Policymakers debuted China’s Bond Connect plan in July last year. Although they are still in the early stages of putting the systems and structures in place to make it an easy-to-use investor platform, the implementation of this programme is one area worth watching closely.
Chinese policymakers signal the opening up of the bond market to foreign investors and the removal of barriers to entry, which will play a major role when it comes to index inclusion. We think with Bond Connect it’s a matter of when, not if, Chinese bonds are included in the big bond indices that global investors follow. This will lead to a significant change in investor behaviour and in the Asian bond markets.
Three of the biggest benchmarks that global investors look at are Citigroup’s World Government Bond Index (WGBI), Bloomberg Barclays Global Aggregate Bond Index and J.P. Morgan’s Emerging Market Global Diversified Government Bond Index. When Chinese bonds start to be included in these three indices, we estimate it could lead to between $300 billion and $500 billion of inflows into Chinese bond markets and have a significant impact on both overseas investors and the Chinese bond market.
Global Investors Will Get a Access to the Market
Bond Connect is uniquely important because it is a platform that is going to help open up the onshore Chinese bond market to global investors.
Looking ahead, we believe this could lead to a significant structural change in the Chinese financial system. When large companies fund themselves today in China, it usually involves going to a bank and taking out a loan that sits on the bank’s balance sheet. Small and medium-sized companies, though, often struggle to get bank loans and have to find other ways to raise money, for example from trust companies and rural banks.
When the bond market starts to open up and we start to see more demand from investors not only in China but also from overseas, we could see a lot of small and medium-sized companies shifting their funding away from trust companies and rural banks and into the bond market. This will lead to a lot more market-based pricing of risk for Chinese debt and will free up a lot of capacity of the banks to fund other companies in the economy.
This market-based pricing of risk is an area of interest for investors for some time. It helps them understand risks and rewards in a company’s financials, business model and trajectory over the coming years. From a credit perspective, the Chinese market has traditionally come up short in this area.
What Impact Will the Open Market Have on Investors?
With the opening of the market, Chinese policymakers will allow an orderly introduction of market-based credit risk, letting defaults happen, which has not historically been the case, and investors will know that if they invest in a low-priced company that they may suffer a loss and should adjust their pricing expectations accordingly. All this should create a more liquid, efficient and accurately priced market.
It is also going to add one more funding channel for companies in China to help shore up liquidity. Thus, it is hard to underestimate the impact of the Bond Connect programme with the far-reaching consequences it could have and the potential sea change that it could bring to China’s financial system.
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