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China closer to world bond benchmark inclusion

(ATF) China announced overnight it had amended some bond trading rules and that now foreign investors will have the flexibility to choose their settlement period without prior notification to authorities.

Analysts said this will increase its chances of inclusion in the World Government Bond Index (WGBI), when index provider FTSE Russell conducts its annual review later this month.

“Both parties will not need to submit an application to independently choose to achieve T +N transactions,” the Shanghai Clearing House said in a statement.

“In the next step, the Foreign Exchange Trading Center, China Central Clearing Corporation and Shanghai Clearing House will continue to optimise their services under the guidance of the People’s Bank of China to continuously meet the needs of China’s bond market for high-quality development and opening up.”

China is currently on the WGBI’s watchlist for potential index inclusion, according to FTSE Russell’s March 2020 interim review.

“We have previously noted that the decision could be a close call, but that we ultimately believe China will be included into FTSE WGBI on 24th September,” Goldman Sachs analysts Danny Suwanapruti, Zhennan Li and Hui Shan said in a note.

“This development increases our confidence about China’s inclusion.”

At the time of the 2019 final review, FTSE Russell had said increased flexibility in foreign exchange execution and the settlement of transactions was required prior to the inclusion.

The FTSE Russell WGBI index is widely followed by Japanese investors, who are very passive. Given Japan has an extended holiday, such a 5-day Golden Week holiday, the flexible settlement cycle in important to them. The settlement cycle for onshore investors in China is T+0 or T+1. However, for foreign investors it is up to T+3. But T+3 is not long enough to cater to long holidays and given Japanese investors are very passive – they prefer not trade before or after the holidays, the analysts said.

This factor was important for FTSE inclusion consideration, because it was on a list of key requests by passive investors for the regulators to address, and has now been addressed, they said.

“Nevertheless, we caveat that, while there has been an improvement in bond liquidity, market access and tradability, it is still not on par with peer markets (such as USTs, Bunds, Gilts, JGBs), as WGBI is predominantly a DM index,” they said.

China’s bond market, already the world’s second biggest, has been expanding at a breathtaking pace over the past two decades and this inclusion would trigger passive inflows of $150-$180 billion, boosting foreign ownership of Chinese Government Bonds (CGBs) by 6-7% and foreign ownership of the overall China bond market by 1%, according to Standard Chartered bank.

“We expect foreign inflows to accelerate further in the coming quarters on a stronger CNY outlook, high interest rate premium, ongoing global reserve diversification, and global bond index inclusion,” Standard Chartered Bank strategists Becky Liu and Terry Chan said in a note issued earlier this month.

They expect foreign ownership of CGBs to rise to 20% by end-2022 from 8.5% currently.

The expected inclusion in the WGBI follows China’s inclusion in the Bloomberg Barclays Global Aggregate Bond Index and the JP Morgan Government Bond Index.

“These three benchmarks, even at their planned low inclusion weights, could draw potential additional inflows of between $250 billion and $300 billion into China’s onshore bond market,” JP Morgan’s Ian Hui and Chaoping Zhu said.

Umesh Desai

Umesh Desai is the Executive Editor at Asia Financial. Prior to this he spent over two decades with Reuters News as Asia Pacific Chief Correspondent in Hong Kong and Bureau Chief in Bombay. Before becoming a journalist Umesh was a credit ratings analyst with Moody's arm in India - ICRA. A chartered accountant by training, Umesh began his career as an equity analyst. His Twitter handle is @umesh_desai

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