound’ trade, allowing foreign investors to buy Chinese debt. Chinese institutions still can’t invest overseas. A ‘southbound’ extension is under consideration, but it’s not imminent. Trading in both directions is required for full transparency and liquidity.
A further restriction limits overseas investment to institutions only, and rules out hedge funds. Again, transparency and liquidity in the market won’t be accomplished until a wider range of investors can trade. If China wants to truly offer its debt to the world, there’s still a way to go.
Away from Bond Connect, concerns remain about potential corruption in the Chinese market. Whilst heartening to see foreign money pouring into China… some still tread warily given potential problems trying to take that money back out.
However, considering how far China has come over the past decade, the fact that Stocks Connect and Bond Connect exist is hugely positive. Once rules and platforms are properly integrated, demand will rise. This will be good news for both sides of the market, with Chinese issuance likely to follow investor demand. This should push Chinese and global economies to higher heights.
Given these developments, at Origin we’re planning our first Asian roadshow this autumn, keen to explore what demand there is for our platform in these growing markets. It’s an exciting prospect, one that will be a significant step forward for us. With the Chinese dragon opening its doors, we’re hoping to be welcomed inside.