- The Hong Kong Monetary Authority has added bonds issued by the Chinese government and policy banks as eligible collateral for its yuan liquidity facility
- The next big impending change is letting more foreign investors into China’s onshore repo market
The People’s Bank of China (PBOC) and the Hong Kong Monetary Authority (HKMA) announced several policy steps to deepen two-way financial cooperation. Two of these measures specifically focus on strengthening the bond market, the biggest outside the US.
One pertains to expanding the list of eligible collateral in the RMB Liquidity Facility in Hong Kong to include yuan-denominated bonds sold by the Chinese government and the nation’s policy banks. The second involves wider access to the onshore repurchase agreement or repo market, pending legal and regulatory fine-tuning.
South China Morning Post (SCMP) talked to a senior HKMA official, investment bankers and analysts to highlight the importance of these impending changes and concerns among the industry players.
Expert commentary highlights:
Initial market reaction has generally been positive, according to Kenneth Hui, an executive director at the HKMA. Adding Chinese government bonds and policy bank bonds marks the first time these yuan-denominated securities have been formally recognized as eligible collateral in the offshore market, he added.
Transactions were completed on February 26 making use of expanded eligible collateral, the HKMA said, and the Facility continues to operate in an orderly manner. The PBOC and HKMA initiatives could facilitate the diverse use of Chinese bonds held by Bond Connect investors, such as bridging intraday funding gaps, according to Hui.
“The gradual opening up of the onshore repo market will address offshore market players’ growing need for funding and liquidity management as they increase their allocation to the onshore bond market,” he told SCMP. “This initiative will, for the first time, enable more foreign investors (including Bond Connect investors) to conduct onshore repo transactions to obtain liquidity at a lower cost.”
“If offshore [market] starts being very dependent on the repo market, then [China’s] monetary policy will reach offshore effectively,” said Lillian Tao, head of China macro and global emerging-market sales at Deutsche Bank, speaking to SCMP. “When they cut rates, or reserve ratio for example, those liquidity signals will be received by the offshore stronger than before.”
She added: “The PBOC started allowing the yuan-participating banks into the repo market because banks have liquidity management needs. Now, it will roll out to all investors: asset managers, life insurers, pension funds, sovereign firms and hedge funds.”
The implications of China widening its repo market to all offshore institutional investors will be viewed “as the last mile in a country’s capital account liberalization,” said Ju Wang, head of Greater China foreign-exchange and rates strategy at BNP Paribas, to SCMP.
The existing pain point in the industry is around the limited offshore yuan (CNH) funding, according to Deutsche Bank’s Tao. The shorter-maturity CNH funding is mainly supported by the currency swap market from participating banks with access to the onshore yuan funding pool.
On the downside, China will be conflicted by its goal of maintaining a stable yuan while pushing for its greater use globally, BNP Paribas’s Wang said. This is likely to take years to resolve, especially in the face of global supply-chain upheavals. Hence, much of the tonic is diluted by policy constraints.
Wang also highlighted the cost of using the HKMA’s RMB Liquidity Facility, currently pegged to CNH Hibor rates that are higher than onshore interest rates. This pricing structure reduces its appeal, making it more useful in emergency liquidity situations, rather than for daily operations, she said.
Andrew Fei, a partner at law firm King & Wood Mallesons, noted that: “One key issue is whether offshore investors can use internationally recognized master agreements to document their repo transactions in the onshore market. Some foreign investors may not be familiar with existing Chinese-language onshore master repo agreements, while many are seeking advice on the enforceability of “close-out netting” for repos in the onshore market. The PBOC and HKMA will also need to clarify how Bond Connect investors can access the onshore bond repo market.
The inclusion of Chinese government bonds and policy bank bonds as eligible collateral is a step forward in promoting them in the international markets and strengthening Hong Kong’s unique role in connecting mainland China and global markets through the Connect schemes, HKMA’s Hui said: “We will continue to explore more use cases, for instance, the use of onshore bonds as margin in transactions under the northbound trading of Swap Connect and as margin in offshore treasury bond futures trading.