Despite a challenging backdrop, 2021 was a landmark year for the internationalization of China’s financial markets. The ongoing disruptions caused by the pandemic have done nothing to slow the integration of the Chinese mainland with global markets. With the year ended, now it is the right time to assess how much has been achieved over the last 12 months.
Improved access channels
In terms of access channels, the standout event was the launch of the Bond Connect program’s southbound leg in September, which created a convenient route for investors on the mainland to gain exposure to international bonds via Hong Kong.
Why is it happening now? Chinese domestic savings have reached a scale where it makes sense for investors to diversify both risks and returns. The local institutional investor community managed assets worth approximately $16 trillion at the end of 2019. It is only natural that they broaden their portfolios by allocating capital to offshore assets.
At the same time, the Chinese central bank and other regulators are also confident that local investors are ready to take advantage of the opportunities that the southbound link provides, while the market infrastructure is robust enough to support them.
Although we expect onshore investors to take a steady approach to offshore markets, the southbound channel is the start of a journey that will lead to Chinese institutions becoming active participants in international bond markets, alongside investors from other major economies. They will bring their own market preferences and trading style, which the global financial services industry will have to cater to.
Read more Six Things to Know About China’s ‘Southbound Bond Connect’ Program
Beyond the southbound launch, the other major development for access channels relates to the oldest route for foreign investors to enter China’s onshore capital market. At the end of 2020, regulators combined the Qualified Foreign Institutional Investor (QFII) program with its renminbi sister scheme RQFII, streamlining the application process. As a result, the number of QFII licenses grew by 110 in the first 11 months of 2021, bringing the total to 663.
The impact of index inclusion
Beyond improvements to market access, there have also been structural changes that make China an important destination for international capital. The most significant is the ongoing inclusion of Chinese bonds in global indexes. Index provider FTSE Russell recently started to add Chinese government bonds (CGBs) to its World Government Bond Index.
This flagship index is tracked by funds managing as much as $3 trillion, typically passive funds, and FTSE Russell predicts that the 36-month inclusion will result in $130 billion to $158 billion in funds heading into CGBs. Add this to money allocated due to earlier inclusions — such as the Bloomberg Barclays Global Aggregate Index — and foreign investors look set to become significant holders of CGBs.
In addition to index inclusion, there are tax incentives to invest in China. In late 2021, the government extended preferential tax policies for overseas institutions that invest in the onshore bond market. In place until the end of 2025, the exemption means that foreign institutions do not have to pay corporate income tax or value-added tax on interest income from their bond investments on the mainland.
Read more
Overseas Investors in Chinese Bonds Get Four More Years of Tax Breaks
The implications of a growing presence of offshore capital in China’s onshore market are manifold, as overseas investors tend to be more active traders than their local counterparts.
Once again, there will be a learning curve as Chinese financial institutions will need to adapt their offering for a growing number of foreign investors. Another upshot of having more active traders is that there will be greater liquidity in the market for all investors, making it easier to complete larger trades without negatively impacting the price.
More reform to come in 2022?
Taken together, these developments have made China’s financial markets more connected and accessible than ever before. Onshore investors will benefit from greater liquidity and diversification into international assets, while global investors have more options to allocate capital into the world’s second-largest economy. The regulators have made significant achievements over the last 12 months, and if they hold to the same course, we expect that 2022 will be another important year for market reform.
James Sun is Tradeweb Markets Inc.’s head of Asia.
The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.
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Contact editor Lin Jinbing (jinbinglin@caixin.com)
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