By Stanley Zhou(partner)Minny Siu(partner)Janet Gu(consultant)
China’s bond market is the world’s third largest bond market in the world in terms of trading volume. China has two main bond markets: the inter-bank bond market (“Inter-bank Bond Market”), which is primarily regulated by the People’s Bank of China (“PBOC”) and an exchange-based bond market (“Exchange Bond Market”), which is primarily regulated by the China Securities Regulatory Commission. The Inter-bank Bond Market accounts for almost 95% of the total trading volume in China’s bond market. This regulatory update will review at how efforts have been made in the past to gradually open up the Inter-bank Bond Market to foreign investors, as well as some of the latest development in this market.
Process of Opening-up
Efforts have been made to open up the Inter-bank Bond Market to foreign investors since 2005. Some of the key milestone events include:
In 2005, Pan Asia Fund and Asia Debt China Fund were granted approvals by the PBOC to invest in the Inter-bank Bond Market. This was the first time in which foreign institutions were allowed to access the Inter-bank Bond Market.
On 16 August 2010, the PBOC promulgated the PBOC Circular on Certain Issues Concerning the Pilot Program on Three Types Institutions Including Offshore RMB Settlement Banks Making RMB Investment into the Inter-bank Bond Market (the “Circular 2010”). Pursuant to the Circular 2010, “offshore financial institutions” (namely (i) foreign central banks or monetary authorities, (ii) RMB settlement banks in Hong Kong or Macau; and (iii) cross border RMB settlement participating banks in Hong Kong or Macau) were allowed to use RMB invest in the Inter-bank Bond Market, provided that they have obtained prior approval from the PBOC and invest within the quota approved by the PBOC. Amongst the three types of offshore financial institutions, types (i) and (ii) had the option of either appointing an onshore agent to conduct trade and settlement or make an application to open its own bond account, whereas type (iii) must appoint onshore entities to conduct trades and settlement.
Thereafter, RMB settlement banks or cross border RMB settlement participating banks from other parts of the world were also granted approval to invest in the Inter-bank Bond Market.
On 10 March, 2013, the PBOC promulgated the Notice on Certain Issues Regarding QFII Making RMB Investment into the Inter-bank Bond Market, pursuant to which qualified foreign institutional investors (“QFIIs”) approved by the CSRC were permitted, with the PBOC’s approval, to invest in the Inter-bank Bond Market within the approved quota. Thereafter, Renminbi qualified foreign institutional investors (“RQFIIs”) were also allowed to invest in the Inter-Bank Bond Market.
On 14 July, 2015, the PBOC promulgated the PBOC Circular on Certain Issues Concerning Foreign Central Banks, International Financial Institutions and Sovereign Funds Making RMB Investment into the Inter-bank Bond Market (the “Circular 2015”). Pursuant to Circular 2015, these three types of entities were allowed, upon registration with the PBOC, to engage in bond trading, bond repurchase, bond lending, bond futures, interest rate swap and other trades permitted by PBOC, without PBOC approval or any quota restrictions.
On 17 February, 2016, the PBOC promulgated the Announcement of 2016 No. 3 which further relaxed the rules applicable to foreign institutional investor accessing the Inter-bank Bond Market. The Announcement of 2016 No. 3 will replace all existing rules (except Circular 2015) to the extent that they contravene provisions of the Announcement of 2016 No. 3.
1. Which entities will benefit from the Announcement 2016 No. 3 of 2016?
- Financial institutions such as commercial banks, insurance companies, securities companies, fund management companies or asset management companies incorporated outside of mainland China
- Investment products lawfully sold by the above-mentioned financial institutions to their clients
- Medium and long term institutional investors recognized by the PBOC including senior funds, charity funds and donation funds
- QFIIs and RQFIIs
- Institutional investors based in Hong Kong, Macau and Taiwan
2. What are the eligibility requirements for these entities?
- They are legally incorporated in accordance with the laws of its country or region
- Sound corporate governance without being subject to any material punishment by regulators in the past three years caused by bond investments
- Funds source comply with all legal and regulatory requirements
- Has a good understanding of risks associated with bond investment and has the ability to identify and bear such risks
3. Who will determine the eligibility of an entity?
- An entity’s eligibility will be determined by onshore settlement agents and such onshore settlement agents will only be eligible to act as the settlement agents for entities whom they determined to be eligible
4. What approval or filing is required for these entities to trade in the Inter-bank Bond Market?
- No prior approval is required for the above mentioned foreign institutional investors to access the Inter-bank Bond Market
- Onshore settlement agent appointed by foreign institutional investors for trading and settlement purposes are required to submit an investment filing with the PBOC Shanghai branch on behalf of such foreign institutional investors
5. What are the key pre-conditions for trading in the Inter-bank Bond Market?
- Settlement agent to vet the qualifications
- Settlement agent to complete investment filing with PBOC Shanghai branch
- Opening of accounts (such as an RMB account and bond trading account) with the assistance of settlement agents
6. What are the methods of trade and settlement?
- Unless otherwise provided by PBOC, trade and settlement of bonds shall be conducted through qualified onshore settlement agent
- Subject to clarification by PBOC, we understand that foreign central banks or monetary authorities will still be permitted to trade through its own bond account
7. What are the types of products that can be traded?
- We understand any products available on the Inter-bond Market can be traded
8. What types of services will settlement agents provide?
- Procure investment filing on behalf of foreign institutional investors
- Assist with the opening, amendment and cancellation of accounts
- Conduct trades and settlements in accordance with the instruction given by foreign institutional investors
- Assist with the repayment of principals and coupons of the bonds
9. Under what circumstances will an entity be prohibited from further access to the Inter-bank Bond Market?
- If such entity is subject to dissolution, winding up, revocation or bankruptcy
- Expiry of term of investment products
- Other circumstances provided by the PBOC
The two ground-breaking features of the Announcement 2016 No. 3 of 2016 are the removal of prior approval and quota requirements for all participants. This significantly simplifies the administrative burden and will no doubt attract more qualified foreign investors (particularly medium and long term investors) to invest in the Inter-bank Bond Market in the future.
From China’s perspective, the ability to attract more qualified foreign investors to invest in its Inter-bank Bond Market will undoubtedly facilitate the healthy development of China’s bond market, and also serves as an effective way of reducing the risks in the banking sector. Given that return on bond in China is relatively higher, we anticipate interest of foreign investors to invest in the Inter-bank Bond Market is high. The inflow of capital for making investment in the Inter-bank Bond Market will to some extent offset the capital outflow.
With the addition of RMB into the special drawing rights basket, the demand for global institutional investors to invest into RMB denominated assets is ever-increasing. Therefore, from the perspective of such foreign investors, Announcement 2016 No. 3 of 2016 presents them with more opportunities to tap into China’s bond market.
The Announcement 2016 No. 3 of 2016 may also have implications on deal structuring. In the past, it was not feasible to provide bond pledge directly in favor of an offshore entity due to restrictions on account opening and pledge registrations. Announcement 2016 No. 3 of 2016 and its implementation rules may increase the possibility for the use of onshore bond as security in favor of offshore beneficiaries in the future.
Editor’s note: This article was first published on Chinalawinght.com