Non-rating action commentary: Southbound Bond Connect can help Mainland investors to further realise the practical value of global ratings on Chinese offshore bonds


30 Sep 2021

    HONG KONG, 30 September 2021. Following the introduction of Northbound Trading in 2017, Southbound Bond Connect was officially launched on 24th September, marking another milestone to promote mutual access between Hong Kong and Mainland bond markets. The new platform is expected to speed up the opening of the Mainland financial markets, to diversify investment channels for Mainland institutional investors and to promote the vibrant development of the Hong Kong bond market.

    Southbound Bond Connect is a platform designated for Mainland institutional investors to invest in the Hong Kong bond market without altering the current policy framework, through existing exchanges and clearing institutions in Mainland and Hong Kong. Eligible bonds are those issued offshore and tradable in the Hong Kong bond market. Cash bond trading will be available in the initial phase. Eligible Mainland investors are designated tentatively as 41 banking financial institutions on the list of the 2020 PBC primary dealers for open market operations, Qualified Domestic Institutional Investors (QDIIs) and Renminbi Qualified Domestic Institutional Investors (RQDIIs). 13 market makers for Southbound Bond Connect designated by the Hong Kong Monetary Authority (HKMA) will act as trading counterpart tentatively. Similar to Northbound Trading, Southbound Bond Connect adopts the internationally-accepted nominee holding structure. At present, the annual quota and daily quota for Southbound Bond Connect are equivalent to RMB500 billion and RMB20 billion respectively. The People's Bank of China (PBC) will adjust the quotas based on the circumstances of cross-border capital flows.

    The introduction of Southbound Bond Connect is expected to bring profound influences to Chinese offshore bond market. As Mainland institutional investors are more familiar with the fundamentals and credit risk profiles of Chinese bond issuers, they are more open to invest in Chinese offshore bonds, especially USD-denominated Chinese bonds, which accounts to over 90% outstanding amount of the whole Hong Kong bond market. As a result, this would bring capital inflow to the offshore bond market, and therefore enhances market participation and liquidity. Meanwhile, we believe USD-denominated Chinese bonds
    have advantages such as higher risk premiums, better liquidity and more category options compared to onshore credit bonds, which makes the former more attractive to Mainland investors as an investment. Prior to the launched of Southbound Bond Connect, only QDII, RQDII and TRS qualified securities firms were able to invest in overseas bond markets, and are highly restricted on: the investable limit, PBC macro-prudential management and balance sheet scale of securities companies in terms of investment quota, and investment grade or quality of the products. With the introduction of Southbound Trading, Mainland capital will subject to less restrictions when investing Offshore bonds, especially non-investment grades.

    Mainland investors have long referred to the domestic rating system in their credit bond investment and internal risk management, while the credit ratings for Chinese offshore bonds are based on the global rating system. There are large differences between the rating system in China and in global, and it could lead to several confusions for Mainland investors, when assessing judgements on offshore bond credit risk, since they are not familiar with the global rating system. China's domestic rating system appears to have limited global comparability and credit differentiation. Compared with domestic credit ratings, global ratings have higher differentiation in their rating score and are stronger correlated to bonds’ credit spreads, making them broadly adopted by international capital market and regulators. Additionally, due to the fact that global bond market has detailed and cross-cycle rating performance and default data, global ratings can be associated with more stable and precise historical default rates.

    Overall, as Mainland investors increase their participation in Chinese offshore bond market, they will be unavoidably exposed to and utilize the global rating system that is largely different from what they accustomed to. Thereafter, mainland investors should realise the practical value of global ratings on Chinese offshore bonds. As of now, many of the offshore bonds are issued without global ratings. According to Bloomberg, non-rated issuers account for nearly 49% of all USD-denominated Chinese bond issuers. In our view, with the increasing market participation in USD-denominated Chinese bonds, more issuers and issues should have global rating coverage and more Mainland investors will adopt the global ratings framework.

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