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China's southbound bond link opens amid Evergrande turmoil

HONG KONG (BLOOMBERG) – A new channel for Chinese investors to purchase debt overseas launched on Friday (Sept 24), with HSBC Holdings and Standard Chartered among the major banks completing early trades.

The southbound link of the Bond Connect draws capital from the mainland to the southern city of Hong Kong to complete the loop with a northbound programme started in 2017. With 41 banks among those eligible to participate during the initial phase, analysts see it eventually boosting China’s offshore bond market and issuance of Dim Sum and ESG-compliant notes, as well as bringing offshore and onshore yields closer.

The launch, announced last week by the People’s Bank of China and the Hong Kong Monetary Authority, has come at a tumultuous time with markets roiled by concerns over China Evergrande Group’s liquidity crisis and the financial health of other developers that are grappling with tougher rules on leverage. China junk bond yields recently touched the highest in nearly a decade, according to a Bloomberg index.

As market makers for the southbound link, HSBC and Standard Chartered said in statements they had had assisted mainland clients to trade overseas bonds and closed multi-currency deals through the channel. Citic Securities said it had completed a 50 million yuan (S$10.5 million) trade with China Citic Bank International on a central bank bill.

Part of China’s push to modernise its financial markets and allow for more cross-border fund flows, the southbound connect will “gradually become the major channel for domestic financial institutions to trade offshore bonds,” said Ming Ming, head of fixed income research at Citic Securities. He added that “short-term sentiment will be negatively impacted by recent credit risk concerns.”

Before Friday’s southbound launch, the link only allowed flows in the northbound programme, providing global access to China’s vast interbank debt market. “The long-awaited southbound Bond Connect shows China is now less worried on capital outflows,” said Gary Ng, senior economist at Natixis.

The programme has an annual quota of 500 billion yuan and a daily quota of 20 billion yuan, both of which can be adjusted based on cross-border fund flows. Hong Kong-issued yuan bonds – also known as Dim Sum bonds – as well as US dollar and Hong Kong dollar-denominated notes will be available through the channel.

Expectations are that investors will be initially risk-averse. Given “the recent turmoil of the Chinese dollar bond market as well as the intensifying property bond risks, we don’t expect investors to buy risky notes,” said Zhou Hao, senior emerging markets economist with Commerzbank. “They may start by trading relatively safe assets.”

Other channels are already open to the investors the Southbound link targets, such as the Qualified Domestic Institutional Investor (QDII) and RMB Qualified Domestic Institutional Investor (RQDII) programmes. “While it offers another path for cross-border investment, the initial attractiveness may still depend on whether the investment costs are lower than other options,” said Natixis’ Mr Ng.

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