New Opportunities for Foreign Investment in China's Bond Market
The 2023 China Balance of Payments Report reveals a notable shift in foreign investment trends, with a net inflow of US$14.1 billion into China's securities, marking a turnaround from the net outflow observed in 2022. This surge is primarily attributed to heightened foreign capital allocation toward RMB-denominated bonds, fostering a gradual stabilization in foreign investment within China's securities domain. Amidst evolving international and domestic macroeconomic policies, alongside trends in economic operations, the ongoing promotion of RMB internationalization, the stable foundation of the RMB exchange rate, and the burgeoning bond market, the allure of China's bond market for international investors is on a steady ascent. Foreign investors are increasingly directing their capital toward RMB-denominated bonds, particularly government bonds, heralding a trajectory of rapid growth and solidifying their role as the primary avenue for foreign investment in China's securities.
Expanding Opening-Up Paves the Way for Foreign Investor Participation
To facilitate foreign investor entry, China has progressively introduced policies opening its bond market since 2005, effectively propelling its continual liberalization. The evolution of China's bond market opening-up can be delineated into three key stages.
2005-2009: Preliminary Opening-Up Phase
In 2005, the Pan Asia Bond Index Fund, a subset of the Asian Bond Fund, gained access to the interbank bond market, marking the initiation of foreign institutional entry into China's bond market. The pilot initiative for cross-border trade settlement in RMB in 2009 fueled the growth of the offshore RMB liquidity pool, escalating the allocation demand and liquidity demand of foreign institutions. The opening-up of China's bond market emerged as an inexorable trend.
2010 to 2015: Foundational Opening-Up Phase
This period witnessed the inception of the China Interbank Bond Market (CIBM) Direct scheme, enabling overseas institutions to partake in the domestic bond market. The RMB Qualified Foreign Institutional Investors (RQFII) pilot program was launched, expanding its scope and relaxing investment restrictions. The participation of foreign central banks, monetary authorities, and sovereign wealth funds was streamlined to a filing system, with quota constraints removed and investment scopes broadened.
2016 to Present: Expansionary Opening-Up Phase
A plethora of financial institutions gained access to the interbank bond market, engaging in various transactions, including spot trades and hedging activities, with quota restrictions lifted. The eligibility criteria for qualified foreign investors were broadened to streamline market entry. The CIBM Direct mechanism witnessed accelerated development, and the foreign exchange derivatives market was opened to overseas entities. The establishment of Bond Connect facilitated indirect entry for smaller foreign investors.
Since 2019, the interbank bond market has introduced flexible policies, allowingnon-transacting transfer of bonds under the same overseas entity QFII/RQFII and direct entry channels. In 2020, restrictions on foreign exchange risk hedging under the direct investment mode of the interbank bond market were relaxed. Policies exempting foreign institutional investors from corporate income tax and value-added tax on bond interest income were extended until the end of 2025, aiming to bolster foreign investor participation.
In 2022, further market liberalization occurred, enabling investors in the interbank bond market to participate directly or via connectivity in the exchange market. QFII/RQFII were permitted to engage in related futures and options contract trading, while unified regulations were established for foreign institutional investors, streamlining their market operations. Enhanced management requirements for panda bond funds were implemented, and the Swap Connect was launched, facilitating domestic and foreign investor connectivity.
Continued Expansion of China's Bond Market Opening-Up
The ongoing expansion of China's bond market opening-up has led to a steady uptick in the number and diversity of foreign investment entities participating in the market. According to data from the ChinaBond Research Center, as of the end of 2023, a total of 1,124 foreign institutional entities had ventured into the interbank bond market, spanning central banks, sovereign wealth funds, commercial banks, insurance companies, asset management institutions, and international financial organizations. Remarkably, nearly 90 out of the top 100 global asset management institutions have made inroads into China's bond market. Collectively, these entities held a custody balance of 3.67 trillion yuan in the domestic interbank bond market by the close of 2023, contributing to 2.3% of the total custody balance. Foreign institutions have diversified their holdings across various domestic bond categories, including treasury bonds, local government bonds, financial bonds, corporate bonds, and negotiable certificates of deposit. Notably, owing to their high credit ratings and stable returns, treasury bonds have emerged as a preferred choice among foreign investors. As of the end of 2023, the custody balance of treasury bonds in the interbank bond market held by foreign institutions surged to 2.29 trillion yuan, marking a 2.7-fold increase from the end of 2017 and accounting for over 60% of the total bonds under foreign cus