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In another move for higher integration of their financial markets, China and Hong Kong will work together to launch an interest rate swaps trading facility called Swap Connect after six months. The mutual access to interest rate swap trading will allow foreign investors to hedge the market risks attached to the $553 bn in onshore yuan bonds held by them.
The latest initiative of promoting the onshore financial derivatives market is among a string of moves that China has made to integrate its markets with those overseas. Beijing has been trying to hype up Hong Kong’s role as an international financial hub and is further opening China’s interbank derivatives market.
The benefit of interest rate swap
Investors in Hong Kong and overseas will be allowed access to the mainland interbank derivatives market through northbound trading. A joint statement by Hong Kong’s Securities and Futures Commission (SFC), the Hong Kong Monetary Authority (HKMA), the People’s Bank of China (PBOC), China Foreign Exchange Trade System (CFETS) and Shanghai Clearing House said the service will launch at the end of 2022.
“Swap Connect is another major milestone in deepening connectivity between mainland China and international markets,” said Nicolas Aguzin, CEO of Hong Kong Exchange and Clearing Limited (HKEX). “Just as Stock Connect and Bond Connect have changed the DNA of equity and fixed-income markets, Swap Connect will do the same for the interbank derivatives market.”
The Hong Kong-China Stock Connect and Bond Connect program allows Hong Kong and overseas investors to trade in stocks and bonds, respectively, listed on the Shanghai and Shenzhen exchanges.
The Swap Connect scheme is expected to further bolster the development of China’s capital markets while giving overseas investors better access to financial assets available in the country. An additional feature is the ability to aid foreign investors to hedge their yuan bond bets. Foreign investors have been reducing exposure to yuan bonds throughout 2022 owing to geopolitical uncertainties as well as a slowdown in China’s economy due to its zero-Covid policy. Investor pessimism has been so high that they even sold China’s sovereign bonds, generally considered the most liquid instruments traded on China’s interbank bond market.
“Over the longer term, this mechanism (Swap Connect) will help stabilise the (bond) market development in China, as it helps encourage longer-term investing,” said Leung Fung-yee, the SFC’s deputy CEO.
At present, the Swap Connect scheme will only offer interest rate swaps with a possibility of expansion into other derivatives. While northbound trade will begin first, southbound trade will be launched later to enable mainland investors to access the Hong Kong derivatives market.
The new initiative comes days after the 25-year anniversary of the handover of Hong Kong to China. Recent geopolitical moves by China to integrate Hong Kong with the mainland have put off overseas investors, impacting the trade volumes on the Hong Kong stock exchange.
Separately, an ETF Connect scheme was launched earlier this week to solidify Hong Kong’s position as the top ETF trading hub in Asia. The total turnover on the debut day of ETF Connect stood at $32.7 m. China has also upgraded a currency swap facility with Hong Kong to a permanent agreement — expanding the size to 800 bn yuan ($119.32 bn) from 500 bn yuan.
