Opportunities for global asset allocation

Author: | Published: 18 Mar 2015
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Bing Li of ICBC charts a shift in attitude towards the renminbi (RMB) as policy-makers in China encourage its internationalisation

China is now the second largest economy and the largest export nation in the world. The impressive growth of China's economy over the past decade has greatly strengthened its global influence, while the role of China's currency, the renminbi (RMB), has been far less represented compared with its economic size and dominance in global trade. The notable shift in attitude towards RMB from the policy makers started from 2006 when China established a three-step approach to RMB internationalisation: (i) expanding the role of the RMB in cross-border trade settlement; (ii) encouraging the wider use of the RMB in cross-border investment; and, (iii) promoting the RMB as a global reserve currency.

The RMB overtook the euro to become the second-most used currency in global trade finance after the dollar in December 2013 and became the fifth-most used global payment currency in January 2015. Moreover, the size of the offshore RMB bond market has doubled each year since 2008 as more international issuers use the platform for RMB financing, global investors find the currency an asset class offering attractive yields and, until recently, a strengthening exchange rate. The offshore RMB market has also surpassed Hong Kong after Singapore, Taiwan, London, Luxembourg and other financial centres took steps to become offshore RMB hubs, resulting in the total pool of offshore RMB assets, including deposits, bonds and CDs, exceeding Rmb1.8 trillion ($290 billion) at the end of 2014.

"Capital account liberalisation is one of the most important pre-conditions in achieving international currency status for the RMB"

The international use of the RMB as an official reserve currency has remained limited so far, mainly due to the fact that it is still largely inconvertible for investment purposes. The amounts invested by several central banks and monetary authorities are still marginal to date, although they have been given approval to participate in China's onshore bond market, the third largest bond market in the world after the US and Japan, through a specific interbank investment programme initiated by the People's Bank of China (PBoC).

Capital account liberalisation is one of the most important pre-conditions in achieving international currency status for the RMB (which is closely linked to the development of the onshore bond market) with the purpose of enabling the market to play a decisive role in the allocation of capital during the course of economic development. The convergence of the onshore and offshore markets, the liberalisation of the domestic interest rate system, and the improvement of foreign access to the onshore bond market are part of China's capital account liberalisation process, which is providing valuable opportunities for global investors.

An emerging asset class

China's onshore bond market has grown at an average rate of 14% for the past five years and ranked the third largest in the world, with a total outstanding amount at Rmb35.6 trillion as of the end of 2014, driven by an increasingly diversified range of products. Interest rate bonds, including government bonds, policy bank bonds, municipal bonds and PBoC bills, which are exposed to the risk of fluctuation in interest rates rather than credit quality of the issuers, account for 60% of total outstanding bonds. The remaining 40% is made up by credit bonds, which are issued by companies and enterprises exposing investors to default risk and include enterprise bonds, corporate bonds, financial bonds, commercial paper and mid-term notes. The range of product offerings for credit bonds is much more diversified than it is for interest rate bonds.

Interest rate bonds are issued or backed by the government, and enjoy sovereign credibility. China's sovereign rating has been upgraded to AA- from BBB by international rating agencies over the past decade, while the sovereign ratings of most developed countries have been downgraded during the same period. China remains on track for future potential upgrades backed by its sound economic fundamentals, substantial amount of foreign reserves and strong growth potential. China's onshore government bond market offers an attractive yield pick-up over developed countries, especially under the existing low interest environment, which is further enhanced by the gradual appreciation and low volatility of the RMB since 2005. In addition, the historical correlation between China's government bond yields and developed countries' government bond yields is quite low due to their different interest rate cycles, which provides attractive diversification benefits for global investors.

In order to encourage corporations to raise funds through bond markets rather than over-relying on bank loans, the Chinese regulator highlighted the plan to further develop the bond market (particularly the corporate bond sector) in its five-year strategy. As a result, the percentage of outstanding credit bonds in the whole market soared to 40% at the end of 2014, compared with only 2% in 2000. The new issuance of credit bonds in 2014 accounts for 62% of the total new issuance of China's onshore bonds. With further development of China's onshore credit bond market, increased corporate issuance from the private sector will potentially generate more opportunities for global investors.

China's onshore bonds are traded in two separate markets: the interbank bond market and the exchange traded bond market. The interbank bond market plays a dominant role, with Rmb34.3 trillion at the end of 2014, accounting for 96% of the total outstanding balance of onshore bonds. Interest rate bonds previously dominated trading volume; for instance, government bonds and policy bank bonds usually trade at 1-10bps bid-offer spread with typical trading slot size of Rmb10 to 100 million. Over the past few years, the trading activities of credit bonds has become more and more active with the onshore credit bonds market boom, among which commercial paper, mid-term notes and enterprise bonds together accounted for more than 90% of credit trading turnover. All the onshore credit bonds are rated by domestic rating agencies with AAA-rated and AA-rated bonds traded at 5-10bps and 10-20bps bid-offer spread respectively, in typical trading slot sizes of Rmb30 to 50 million. The improved liquidity of the onshore bond market facilitates global investors' asset allocation into this market.

