Starting from today (10 February 2025), international investors can use their Northbound Bond Connect bonds to enter into repo transactions in Hong Kong.
Recently, the People’s Bank of China (PBOC) and the Hong Kong Monetary Authority (HKMA) have jointly announced a series of new policy measures to deepen financial market connectivity between Chinese Mainland and Hong Kong, most notably the innovative Bond Connect repo arrangement, which has attracted significant attention from international market participants.
The new Bond Connect repo arrangement allows offshore investors to use their China Inter-bank Bond Market (CIBM) bonds held through Northbound Bond Connect for repurchase transactions (repos) in Hong Kong.
A key advantage of the Bond Connect repo arrangement is the ability to use global standard agreements such as the GMRA to document title transfer-based repos. This development, along with other recent regulatory initiatives, underscore China’s on-going efforts to promote greater use of RMB-denominated bonds in financial transactions and to harmonise with international financial market norms.
This article tells you what you need to know about the new Bond Connect repo arrangement.
1. Background on the CIBM bond market
China’s onshore bond market is the second largest in the world and consists of the CIBM and an exchange-traded bond market. Over the past decade, the onshore bond market has experienced rapid growth due to China’s economic development and financial reforms.
The CIBM is an over-the-counter wholesale market and is much bigger than the exchange-traded market. Bonds traded on the CIBM primarily include Chinese government bonds and Chinese policy bank bonds. Participants in the CIBM include financial institutions and investment vehicles such as pension funds, mutual funds and private funds.
Offshore investors can access the CIBM through various channels, including Northbound Bond Connect, the CIBM Direct Access scheme and the (RMB) Qualified Foreign Institutional Investor scheme.
2. Overview of Northbound Bond Connect
To understand the Bond Connect repo arrangement, let us first take a look at how offshore investors hold CIBM bonds through Northbound Bond Connect.
Launched in 2017, Bond Connect is a mutual access scheme for (1) offshore investors to access the CIBM (Northbound Bond Connect) and (2) onshore investors to access the bond market of Hong Kong (Southbound Bond Connect) through a market infrastructure linkage between Chinese Mainland and Hong Kong. The Bond Connect repo arrangement is related to the Northbound Bond Connect component of Bond Connect.
Under Northbound Bond Connect, CIBM bonds are held through a custody link between the Central Moneymarkets Unit of the HKMA (CMU) and the two onshore central securities depositories (CSDs), being China Central Depository & Clearing Co., Ltd. (CCDC) and Shanghai Clearing House (SCH). Specifically, Northbound Bond Connect uses a multi-tiered custody structure, as illustrated in the diagram below.
The multi-tiered custody structure consists of the following three levels:
- Level 1 (at the onshore CCDC and SCH level) – The CIBM bonds are held in the omnibus securities account maintained with the relevant onshore CSD in the name of the HKMA (as operator of the CMU) (hereinafter referred to simply as the “CMU”). The CMU holds the bonds as nominee holder for CMU members and their underlying clients. As explained below, the ultimate investors are recognised as the beneficial owners of the bonds and can exercise their rights against the bond issuer through the CMU as nominee holder.
- Level 2 (at the offshore CMU level) – At the CMU level, each CMU member’s account in the CMU system is separate from other CMU members’ accounts and therefore the bonds recorded in the account of one CMU member are segregated from those recorded in other CMU members’ accounts. Each CMU member must also open and maintain segregated sub-accounts within its account in the CMU system to hold its or its clients’ bonds at the individual investor level.
- Level 3 (at the offshore CMU member level) – At the CMU member level, each investor is required to open a segregated debt securities account (known as an investor sub-account) with its local custodian (being the CMU member). One investor’s sub-account with a CMU member is separate from other investors’ sub-accounts with the same CMU member. The bonds held in one investor’s sub-account are therefore segregated from those held in other investors’ sub-accounts at the CMU member level.
Significantly, under Northbound Bond Connect’s multi-tiered custody structure, trades and transactions taking place offshore do not affect the CMU’s status as nominee holder of the CIBM bonds because what is in fact being traded or transacted offshore are beneficial ownership interests in the CIBM bonds. Offshore investors’ beneficial ownership of CIBM bonds held through Northbound Bond Connect are recognised under both the laws of Hong Kong and Chinese Mainland.
