The inclusion of Chinese bonds in the Bloomberg Barclays Global Aggregate benchmark on April 1 has been called a seismic event for markets, but the smaller tremors being felt now are more related to global money managers hustling to get their trading arrangements for mainland bonds in order.
Many are looking to use both of the major platforms offering access to foreign investors — China Interbank Bond Market Direct Access, launched by the People’s Bank of China in early 2016, and Bond Connect Co. Ltd., the joint venture of China Foreign Exchange Trade System and Hong Kong Exchanges and Clearing Ltd., which debuted in mid-2017.
Industry veterans say both Bond Connect’s principal model, which allows foreign managers with global custodians to trade mainland bonds via Hong Kong, and CIBM Direct’s agency model, which requires local custodians and settlement agents, have enduring roles to play.
If you’re a huge national pension fund with only one account and your counterparty as an agent is the central bank, then using CIBM Direct is a “no-brainer,” said Julien Martin, a managing director with HKEX and the exchange’s head of fixed income and currency product development, market development.
But for money managers with multiple clients, including clients with segregated accounts, and ties to global custodians, Bond Connect offers operational advantages, he said.
A CIBM Direct license is tied to a specific asset manager or asset owner so if a money manager’s clients want to set up a segregated mandate, they would have to appoint their own settlement agent bank, said Edmund Goh, a Shanghai-based Asian fixed-income investment manager with Aberdeen Standard Investments.
As of April 1, just more than half of the top 100 global money managers “are registered with us, and 39 are ready to trade,” Mr. Martin said.
“There’s varying degrees of readiness here,” said Nick Gendron, global manager for Bloomberg’s fixed-income benchmark index business. “For whatever reason, some clients got a late start, sometimes maybe it was the account approvals holdings things up,” he said.
A rush of global managers all heading to the entrance of China’s onshore bond market at the same time looks to be straining the ability of the system to take them all in for now, noted Tariq Ahmad, Singapore-based CEO and director, head of Asia (ex-Japan) with Brandywine Global Investment Management (Asia) Pte. Ltd.
Almost 12 months ago, Brandywine began the “onerous, operational process” of getting clients’ permission to trade mainland bonds on their behalf through the Bond Connect and China Interbank Bond Market platforms, Mr. Ahmad said.
The firm’s operations team set up a dedicated project to drive that process, and today “we’re almost there — not completely, but we’re ahead of the game,” he said.
Aberdeen Standard’s Mr. Goh said his firm already invests in mainland bonds via CIBM Direct and is moving to register with Bond Connect as well, with hopes of resolving a few outstanding issues in coming months.
One such issue: funds operating under current Bond Connect rules can’t have more than one foreign-exchange bank, a requirement which offers clean, streamlined arrangements but leaves agents facing no pressure to offer best execution, Mr. Goh noted.
With Chinese bond exposure equivalent to 30 basis points of the Bloomberg Barclays Global Aggregate Bond index set to be added every month between this April and November 2020, managers say they still have time to get their ducks in order.
A “chunk of clients” have said for now they’ve decided to go for benchmarks that exclude China, Bloomberg’s Mr. Gendron said.
Aberdeen Standard’s clients are OK with China inclusion but “a lot of them aren’t ready at the moment,” still trying to figure out the best way to access the market and deal with its operational idiosyncrasies, Mr. Goh said.
But by the end of 2019, with Chinese government and policy bank bonds accounting for roughly 2.4% of the global aggregate, en route to a 6% target weight by the end of 2020, it will become increasingly uncomfortable for any investor concerned about tracking error to remain on the sidelines, industry veterans said.
Some clients may prefer to continue investing for now against an index that excludes China, but within six months or so that index’s tracking error vis-a-vis the Bloomberg Barclays Global Aggregate will begin to be meaningful, Mr. Ahmad said.
With both the CIBM Direct and Bond Connect platforms in operation, foreign investors’ share of China’s $13 trillion bond market has more than doubled to 2.3% over the past three or four years, said HKEX’s Mr. Martin.
And with roughly $2.5 trillion in assets globally tracking the Bloomberg Barclays Global Aggregate, the 6% target weighting for Chinese bonds would bring another $150 billion of foreign capital into the country by December 2020.
Mr. Martin said the run-up to the inclusion of China’s bonds in the Bloomberg Barclays global aggregate has already given the mainland bond market a more institutional feel — a down payment on a revolution to come that will see institutional money, including pension funds and insurance companies, both Chinese and global, focusing more and more on long-duration investments.
“Up until November of last year, the majority of investors we’ve seen going in … were more driven by the foreign-exchange play — investing in relatively short-term paper,” Mr. Martin said.
Now the focus of investors is shifting more to government and policy-bank paper, he said.