Foreign access and internationalisation

China has allowed foreign investors to access its onshore market since 2002 through the qualified foreign institutional investor (QFII) scheme. The QFII licence was applicable to asset management companies, insurance companies, securities companies, commercial banks and other institutional investors (such as pensions, trusts and foundations), with quotas mainly used for equity and fixed income investment in China's onshore exchange traded market using foreign currency obtained outside mainland China during the early years. The foreign access to China's interbank bond market started in 2010 when PBoC announced its interbank investment programme, which was originally open to foreign central banks, RMB clearing banks and RMB settlement banks, and then extended to sovereign wealth funds, supranationals and insurance companies. This process was accelerated by the establishment of the RMB qualified foreign institutional investor (RQFII) scheme in late 2011, which enabled foreign investors to access China's onshore exchange traded market using RMB obtained outside mainland China. Under revised QFII and RQFII rules in 2013, the scope of permitted investment was expanded to fixed income products traded on the interbank bond market.

RQFII quota globally (end of January 2015)
Location Authorised quota
limit (Rmb billion)
Aggregated approved
(Rmb billion)
Hong Kong 270 270
Singapore 50 12.3
UK 80 12.2
France 80 6
South Korea 80 4
Germany 80 0
Qatar 30 0
Canada 50 0
Australia 50 0
Switzerland 50 0
Total 820 304.5

The total capacity of the QFII scheme is $150 billion, with $68 billion of investment quota granted to 262 investors at the end of January 2015. The RQFII scheme was initiated in Hong Kong and then expanded geographically to Singapore, UK, France, Korea, Germany, Qatar, Canada, Australia, and recently to Switzerland. The total capacity of the RQFII scheme is Rmb820 billion, among which the Rmb270 billion of Hong Kong capacity has already been fully taken up by 79 local managers, while the remaining geographic regions still have plenty left. Rmb304.5 billion of the RQFII investment quota was granted to 99 investors at the end of January 2015. With regard to PBoC's interbank investment programme, a total of Rmb600 billion quota had been assigned to 138 investors as of November 2013, according to the available figures from an official PBoC statement.

In additional to foreign central banks, sovereign wealth funds and supranationals, there were 125 foreign institutional investors accessing China's interbank bond market as of the end of September 2014, including 87 RMB settlement and clearing banks, 30 RQFIIs and 8 QFIIs. Within a few years of the opening of the interbank bond market to foreign investors, the total amount of interbank bonds held by foreign institutional investors soared to Rmb491 billion, an increase of 56.3% compared with the end of 2013, while the market share of foreign investors is still quite small at around 1.74%. There is huge potential for foreign investors to boost their market share, despite the fact that foreign participation in this market is still in its early stages. The recent reforms in China's onshore bond market including the active promotion of financial innovation, the development of market infrastructure and boosting of the corporate bond market lay a solid foundation for the internationalisation of the market in which global investors could seek more opportunities for their asset allocation.

Ucits initiatives

As China opened its capital market to foreign investors at a significant pace, more and more global asset managers have now access to China's onshore market through QFII and RQFII scheme. The recent regulatory development of the QFII and RQFII schemes offered greater compatibility with Ucits (Undertakings for Collective Investment in Transferable Securities) rules, which enables global asset managers to connect their investment strategies on China's onshore market to their clients around the world through the Ucits structure.

"The Chinese regulator highlighted the plan to further develop the bond market in its five-year strategy"

The revised QFII rules regarding open-end China funds (publicly offered open-end investment funds established outside China) provide more flexibility to the remittance and repatriations of monies in and out of China. However, it is still hard to reconcile the QFII rules with Ucits requirements due to the liquidity concerns arising from the lock-up period and monthly repatriation limitations. In contrast, open-end China funds under revised RQFII rules offer much better flexibility, such as daily liquidity and no lock-ups as well as no limits on the aggregate amount repatriated each month, which further opens the door to structuring RQFII Ucits in the European market. Another key development within the revised RQFII rules is allowing RQFII managers to raise RMB from other rising RMB financial centres outside Hong Kong, for which the use of the Luxembourg Ucits structure to accommodate an RQFII investment strategy would be feasible even if the RQFII quota has not been extended to Luxembourg.

Following the first wave of launching RQFII Ucits with 100% exposure on China's onshore equity market from November 2013, recent efforts have moved onto the recognition of China's interbank bond market as the regulated market eligible for Ucits investment. The interaction last year between the market players and regulator in China's interbank bond market focused on several key issues, such as market transparency, liquidity, regular functioning and local rating credibility. The impressive development of China's interbank bond market, the progress of RMB internationalisation, the expansion of RQFII quotas worldwide and the convincing statement provided by Chinese players in the discussion with the regulator facilitated China's interbank bond market to be recognised as an Ucits-eligible market by the Luxembourg regulator in April 2014.


Head of Asset Management Department,

ICBC (Europe) S.A.
32 Boulevard Royal L-2449 Luxembourg
T: +352 26 86 66 58
F: +352 26 86 66 651
E: li.bing@eu.icbc.com.cn
W: www.icbc.eu

As reported in October 2014, ICBC (Europe) launched its first RQFII Ucits in the European market by leveraging ICBC's expertise in China's onshore bond market, not only enabling it to be the first Chinese bank tapping the European investment fund industry through its European arm, but also signalling the key milestone of the Luxembourg investment fund industry in connecting a Luxembourg Ucits structure with investment strategies on China's onshore bond market through an RQFII scheme. With the Chinese economy's growing expansion and global influence, more and more global asset managers will be brought into China's economic rebalance through their active involvement in China's onshore bond market.