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Fixed income investors eyeing China’s bond market, survey finds

International fixed income investors are preparing to substantially increase their exposure to China’s domestic bond market, a survey from Deutsche Bank has shown.

According to the survey, the aggregate share of respondents’ Asian local-currency bond portfolio allocated to onshore renminbi is expected to reach 13 per cent a year from now, and 26 per cent in five years, up from the present level of just 5 per cent.

The respondents were primarily Asia-based senior staff at global asset management firms.

China’s interbank bond market is the third largest in the world, but until this year it had been closed to most international investors. Deutsche Bank research estimates that foreign investors’ share of domestic interbank holdings was about 1.52 per cent in August.

However, in the last 18 months, China has been seeking to open up its bond markets further to overseas investors. In February this year, China’s authorities announced that a wide range of foreign institutional investors would be given quota-free access to the Chinese Interbank Bond Market (CIBM), and in May the People’s Bank of China published implementing rules that a note from BNP Paribas at the time described as “even more flexible than had been expected.”

At present, the CIBM represents over 90 per cent of the total market for Chinese bonds.

Over half of respondents to the Deutsche Bank survey indicated that the shift to a registration-based, quota-free system for CIBM market access had brought forward their institution’s timeline for increasing investment in the market.

“Now that access has opened up substantially for offshore investors, we expect foreign participation in China’s domestic bond market to accelerate and for onshore renminbi bonds to be an increasingly important component of major global fixed income investors’ portfolios,” said Deutsche Bank Asia Pacific head of global markets Michael Ormaechea.

However, access has not been the only issue preventing foreign investors increasing their exposure to Chinese bonds. One oft-cited reason is a concern about the reliability of bond ratings, with some significant discrepancies existing between the ratings given by local ratings agencies to a company’s onshore Chinese bonds, and those given to their offshore bonds by international agencies.

Among the respondents to the Deutsche Bank survey, however, the challenge most often noted by investors was access to liquid hedging instruments. The authorities have made instruments including bond lending, bond forwards and forward rate agreements available for hedging purposes, but it seems that these are not sufficient.

Half of respondents also flagged the absence of onshore yuan bonds from major indices as being a factor limiting their desire to invest, though 82 per cent said that they expected inclusion in a major emerging market fixed-income index to happen within the next two years.

In March, JP Morgan placed the CIBM on review to be included in its emerging market bond index, but there have been few developments since then.

Respondents to the Deutsche Bank survey also expressed their interest in China’s so-called Panda bond market – onshore Renminbi bonds issued by non-Chinese entities – with nearly half indicating that they might invest within the next 12 months. A further 38 per cent expected to invest in between one and three years time.

Despite the fanfare surrounding the recent creation of China’s market for SDR-denominated bonds (so-called Mulan Bonds), so far there has been little interest in them from either domestic or international investors.