MNI: China Seen Boosting Swap Connect As CNY Bond Demand Grows

Chinese authorities have set low initial quotas for the nascent Swap Connect platform, which launches May 15, but expect to raise trading limits once northbound appetite for yuan-denominated bonds increases, bond traders and lawyers with knowledge of the scheme told MNI.

Swap Connect, which gives offshore investors access to China’s USD5 trillion interest-rate swaps market, will initially have a CNY20 billion ($2.89 billion) daily trading limit.

“The initial quotas will be easily reached by the market,” said a senior Hong Kong trader familiar with the matter. “Regulators know this and are starting conservatively to ensure an initial success. They will increase the limits once fundamentals improve.”

Offshore investors decreased holdings of Chinese government bonds to CNY3.2 trillion in March, from January 2022's CNY4 trillion high, according to data from Bond Connect. The difference between U.S. and China bond yields – U.S. 10-year Treasury yield was 3.44% compared to China's 10-year 2.845% yield last week – drove the selloff.

Economic sentiment also remains uncertain, with investors pointing to the concerning uneven rebound in Q1 and low inflation data. (See: MNI CHINA LIQUIDITY INDEX: Index Tighter, Economy Outlook Down - Bonds & Currency News | Market News)

“Authorities were worried about launching when demand for northbound bonds is low,” the Hong Kong trader added.

Under swap connect, PBOC-recognised overseas electronic trading platforms will jointly provide trading services for Hong Kong and international investors, giving them access to interest-rate swaps at the initial stage priced, settled and cleared in renminbi. Hong Kong Exchanges and Clearing via OTC Clear and the Shanghai Clearing House will provide clearing and settlement services through a central counterparties link.

A Hong Kong-based lawyer involved in the development of Swap Connect said mainland firms have so far shown greater interest in the platform than offshore peers.

LAUNCH NOW

The People’s Bank Of China announced the scheme in July 2022 and originally planned to launch the platform by the end of 2022.

Kingsley Ong, head of structured finance and restructuring at international law firm CMS in Hong Kong, told MNI that various factors, including the Covid-19 wave following China’s reopening, may have contributed to the slight delay.

Eric Liu, a senior fixed-income portfolio manager and former head of fixed income at Harvest Asset Management in Hong Kong, said the launch follows stabilised northbound outflows. “And U.S. yields have come down, which helps create a calm environment for launch," he added.

U.S. 10-year Treasury yields peaked at 4.08% in March, and have since fallen to 3.44%, narrowing the differential with Chinese bonds.

LEGAL MATTERS

Offshore firms have also raised concerns over the legality and enforceability of netting agreements made with mainland counterparties, lawyers told MNI. The agreements allow counterparties to consolidate multiple transactions into a single net amount, tidying books and reducing risk.

“The new PRC Futures & Derivatives Law (FDL) introduced in 2022 has provided the foundation for netting out issues and Swap Connect," Ong said. “Although it is not entirely clear that the FDL overrides conflicting provisions in the existing PRC Enterprise Bankruptcy Law, for now, the market is comfortable that the FDL has provided sufficient legal certainty.”

The other Hong Kong-based lawyer noted China had become a clean netting jurisdiction in principle. “This has lessened offshore firms' concerns to some extent,” the lawyer said.

HKEX said it will work with all parties to ensure Swap Connect rolls out successfully. The PBOC and SHCH did not respond to questions before publication.