Upcoming Chinese mainland- Hong Kong ‘ bond connect’ offers dual benefits

China’s plan to allow investors in the Chinese mainland and Hong Kong to trade each other’s debt is good news for the Special Administrative Region. By making it easier for foreigners to trade onshore bonds, the tie- up means Chinese debt is more likely to join benchmark global indexes. And allowing mainland investors into Hong Kong’s fixed income market will deliver a fresh source of liquidity. Both results will benefit Hong Kong’s financial industry.

Plans for a “bond connect” program have been percolating since Beijing launched schemes allowing two- way trading between bourses in Shanghai and Shenzhen and Hong Kong’s stock market. However, soft economic data, a weakening currency and tighter capital controls have made most foreign fund managers wary of holding yuan assets.

But signs of economic warming have some fund managers wondering whether they may be unduly underweight in China. Citigroup recently incorporated Chinese sover- eign bonds into a few smaller indexes, but China wants them included in major international benchmarks, which could induce passive funds that track them to redeploy hundreds of billions of dollars.

The central government already allows institutions direct access to its primary onshore bond market, but some foreign managers are wary of setting up shop on the Chinese mainland given concerns about its onerous regulatory environment. A bond connect would allow them to set up shop in Hong Kong instead.

Meanwhile, for mainland investors, Hong Kong dollardenominated bonds could help hedge against currency risks and rising global interest rates. Mainland funds began aggressively moving into Hong Kong stocks via the connect programs in February. If such enthusiasm were replicated via a bond connect, the city’s fixed income market – which had a modest HK$ 1.5 trillion ($ 193 billion) outstanding at the end of 2015 – could get a decent boost.

So far the plans are short on specifics, and details on things like quotas, profit remittance and taxation will matter a great deal. But if Beijing gets the details right, Hong Kong will be the winner.