Oct 12, 2021 08:16 PM

Six Things to Know About China’s ‘Southbound Bond Connect’ Program

Hong Kong Monetary Authority Chief Executive Eddie Yue introduces the Southbound Bond Connect program at a press conference in Hong Kong on Sept. 15. Photo: VCG
Hong Kong Monetary Authority Chief Executive Eddie Yue introduces the Southbound Bond Connect program at a press conference in Hong Kong on Sept. 15. Photo: VCG

More than four years after China launched the northbound channel of a bond connect program that allows overseas investors to trade bonds on the Chinese mainland through Hong Kong, the southbound leg was finally launched on Sept. 24.

On the first day of trading, more than 150 deals were made via the Southbound Bond Connect between more than 40 mainland institutional investors and 11 Hong Kong market makers. The transactions covered almost all major types of bonds on the Hong Kong market, with a total volume of about 4 billion yuan ($620 million).

The launch of the southbound leg finally completes the two-way program. It is expected to broaden the types of investment alternatives available to mainlanders, further inject mainland capital into Hong Kong and attract more companies to issue bonds in the Asian financial hub.

Here are six things to know about the Southbound Bond Connect program.

1. What is the Southbound Bond Connect program?

“The Southbound Bond Connect is an arrangement that will enable mainland institutional investors to invest in the Hong Kong bond market through a connection between the mainland and Hong Kong financial infrastructure services institutions,” according to a joint announcement from the People’s Bank of China (PBOC) and the Hong Kong Monetary Authority (HKMA) released on Sept. 15.

It is essentially the southbound leg of the overarching Bond Connect program, a reciprocal market access scheme launched in July 2017 that allows investors on the mainland and in Hong Kong mutual access to their respective bond markets via financial institutions in both locations.

This was not the first such scheme linking China’s financial markets. Nearly seven years ago, the Shanghai-Hong Kong Stock Connect was launched, establishing a cross-border investment channel between the bourses in the financial hubs. The scheme gives both onshore and offshore investors reciprocal access to their respective stock markets and at the time was widely recognized as a milestone in the opening-up of China’s domestic financial markets to the rest of the world. In December 2016, the Shenzhen-Hong Kong Stock Connect was also launched.

The launch of the Bond Connect program in its entirety is seen as a further step in Beijing’s efforts to continue opening up its domestic financial markets. Indeed, Cheng Hao, a fixed-income fund manager at Fidelity International, said the scheme will help domestic investors better allocate funds for offshore bonds.

2. Who is eligible to trade via the Southbound Bond Connect program?

Participation in the southbound channel is limited to just a few categories of investors during the initial stages. According to an official announcement (link in Chinese) from the PBOC, altogether 41 banks have been given permission to take part: two policy banks, the “Big Six” state-owned banks, 12 joint-stock commercial banks, 17 city commercial banks, and four China subsidiaries of overseas banks.

In addition, investors in the Qualified Domestic Institutional Investor (QDII) program and its yuan-denominated sibling, the RMB Qualified Domestic Institutional Investor (RQDII) program, are also permitted to participate. They include smaller banks, securities firms, insurance companies and fund managers.

The HKMA, meanwhile, has designated 13 financial institutions as market makers for the scheme.

3. What types of bonds are likely to be the most popular under the program?

Hong Kong is Asia’s largest market for international bonds, with U.S. dollar-denominated bonds dominating the region. A report from the International Capital Market Association shows that in terms of value, 84% of all international bonds issued in Asia in 2020 were denominated in U.S. dollars. Those denominated in Hong Kong dollars and the yuan accounted only for 1.5% and 1.3%, respectively.

The rules for the Southbound Bond Connect, however, appear to favor offshore bonds denominated in Hong Kong dollars and the yuan — the latter are also known as dim sum bonds if they are issued in Hong Kong — as opposed to U.S. dollars. This is because mainland-based investors who deposit their bonds with the Shanghai Clearing House (SCH) can only make payments for their trades via a system called the Cross-Border Interbank Payments System (CIPS).

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At the moment, only transactions in Hong Kong dollars and the yuan are allowed on the CIPS, thus limiting investors to trading offshore bonds denominated in these currencies if they use the SCH as their depository institution.

Some analysts, therefore, predict that dim sum bonds and Hong Kong dollar bonds will see a surge in the near term, alongside a continued recovery in offshore yuan-denominated bonds seen this year.

Total issuance of offshore yuan-denominated bonds in the first seven months of 2021 amounted to 172 billion yuan, nearing the record reached in 2014, according to a report from Standard Chartered PLC.