For a more detailed discussion of Northbound Bond Connect, please refer to our earlier article.
3. Key features of the Bond Connect repo arrangement
Below are the key features of the Bond Connect repo arrangement, presented in the form of questions and answers.
Who can participate in the Bond Connect repo arrangement?
As stated in the HKMA’s announcement, all existing Northbound Bond Connect investors (including CMU members and offshore investors with CMU sub-accounts opened through CMU member custodian banks in Hong Kong) can participate in the arrangement. In the initial phase, each repo transaction under the Bond Connect repo arrangement must involve at least one of 11 Primary Liquidity Providers[1] designated by the HKMA.
Which Bond Connect bonds are eligible?
All bonds held by participating institutions under Northbound Bond Connect are eligible for the Bond Connect repo arrangement, regardless of bond type.
Which master agreements can the parties use to document their repo transactions?
Offering flexibility, the Bond Connect repo arrangement allows participants to choose their preferred repo agreement templates. The HKMA announcement specifically mentioned as examples the Global Master Repurchase Agreement (GMRA) and the NAFMII Bond Repurchase Master Agreement. The ability to use the GMRA, a standard industry agreement widely used in the offshore repo market, is a significant advantage for international market participants, ensuring familiarity and operational ease.
What is the repo trading arrangement?
According to the HKMA, each repo under the Bond Connect repo arrangement may be conducted in one of the following ways:
- bilaterally over-the-counter;
- in the same manner as the existing Northbound Bond Connect transactions, and via the linkage between the relevant CSDs in the onshore and offshore markets;
- through offshore electronic trading platforms; or
- through an onshore electronic trading platform.
What is the repo settlement process?
Settlement under the Bond Connect repo arrangement will be completed under a repo service provided by the CMU. We expect that the CMU would provide triparty repo services to facilitate the settlement and other operational aspects of repo transactions, similar to typical triparty repo arrangements in the international market.
Under a typical triparty repo arrangement, functions such as collateral selection, payments, deliveries, custody of securities, collateral management and other operations (collectively referred to as “triparty repo services”) are outsourced by the two repo parties to a triparty agent, and the arrangement is usually documented in a triparty repo service agreement. A triparty agent is just an agent to the repo parties in relation to certain operational matters. Therefore, the use of triparty repo services by the parties should not fundamentally change the bilateral legal relationship between the repo parties. This means that the two repo parties must still sign a bilateral master agreement such as the GMRA or NAFMII Bond Repurchase Master Agreement.
Will repos involve a title transfer arrangement?
The HKMA announcement expressly states that “bond ownership will be transferred to the repo buyer during the repo period”. Since Northbound Bond Connect trades and transactions take place offshore under the multi-tiered custody structure described above, the ownership interest being transferred to the repo buyer is actually the beneficial ownership interest in the bonds, which is considered to be situated offshore under general conflicts of laws principles.
The GMRA (which is one of the master agreements specifically mentioned in the HKMA’s announcement) only supports title transfer-based repos, while the NAFMII Bond Repurchase Master Agreement contains special provisions that can accommodate “outright transfer repos”.
Are there operational restrictions on the repo buyer’s ability to re-use the bonds?
The HKMA announcement explains that, in order to ensure a smooth operation of the Bond Connect repo arrangement, leverage limits will be introduced during the “initial phase”. As a result, although beneficial ownership in the relevant Bond Connect bonds will be transferred from the repo seller to the repo buyer, the repo buyer will not be permitted to re-use the bonds during the repo period. Instead, as an operational matter, the bonds will be locked and managed by the CMU platform. The HKMA stated that it will review the operation and experience of the Bond Connect repo arrangement and make further adjustments as needed.
Are there any reporting obligations?
For market monitoring purposes, the HKMA-designated Primary Liquidity Providers are required to report transaction data to the HKMA on the same day as the relevant repo transaction. The specific information to be reported includes, without limitation: names of the trading institutions, total amount of funds borrowed by the repo party, bond name, bond code, repo term, total face value, repo rate and transaction date.
