Foreign Institutional Investors are Granted Unprecedented Access to China’s Interbank Bond Market
A new program providing fund managers with access to China’s principal bond market officially opened for business in May 2016. The program – known as the China Interbank Bond Market (CIBM) program – greatly simplifies the process of fixed-income investing in China. Previously, managers needed to obtain licenses and quotas to invest in bonds, a process that could take months. In contrast, managers can now expect to be granted access through the CIBM program in just weeks; the first managers for the CIBM program were announced in June 2016. Despite these enhancements, the CIBM program has some unusual features of which managers should be aware.
The program, first announced in February 2016, took effect immediately after separate announcements from the People’s Bank of China (PBOC)1 and the State Administration of Foreign Exchange (SAFE)2 that established the initial framework for access to the interbank bond market. The CIBM program builds upon other initiatives already introduced by Chinese regulators to encourage foreign investment in an effort to increase liquidity and provide stability in Chinese markets, which have experienced turmoil in recent years (e.g., Shanghai-Hong Kong Stock Connect;3 Shenzhen-Hong Kong Stock Connect; and the extension of a quota allocation to the United States under the Renminbi Qualified Foreign Institutional Investors (RQFII) program4). The program further continues the trend in renminbi (RMB) internationalization, including the addition of the RMB to the International Monetary Fund’s Special Drawing Rights basket of currencies effective October 1, 2016, which has increased the overall demand for RMB-denominated assets.
The Chinese bond market is the third largest in the world (US$ 7.5 trillion in total outstanding bonds as of the end of 2015), with the CIBM representing nearly 95% of the total trading volume in the Chinese bond market. Prior to the PBOC Announcement, foreign investment in the CIBM was restricted to foreign central banks or monetary authorities, international financial organizations, sovereign wealth funds, Qualified Foreign Institutional Investors (QFIIs) and RQFIIs.
Eligible Institutional Investors
The most important development in the program is that managers will no longer need to go through the QFII or RQFII licensing process in order to access the CIBM. Instead, an onshore bank (acting as the Settlement Agent) will be responsible for determining whether or not an investor will be eligible. The following entities may be eligible:
- Offshore financial institutions (such as commercial banks, insurance companies, securities companies and fund management companies);
- Investment products offered by such financial institutions;
- Medium- and long-term institutional investors (such as pension funds, charity funds and endowment funds);
- QFIIs and RQFIIs; and
- Institutional investors from Hong Kong, Taiwan and Macau.
Due to these limits on eligibility, it is not expected that hedge funds or funds with short-term investment horizons will be allowed to participate. Since there is no guidance on the interpretation of “medium- and long-term investment,” managers will initially have to be guided by still-developing market practice.
If an investor is already a QFII or RQFII, the PBOC has indicated informally that such an investor should choose whether to invest via the QFII or RQFII programs or the CIBM program – in effect, investors should be able to select which program’s rules will apply to their interbank bond market investments.
While no prior approval is required, an investor must file registration documents (including a registration form and the Settlement Agent agreement) with the PBOC Shanghai Head Office through the Settlement Agent. The PBOC Announcement anticipates that the PBOC will acknowledge the registration filing within 20 calendar days, although this period may decrease in the future. The Settlement Agent generally provides registration, transaction and settlement services to CIBM investors. Notably, the PBOC implementing rules do not impose any quota restrictions for foreign investment in the CIBM access program; however, a foreign investor must state in its registration filing how much and for how long it expects to invest through the CIBM program. The filing must be amended if the investor is unable to remit at least half of the anticipated investment within nine months of its registration filing.
If a manager intends to invest assets of various funds and accounts into the CIBM, the manager will need to make separate registration filings for each product. It is unclear what contractual arrangements managers will need to enter into for multiple products. While the program clearly contemplates only one Settlement Agent agreement for multiple products, managers should consider the usual issues that may arise when multiple clients share the same service provider (e.g., allocation, set-off rights).
Remittance and Repatriation
To invest in the CIBM, an investor will need to send funds into accounts in China. Funds may be remitted into China in RMB or in a foreign currency. While investors are generally free to take money out of China, the program requires that investors generally take out roughly the same proportion (subject to a 10% variance) in the respective currency as was contributed; in other words, if 40% of the cash that a manager remits into China is denominated in RMB, then amounts repatriated can be no more than 44% nor less than 36% in RMB. In this way, the CIBM program makes the foreign exchange component of the program essentially a closed loop, presumably to limit the risk that the program could be used to influence RMB valuation. There is one exception to this rule – the currency ratio requirements will not apply to the initial repatriation of funds; instead, the amount of RMB or foreign currency repatriated may not exceed 110% of the RMB or foreign currency remitted.
The removal of prior approval requirements and quota restrictions, as well as the expansion of the group of eligible CIBM investors, represents a substantial step in the opening up of the Chinese financial markets, which will likely immediately attract more investment in the CIBM. This policy change may, in turn, promote healthier growth in China’s interbank bond market and, to some extent, offset the capital outflows stemming from China during the months leading up to the PBOC Announcement.
For global asset managers, the PBOC and SAFE announcements provide a new and less restrictive investment model through which to access China’s sizeable bond market, as compared to the QFII and RQFII programs. The CIBM program may be particularly well-suited to separate account mandates or other mandates that are unable to take advantage of the favorable repatriation treatment available to open-end funds under the QFII and RQFII programs.
To begin investing, managers should reach out to their bank service providers that have operations in mainland China. Fund offering documents may also need to be updated to reflect the CIBM program’s specific requirements (e.g., limits on currency repatriation). To the extent that China is a new market for a manager’s clients, such managers should also take care to explain the valuation and market risks in China; despite significant liberalization, access to the Chinese markets still relies on programs, like the CIBM, that are relatively new, lack extensive market practice and rely upon limited guidance from Chinese regulators.
1) PBOC Announcement No. 3, February 24, 2016 (PBOC Announcement).
2) SAFE Announcement, May 27, 2016.
3) For further information, please refer to Dechert OnPoints, Chinese Regulator Responds to Lingering Concerns over Ownership of Stock Connect Securities and The Through-Train Leaves the Station: Hong Kong-Shanghai Stock Connect Launches.
4) For further information about the quota allocation to the U.S., please refer to Dechert OnPoint, United States to Receive $38 Billion RFQII Quota for Investments in China.