Foreign financial institutions were revealed to be the primary issuers of offshore yuan bonds, according to the Standard Chartered report. Moreover, Hong Kong enterprises were the second-largest driver of growth in these bonds so far in 2021.

Likewise, most issuers of Hong Kong dollar-denominated bonds are viewed as high-quality, such as forex funds, statutory bodies, government-owned enterprises, multilateral development banks, and so on.

Yang Jiewen, director of RMB business at the Economics & Strategic Planning Department of Bank of China (Hong Kong) Ltd., believes that more institutions and businesses will issue bonds in Hong Kong now that the Southbound Bond Connect has been officially launched. “Investment is a process of interactions,” he said, adding that more investors will lead to more bond issuances in Hong Kong, including both dim sum bonds and Hong Kong dollar bonds.

4. What are the main rules and regulations governing the Southbound Bond Connect?

In terms of custodians, mainland-based investors can deposit their bonds with either the SCH, or with one of the three appointed domestic banks: Industrial and Commercial Bank of China Ltd., Bank of China Ltd. and China Citic Bank Co. Ltd.

Those who opt for the SCH need to trade via a domestic platform called the China Foreign Exchange Trade System (CFETS) and can only make payments via the CIPS. As a result, for the reasons mentioned above, they can only invest in dim sum bonds or Hong Kong dollar bonds in the offshore market. Due to regulatory reasons, investors in the QDII and RQDII programs are not allowed to join the scheme via this route.

Those who opt to deposit their bonds with one of the three banks, however, are able to trade via both the CFETS and systems provided by Bloomberg or Tradeweb. They are also allowed to trade all types of bonds that are available on Hong Kong’s market, including U.S. dollar-denominated bonds. This is also open to those who are in the QDII or RQDII programs.

On capital limits (link in Chinese), net capital flows from the mainland to Hong Kong is subject to a daily cap of 20 billion yuan, as well as an annual limit of 500 billion yuan. E Zhihuan, chief economist of Bank of China (Hong Kong), noted that the 500 billion yuan limit is equivalent to about 2.4% of China’s current foreign exchange reserves, so it’s not an insignificant amount.

She expects between 200 billion yuan and 300 billion yuan in net capital outflows from the mainland in the first year after the launch of the Southbound Bond Connect.

The funds, whether they are in the yuan or foreign currencies, once approved, must be managed in a closed-loop manner and they can only be used for trading bonds. If investors decide to quit the Southbound Bond Connect after they have closed all their positions or after their holdings have reached maturity, the capital from the trades should be wired back to the mainland.

5. Which financial institutions will show the greatest interest?

In theory, almost all mainland-based financial institutions can go abroad to trade and allocate overseas bonds now. Through their overseas branches they can work with global depository platforms such as Euroclear or Clearstream to trade international bonds on the global market. Indeed, the rules for the Southbound Bond Connect don’t necessarily make cross-border bond trades easier for domestic institutions. So who will be more likely to take part in and make better use of the scheme?

The answer is small or midsize banks, which, in practice, are not eligible to open depository accounts directly with Euroclear or Clearstream. “The Southbound Bond Connect provides them with the convenience of opening accounts with the SCH,” said Wang Long, an expert on U.S. dollar bonds from Chinese issuers.

A banker who is involved in the Southbound Bond Connect program told Caixin that the scheme should also be attractive to small or midsize banks that don’t have a way to directly invest abroad.

6. What should we expect from the Southbound Bond Connect in the long term?

Since the annual limit of 500 billion yuan for the Southbound Bond Connect is equivalent to a large proportion of the QDII program quota, which stands at $180 billion, it’s likely that the scheme will become the second-largest channel for investing abroad in about two years, second only to the Shanghai and Shenzhen stock connect programs with Hong Kong.

Several industry insiders who spoke to Caixin estimated that the annual capital limits on the Southbound Bond Connect will eventually be scrapped, just like those on the stock connect channels. Liu Jie, head of China macro strategy at Standard Chartered, said the Southbound Bond Connect will ultimately replace some of the existing channels for investing abroad due to its greater flexibility, lower costs and higher capital limits.

E Zhihuan of Bank of China (Hong Kong) predicts that in the early stages of the Southbound Bond Connect, domestic investors will likely prefer to trade dim sum bonds or U.S. dollar bonds issued by Chinese institutions with higher ratings. As they gain more experience and enhance their risk management, they might be tempted to add more types of bonds to their portfolios.

Overall, the Southbound Bond Connect will help drive down the offshore financing costs for Chinese enterprises, thus reducing the spread between onshore and offshore bonds in the long run, E said.

Wei Yiyang contributed to this article.

Contact editor Lin Jinbing (

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