Chinese bonds lure foreign funds

Entering China’s onshore fixed income market is a complicated process

Last month, China reached an important milestone in the long process of opening its financial markets to the world, as the yuan was added to those currencies that make up an artificial currency designed as a backup for the global financial system.

While the decision to add the yuan to the International Monetary Fund’s Special Drawing Rights basket could be seen as a political move, with relatively little impact on daily life in Chinese fixed income markets, it is likely to be an inflection point in overseas fund managers’ accelerating attempts to gain access to those markets.

Entering China’s onshore fixed income market is a complicated process. The initial licence for an RQFII (renminbi qualified foreign institutional investor) quota gives access only to the small pool of bonds traded on exchanges. Trading in the much larger interbank bond market (IBB) requires a further application for permission to the People’s Bank of China.

Even this two-stage bureaucratic process is an advance, since it allows foreign investors into the world’s third-largest bond market (after the US and Japan) for the first time.

Of the 45 trillion yuan (Dh25.6 trillion, $7 trillion) onshore credit market, just 765 billion yuan is held by foreign investors, the bulk of this by central banks and sovereign wealth funds. These institutions were granted free access to the IBB market earlier this year, but lesser bodies still need to apply for licences.

Although the Chinese fixed income market is the thirdlargest in the world, behind only the US and Japan, one of the biggest challenges for new investors will be a lack of liquidity.

With the majority of turnover happening in shorter-dated instruments, portfolio managers looking for longer duration may have difficulty.