China mulls doubling Southbound Bond Connect to one trillion yuan

[HONG KONG] China is considering doubling an investment channel local investors use to buy bonds overseas, according to sources familiar with the matter, a major step in its efforts to loosen restrictions on financial flows.

Regulators in the country have held early talks about expanding the so-called Southbound Bond Connect programme to as much as one trillion yuan (S$178 billion), said the sources, who asked not to be identified because the details are private. The expansion would be through an up to 500 billion yuan annual quota to non-bank financial institutions, which are currently left out of the trading link.

Any such move would allow onshore firms to ramp up their exposure to international bonds that are tradeable through Hong Kong’s stock exchange, including those denominated in US dollars. The country’s biggest mutual funds would be among the firms eligible for the new quota, the sources said.

No final decisions have been taken and any eventual plan would need approval from relevant regulators, the sources said.

The proposal is the latest sign of Beijing’s increasing determination to boost two-way flows in its financial market, something that may ultimately bolster the international appeal of the yuan. Chinese policymakers for years kept a tight grip on investments into and out of the country, wary of putting pressure on their currency. But as the US dollar has plummeted this year, they have seized their chance.

The potential doubling of the southbound link comes after a flurry of moves including an expansion of a cross-border payment system, a broadening of the contracts foreigners can trade and a separate move to allow Chinese funds to invest more of their money overseas.

The People’s Bank of China did not immediately respond to a request for comment. The Hong Kong Monetary Authority declined to comment.

A Bond Connect anniversary summit will take place on Tuesday (Jul 8) in Hong Kong, though there is no indication that any announcements concerning the southbound programme would be made there.

Currency ambitions

Although any expanded southbound investment link would not directly spread the international use of the renminbi, it could help chip away at one of the main criticisms from yuan sceptics: that China’s capital controls mean its market is effectively closed off to the world, limiting the appeal of its currency.

If any expansion were to eventually go ahead, it could also spark stronger demand for offshore yuan-denominated bonds, giving a boost to the dim sum market. Chinese investors can get a big pick-up by putting their money into offshore yuan debt, where yields are frequently higher than the same issuers pay onshore.

China’s central bank governor Pan Gongsheng delivered a speech last month outlining what it would take to challenge the US dollar’s place at the heart of the global trading system. He suggested a shift away from a global system reliant on the US dollar to one where several currencies play a big role.

Foreign investors can buy onshore bonds through a similar northbound link, which is not subject to a quota.

Bloomberg LP, the parent company of Bloomberg News, provides services related to Bond Connect.

Investors already had a hint that such a move could be coming: In January, the People’s Bank of China and the Hong Kong Monetary Authority tentatively agreed to expand the list of eligible investors for the southbound bond link, saying they wanted to include securities firms and insurers.

Bond Connect operates in a closed-loop system, meaning investors are not permitted to buy bonds through the trading link and then use the proceeds from selling them to invest elsewhere outside mainland China.

The annual quota for the southbound link has been unchanged at 500 billion yuan since it was launched in 2021. BLOOMBERG