4. Key legal considerations under the Bond Connect repo arrangement
The unique features of the Bond Connect repo agreement, combined with the need to enter into new legal documents such as the triparty repo service agreement, give rise to a number of important legal and regulatory issues for market participants to consider.
The need for additional netting and title transfer legal opinions
The Bond Connect repo arrangement gives rise to various multi-jurisdictional legal and regulatory issues, such as: (1) the validity and enforceability of (beneficial) title transfer of Bond Connect bonds under applicable laws; (2) the interaction between the relevant repo master agreement, the triparty repo service agreement and the CMU’s operating rules; and (3) certain ‘non-trade transfer’ considerations.
These unique legal and regulatory issues are not addressed in industry legal opinions commissioned by relevant trade associations such as the International Capital Markets Association (ICMA). Therefore, market participants – especially regulated financial institutions that require clean netting and title transfer opinions for regulatory capital and other purposes – should consider engaging external counsel to issue additional legal opinions that address the multi-jurisdictional legal and regulatory issues associated with the Bond Connect repo arrangement. We at KWM have been advising a number of major market participants in this regard.
Legal documentation – GMRA or NAFMII?
While most offshore market participants will likely use their existing GMRAs to document Bond Connect repos, some market participants (e.g., Hong Kong branches or subsidiaries of certain PRC financial institutions and their clients) may prefer to use the NAFMII Bond Repurchase Master Agreement. Since the standard form NAFMII Bond Repurchase Master Agreement is governed by PRC law and is designed for the onshore bond market, certain adjustments (which can be effected through a supplemental agreement) may be required to accommodate the Bond Connect repo arrangement’s unique features.
5. Connecting the dots
In addition to the Bond Connect repo arrangement, Chinese regulators have recently taken other measures to encourage greater use of RMB-denominated bonds and to harmonise with international financial market practices.
For example, Mainland Chinese and Hong Kong regulators have begun allowing offshore investors to use onshore bonds issued by the PRC Ministry of Finance and PRC policy banks that are held under Northbound Bond Connect as margin collateral for derivative transactions at OTC Clearing Hong Kong. Also, the National Financial Regulatory Administration (“NFRA”) recently published its highly anticipated regulatory margin rules for non-centrally cleared derivatives, which are broadly consistent with the global regulatory margin standards published by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions. Significantly, the NFRA’s regulatory margin rules expressly encourage the use of RMB-denominated assets as margin for derivatives transactions.
6. How can I find out more about the Bond Connect repo arrangement and related legal issues?
We at KWM are here to help you. KWM advised the China Foreign Exchange Trade System (CFETS) on the establishment of Bond Connect, and we are currently advising a number of major market participants regarding the new Bond Connect repo arrangement.
Our fully bilingual team of partners and lawyers regularly assist international and PRC-based financial institutions and corporates with GMRA, NAFMII and ISDA documentation negotiations, as well as with designing and documenting innovative and complex cross-border repos, securities lending and derivatives products. We also regularly advise international and PRC-based clients on regulatory requirements that apply to repos, securities lending and derivatives transactions.
In addition, KWM has been actively participating in legal developments relating to the enforceability of close-out netting, central clearing, as well as security and title transfer arrangements in the PRC and Hong Kong. We are familiar with the unique issues faced by Hong Kong and PRC-based financial institutions (including market infrastructure organisations) and their counterparties and would be pleased to share our insights with you.
*In this article, “Hong Kong” or “HK” means the “Hong Kong Special Administrative Region of the People’s Republic of China”, and “PRC” or “Chinese Mainland” means the People’s Republic of China, excluding Hong Kong, Macao Special Administrative Region and Taiwan.
The 11 Primary Liquidity Providers include: 1) Agricultural Bank of China Limited, 2) Bank of China (Hong Kong) Limited, 3) Bank of Communications Co., Ltd., 4) BNP Paribas, 5) China CITIC Bank International Limited, 6) China Construction Bank (Asia) Corporation Limited, 7) Citibank, N.A., 8) Hang Seng Bank Limited, 9) The Hongkong and Shanghai Banking Corporation Limited, 10) Industrial and Commercial Bank of China (Asia) Limited, and 11) Standard Chartered Bank (Hong Kong) Limited.
