China, from niche to necessity:
Inclusion event coverage

Head of EMEA iShares Investment Strategy, Wei Li, and Head of EMEA iShares Fixed Income Strategy, Vasiliki Pachatouridi, discuss the recent Bloomberg Barclays China bond inclusion.

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    Hello, welcome to the Index Insight series, a series of short videos covering major index events with significant implications on portfolios. Today we want to talk about China – China has the second biggest equity market globally and the third biggest bond market globally and yet its assets are not really being held widely outside of China by international investors. Chinese equities are being included in major international benchmarks and the same is starting to happen for China bonds.

    Joining me today to talk about China bond inclusion is Vasiliki Pachatouridi who runs the iShares EMEA Fixed Income Product Strategy team and we are here to talk about all you need to know about China bond inclusion in major international benchmarks. To start: what do we need to know about China bond inclusion?

    Hi Wei, you’re right we’re seeing Chinese bonds starting to be included in international indices – Bloomberg is the first major index provider who has announced their decision to include Chinese bonds in their flagship bond index “The Bloomberg Barclays Global Aggregate Index” (Global Agg), starting on 1st April 2019. The inclusion will be phased out over a period of 20 months which comes down to adding about 30bps of China bond risk every month until November 2020. Using data as of January 2019, the index would include about 360 Chinese securities and that will add up to a weight of about 6% of China being part of the Global Agg Index. That is very significant, it is going to actually be the 4th largest currency pair within the Global Agg – important for every international fixed income investor. In terms of issuers, in the initial inclusion Bloomberg is adding government bonds into the benchmark as well as policy bank bonds from the China Interbank Bond Market.

    6% of Global Agg – that is really significant. What kind of bond market is the China bond market?

    The China bond market has three key components. The first one is the offshore renminbi (RMB) bonds, the second is hard currency bonds, so USD denominated, and the third one is the onshore RMB bonds. Bloomberg’s China bond inclusion initiative relates to Chinese government bonds and policy bank bonds from the onshore RMB bond segment. Just to give you some scale in terms of the size of the market we are talking about – the Chinese onshore market is roughly USD 13 trillion, this is going to be the third largest global bond market.

    When we talk about China bonds being included in major indexes such as Global Agg, what kind of demand does that create in the market?

    We estimate – if you think about the inclusion of Chinese bonds into the Global Agg and the amount of indexed assets that follow that flagship benchmark – that could bring at least USD 150 billion of inflows from overall investors. Taking a step back, this inclusion overall demonstrates the Chinese policymakers support for increased foreign participation in the onshore bond market. Just to remember, we are starting from a very low base, out of about USD 13 trillion of Chinese bond assets, only about 3% of those assets are owned by overseas investors. Really this is just the first step for opening up these markets to international investors.

    When we talk about USD 150 billion of potential demand for the market, is there sufficient infrastructure to support inflows?

    There have been several structural developments and improvements in the Chinese onshore bond market just to get us where we are today. In terms of infrastructure access, there are a couple of schemes for offshore international investors investing into this market. BlackRock considers Bond Connect to be one of the most appropriate access channels that we have at our disposal today. The reason why we have a preference for Bond Connect comes down to operational efficiency, it is a scalable platform, it allows for straight through processing, for trading and settlement and it is also an e-trading platform which is in line with the general direction that fixed income is trending towards – being more of an electronically traded market. We have also seen the improvements and plans to further develop this channel and we are seeing instruments such as hedged products and derivatives being included into Bond Connect in the near future. We welcome all these improvements, they do ultimately make the market more accessible and investible to offshore investors.

    Speaking to offshore investors, in Europe for example, some of the concerns they raise about owning China bonds – or China equities for that matter – is what about liquidity? Specifically for bonds, what about credit ratings, the regulatory environment? It’s not entirely familiar to them, what do we think?

    I don’t foresee any considerable grounds for this concern at this stage. At this point we are talking about bond index inclusion affecting only government bonds and policy banks so the question about credit risk is definitely not relevant until you get to the credit part of the market. Overall right now it comes down to access, it comes down to operational readiness and it comes down to inclusion, and that’s what we’re talking about today.

    So, international investors ready to go and buy China, how does it actually look like from a trading perspective?

    What can we expect there?

    It’s actually pretty okay, we are talking about government bonds and policy banks so relatively liquid, the bid-asks are okay. The point about liquidity – international investors coming into this market is going to improve liquidity. If you think about the onshore market today, it is dominated by onshore investors, and the transactions are very low, they are buy and hold investors. Bringing that international dynamic is definitely going to improve liquidity so we actually welcome that.

    From the perspective of portfolios, when you think about international investors buying China bonds for the first time, what does it bring to their portfolio? Can they rely on China bonds to act as diversifiers in the same way that people look to US government bonds, for example?

    Absolutely. The current inclusion – so government bonds and policy banks – we are talking about sovereign risk here. So these bonds are essentially providing investors with the potential for positive yield which is still very desirable, we still live in a world where we have more than USD 10 trillion of government bond assets yielding negative yields, so that’s one advantage. The second one is the benefit of portfolio diversification, you have a new exposure, a new asset class, a new economy entering your portfolio. That is something that we think is additive to an international investors portfolio.

    Excellent! For someone that is not Chinese you know plenty about China bonds. But do you know how to say that in Mandarin?

    Can I please write that down for you?

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any financial instrument or product or to adopt any investment strategy.

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