China integrates bond market trading

China has taken a major step to integrate its bond markets by launching a connect program, a move that will improve market efficiency and facilitate foreign investment, experts said on July 20.

The People's Bank of China, the central bank, said on July 19 that the nation will embark on an infrastructure connection mechanism between the interbank and exchange bond markets, whereby qualified investors from either market will be allowed to trade bonds listed on the other one.

The mechanism aims to liberalize cross-market capital flow to form a unified market and same trading prices, so as to facilitate monetary policy transmission and strengthen the capacity of the bond markets in serving the real economy, a PBOC statement said.

Zhang Xu, an analyst with Everbright Securities, said that the bond connect mechanism will simplify the procedures for institutional investors of opening accounts, trading, clearing and settlement, facilitating cross-market investment and therefore free capital flow across markets.

"Overseas investment institutions can also enjoy the convenience, which will make the onshore bond market more attractive and further promote the internationalization of the Chinese yuan," said Zhang.

Policy and commercial banks, including foreign-invested banks operating in China, will be allowed to opt for trading in the exchange market via the connect mechanism or by setting up an account in the exchange market, according to the PBOC.

The move came after a high-level guideline released in April specified a slew of tasks to promote market-based allocation of production factors, including pushing ahead the connection of bond markets.

Partly due to the need to isolate risks of the securities sector from the banking industry, the onshore bond markets have been fragmented for years, according to experts. The dominant interbank market is supervised by the PBOC and counts banks as major participants, while the smaller exchange market has non-banking institutional investors and is under the regulation of the China Securities Regulatory Commission, the top securities regulator.

As a step to integrate the two markets, China has allowed a larger scope of banking institutions, including foreign ones, to take part in spot-market auction trading of exchange market-listed bonds after they opened accounts at the market since last August.

The move announced on July 19 will further unify the markets by making spot-market transactions via one-to-one negotiations with the issuer available to banking institutions, a mode analysts said is more favored by banks than auction trading.

Yang Yewei, an analyst with Guosheng Securities, said the link mechanism will help reduce or even eliminate the bond spreads between the two markets and unify the trading prices, enhancing the efficiency of the onshore bond markets.

The move will also foster the opening-up of the domestic exchange bond market. Foreign investment is expected to continually increase, which can consolidate the Chinese bond market's ranking as the second-largest in the world, said Yang.

Xue Yi, a finance professor with the University of International Business and Economics in Beijing, said preparatory work still needs to be done before unveiling the connect program, given the institutional differences of the two exchanges such as when it comes to trading rules.