MNI: China's Swap Connect Eyes Q1 Start To Attract Inflows

Hong Kong and mainland China regulators are set to launch Swap Connect early in the first quarter, allowing foreign access to the USD5 trillion onshore interest rate swaps market and providing investors with hedging tools at a time of heightened volatility in global bond markets, sources told MNI.

The opening up of the interest rate swaps (IRS) market comes as regulators prioritise policies to attract foreign capital back into China’s capital markets after outflows in 2022, with an expanded suite of risk management tools viewed as key to enticing foreign investors.

Swap Connect, which will allow access to China’s IRS market via Hong Kong, is “on schedule for an early Q1 start, with no major blockers remaining”, one source said. Another source said the program “is in the final stage of development”.

Swap Connect has been backed by policymakers alarmed by the recent sell-off in Chinese bonds by foreigners through the Bond Connect program. Policymakers are “keen to reverse the recent outflow trend”, according to one of the sources, who added that China treasury bond futures, another fixed income hedging tool, were “also close to finalisation”.

As of November 2022, Bond Connect had suffered its worst year on record, with foreign investors decreasing their holdings by CNY740 billion, marking a 22% drop since January’s record high of Yuan 4 trillion, according to data on the Bond Connect website. (See MNI: China Needs Yuan Asset Pool To Drive Currency Ambitions)

Market participants believe the scheme should support renewed interest in China’s bond market. “These new risk management tools may help increase the volume of Bond Connect flows and entice foreign investors back in,” Ken Cheung, chief Asian FX strategist at Mizuho Bank, told MNI.

HEDGING UNCERTAINTY

“Foreign investors accessing onshore markets need more hedging tools to allow them to increase exposure in China, especially in 2023 because there's so much uncertainty,” said Eric Liu, head of fixed income at Harvest Global Investments.

Liu said China’s abrupt Covid reopening and uncertain pace of recovery, plus debate over the Federal Reserve’s interest rate trajectory, had led to heightened volatility in bond markets, increasing the need for foreign investors to access derivative tools to effectively lay off risk.

“These new connected schemes that open up risk management tools will be welcomed” Liu said. He said the tools will appeal to sovereign wealth funds and pension funds, but authorities need to ensure there are flexible clearing hours and low transaction costs to ensure success.

The opening up of the mainland IRS market could soon be followed by China treasury futures, both part of wider capital market reforms aiming at expanding the size of China’s financial markets to more than USD100 trillion by 2030, according to Hong Kong Exchanges and Clearing.

Analysts believe the connect programs could lay the foundation for opening the credit default swaps market and developing more FX trading tools, such as increasing the duration of swaps.

Shanghai Clearing House was approached for comment but did not respond by publication.