Bloomberg Begins Adding China Bonds to Its Global Index

Bloomberg began adding yuan-denominated Chinese government and policy bank bonds to its Bloomberg Barclays Global Aggregate Bond Index on Monday.

The addition will further open China’s debt market to international investors with money in investments that track the index.

Over the next 20 months, 364 bonds will be added to the index, according to Bloomberg. That could end up steering about $120 billion into China’s onshore bond market, said Liu Linan, a Hong Kong-based China strategist at Deutsche Bank AG.

The bonds to be included in the index will be limited to Chinese government bonds and policy bank bonds issued by the Ministry of Finance, the China Development Bank, the Agricultural Development Bank of China and the Export-Import Bank of China. After these bonds are added to the index, they will account for about 6% of the $54 trillion of assets tracked by the index, according to Bloomberg.

Many foreign institutional investors — mostly passive funds and large firms — have been laying out plans to invest in these bonds since Bloomberg announced the inclusion in late January, a source from a domestic bank who acts as a proxy for foreign investors told Caixin.

In addition to bringing in more capital, the inclusion also marks a significant step in advancing reform of the country’s financial markets.

Many foreign institutions have also been concerned about the thin liquidity of China’s bond market, said Eric Liu, a fund manager of BlackRock Inc. One of the solutions is to set up a well-built market-maker system to provide sufficient liquidity.

Some institutional investors have pointed out that although market making has been widely implemented internationally, it isn’t well-developed in China. Market makers are participants in quote-driven financial instrument trading environments, fulfilling the function of providing purchase and sale solutions for investors to keep financial markets liquid.

Another factor that has held back overseas investors in China’s bond market is how inconvenient it is to hedge risks. The mechanism for hedging foreign-exchange risks, for example, needs to be improved, the BlackRock manager said.

Also, the inclusion of yuan bonds will also have a long-term benefit. In the next five years, the Chinese onshore bond market, the world’s third-largest by assets behind those of the U.S. and Japan, could likely see inflows of about $750 billion to $850 billion, with overseas investors holding 5.5% to 6% of all the onshore bonds by value, said Liu from Deutsche Bank.

Overseas holdings of yuan-denominated onshore bonds have totaled more than 1.7 trillion yuan in recent months, accounting for around 2% of these bonds, according to data from the central bank.

“Currently, international investors mainly hold (Chinese) treasuries and policy bank bonds because they are concerned about corporate disclosure, governance quality and secondary market liquidity,” said Ivan Chung, associate managing director at Moody’s Investors Service, adding that recent Chinese corporate debt defaults have further dampened investor sentiment.

Contact reporter Timmy Shen (hongmingshen@caixin.com)