Bond Connect Lures China Offshore Money Back Home to Credit

(Bloomberg) -- Turns out that China's new Bond Connect with Hong Kong isn't just good for foreigners. Offshore Chinese money is using the channel to bring money back home, taking advantage of opportunities in domestic credit products.

With the Chinese yuan's exchange rate rising in recent months against the dollar -- and likely to stay stable with a critical Communist Party leadership conference looming later this year -- that's made it more attractive to invest in higher-yielding domestic bonds.

Since the Bond Connect kicked off on July 3, offshore institutions have taken nearly 1.5 billion yuan ($222 million) of short-term corporate debt with a tenor of no more than one year in the primary market, and another 2 billion yuan plus of secondary transactions, according to data from the Shanghai Clearing House.

With foreign investors generally preferring government bonds, offshore Chinese fund managers are leading the charge into credit, market participants say. Yields on benchmark one-year corporate debt are about 1 percentage point higher than comparable government securities.

"Chinese institutions have a better nose and act more quickly because they're familiar with the issuers and markets on both sides," said Kun Shan, head of local-markets strategy in Shanghai at BNP Paribas SA. Many Chinese banks, securities houses and fund managers have Hong Kong branches or subsidiaries and would choose to repatriate the money to take advantage of the arbitrage opportunity of a rising yuan, according to Shan.

Implied yields on 12-month offshore yuan forward contracts have fallen below the rates on bonds sold by China Development Bank -- a benchmark as it's a so-called policy bank. That shift means it's become cheaper for investors abroad to hedge yuan moves and buy bonds onshore, according to David Qu, a market economist at Australia & New Zealand Banking Group Ltd. in Shanghai.

Bond Connect users have also been dipping into negotiable certificate of deposit, an instrument often used by smaller and regional Chinese banks to raise funds -- securities that would be well known to offshore Chinese managers. Total trade in the securities reached around 2.23 billion yuan since July 3, Shanghai Clearing House show.

Read more here about how China is making its domestic bond market more attractive to investors abroad.

Du Yang, the Hong Kong-based acting head of asset management at China Securities (International) Financial Holding Co., says the fund-management company is now "actively preparing to participate in Bond Connect." He said onshore money-market notes and short-term credit products could provide new assets for the company's clients.

With some recent signs of disruption in the offshore Asian bond market, tapping the Bond Connect to buy domestic credit is all the more attractive. Three sub investment-grade companies recently canceled their debut dollar bonds as buyers sought greater risk compensation.

As for international investors, in time they too might be drawn to Chinese corporate debt, after efforts by regulators to strengthen standards in the market take root. ANZ's Qu reckons it is "just a matter of time."

To contact Bloomberg News staff for this story: Yuling Yang in Beijing at yyang329@bloomberg.net, Ran Li in Beijing at rli279@bloomberg.net, Carrie Hong in Hong Kong at chong61@bloomberg.net.

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Neha D'silva at ndsilva1@bloomberg.net.

With assistance from Yuling Yang, Ran Li, Carrie Hong