Access to China's $16 trillion bond market might be made available

Index provider FTSE Russell is set to decide on whether to include Chinese government bonds in its World Government Bond Index on Thursday, potentially opening the way for more foreign participation in China's $16 trillion bond market.

Below is an introduction to the market for foreign investors.

How can foreigners buy Chinese bonds?

Foreign institutional investors can access the exchange bond and interbank markets, China's two main markets for bonds, through the dollar-denominated Qualified Foreign Institutional Investor (QFII) programme, and its yuan-denominated sibling, RQFII.

China scrapped quotas for QFII and RQFII in June, to give qualified foreign institutions unlimited access to Chinese stocks and bonds.

Some institutional investors, including foreign central banks and monetary authorities and sovereign wealth funds can register for direct access to the interbank market through China Interbank Market (CIBM) Direct.

Bond Connect, introduced in July 2017, allows quota-free access to the interbank market through its "northbound" channel through Hong Kong. China has not launched a "southbound" channel, which would allow Chinese investors to invest in offshore bonds.

What do foreign investors buy?

Foreign holdings are concentrated in the following:

- Chinese government bonds (CGBs) issued by the finance ministry. Foreigners held CGBs worth 1.6 trillion yuan ($236.13 billion) in August, 9.2% of the total. - Policy bank bonds, quasi-sovereign instruments issued by China Development Bank, Export-Import Bank of China and Agricultural Development Bank of China. Foreign holdings stood at 797.9 billion yuan in August, 4.6% of the total. - Negotiable certificates of deposit (NCDs), a short-term interbank debt instrument with tenors of up to one year. Foreign holdings were 210.2 billion yuan in August.

- Medium-term notes, a corporate debt instrument. Foreign holdings were 89.4 billion yuan in August.

Who regulates the Chinese bond market?

The National Association of Financial Market Institutional Investors (NAFMII) regulates the interbank market, under the auspices of the People's Bank of China, with trading conducted through the China Foreign Exchange Trade System (CFETS).

The National Development and Reform Commission (NDRC), China's state planner, regulates enterprise bonds, a corporate debt instrument.

China Central Depository and Clearing Co (CCDC) and the Shanghai Clearing House are the central depositories.

The exchange bond market is regulated by the China Securities Regulatory Commission (CSRC). Trading primarily takes place on the Shanghai and Shenzhen stock exchanges, with China Securities Depository and Clearing Co as the central depository.

What problems do foreign investors still face?

Investors say China lags far behind its developed-market peers in liquidity, ease of trading and market access.

Liquidity remains low as China's banks, pension funds, insurance companies hold on to their inventory because they cannot engage in bond lending, said Eugenie Shen, managing director and head of ASIFMA's Asset Management Group.

Foreign investors have few hedging tools, such as access to bond futures, she said.

China's practice of charging trading fees separately, rather than building them into the spread, has been problematic for asset managers, but Shen said she expects to see progress on conforming to global practice this year.