After the "Stock Connect", "Bond Connect" and "cross-border financial Connect", the "swap Connect" is coming!

The People's Bank of China has drafted the Interim Measures for the Administration of Cooperation on the Connectivity of the Interest Rate Swap Market between the Mainland and Hong Kong (hereinafter referred to as the "Swap Line") (hereinafter referred to as the "Measures"), in order to regulate the relevant business of cooperation on the Connectivity of the Interest rate Swap Market between the Mainland and Hong Kong (hereinafter referred to as the "Measures"), and protect the legitimate rights and interests of domestic and foreign investors. It opened for comment on February 17.

This indicates that the connectivity of the financial markets of the mainland and Hong Kong will soon be further expanded from the fields of stocks, funds, bonds, and wealth management to the financial derivatives market. The chief economist of CITIC Securities clearly said that on the one hand, the launch of the "swap Connect" will have a synergistic effect with the "Bond Connect", further deepening the opening of China's bond market to the outside world, and providing foreign investors with interest rate risk hedging tools; On the other hand, it is also of great significance for promoting the internationalization of RMB.

The bond market has been further opened up

In recent years, China's bond market has been increasingly open to the outside world, especially since 2017, the "Bond Connect" North-South link has been launched, becoming an important milestone in the opening up of China's financial market. By the end of 2022, the trusteeship balance of foreign institutions in China's bond market was 3.5 trillion yuan, accounting for 2.4% of the total trusteeship balance of China's bond market. As foreign investors expand their bond holdings and become more active in trading, their demand for derivatives to manage interest rate risk continues to increase.

It is against this background that, in order to further facilitate the participation of foreign investors in the domestic RMB interest rate swap market, the People's Bank of China, together with the Securities and Futures Commission of Hong Kong and the Hong Kong Monetary Authority, conducted in-depth studies on supporting the clearing of cross-border derivatives transactions through infrastructure connectivity between the two places, and issued a joint announcement on 4 July 2022. Announced the launch of the "swap link". After that, the People's Bank of China conducted extensive market research, studied and drafted the "Measures", and made principled provisions on the relevant mechanism arrangements and regulatory requirements of the "swap line".

Specifically, the "swap line" is a mechanism arrangement for domestic and foreign investors to participate in the Hong Kong financial derivatives market and the mainland interbank financial derivatives market through the connection between Hong Kong and Mainland infrastructure institutions. Initially, the "Northbound Swap Connect" will be opened, that is, overseas investors in Hong Kong and other countries and regions (hereinafter referred to as "overseas investors") will participate in the Mainland interbank financial derivatives market through the mechanism and arrangement of interconnection between Hong Kong and Mainland infrastructure institutions in terms of trading, clearing, settlement, etc.

In the future, the study will be extended in due course to the "Southbound Swap Link", whereby domestic investors can participate in the Hong Kong financial derivatives market through the arrangement of the connectivity mechanism between the infrastructure institutions of the two places.

According to the data previously disclosed by the People's Bank of China, from the perspective of the interbank derivatives market, since its launch in the interbank market in 2006, the RMB interest rate swap, as a major variety, has undergone steady and healthy development for many years, gradually expanding the scale of transactions, increasingly rich participants, and effective play of risk management functions, with a turnover of 21.1 trillion yuan in 2021. "The scale of foreign bond holdings is expanding, while the daily trading is active, and the demand for hedging interest rate risk has also increased. As one of the main interest rate derivatives, interest rate swap can better meet the needs of foreign investors to hedge interest rate risk." Clearly said.

And "bond Connect" to promote the internationalization of the renminbi

Wang Zhiyi, president of the Institute of Cross-border Finance, said in an interview with the Financial Times reporter that the Measures have a total of 23, clarifying the definition and investment scope of the "swap pass". According to the Measures, the initial trading object of the Northbound Swap Connect is interest rate swap products, and the quotation, transaction and settlement currency is RMB.

"Foreign investors investing in China's bond market are more likely to invest in Treasury bonds or policy financial bonds, which have lower credit risk." So from a trading perspective, what they need to pay close attention to is interest rate risk and exchange rate risk. "The hedging channels and instruments are abundant enough so that foreign investors can invest more confidently and boldly in the Chinese bond market." Wang Zhiyi analyzed that the "swap pass" business to be launched this time is a hedging tool for foreign investors in terms of interest rate risk. Specifically, the launch of the "swap line" can facilitate foreign investors to use interest rate swaps to manage risks, reduce the impact of interest rate fluctuations on the value of their bond holdings, smooth the cross-border flow of capital, and further promote the internationalization of RMB.

In the clear view, the launch of the "swap connect" will have a synergistic effect with the "Bond Connect", which will not only provide derivative instruments for foreign investors to hedge interest rate risks, but also improve the participation of foreign investors in China's financial market. "It is not enough to just open up the renminbi bond market at the moment, it is also necessary to open up the interest rate swap market to provide corresponding risk hedging instruments." Mingming also said that last year was subject to the inverted interest rate spread between China and the United States, and the pace of foreign investment in China's bond assets slowed down. Foreign investors have recently resumed their investment in the Chinese market. In the medium and long term, under the background of deepening opening-up of China's bond market, it is still the general trend for foreign capital to continue to increase its holdings of China's bond assets.

At the same time, it is clearly indicated that the launch of the "swap connect" is also of great significance for the internationalization of RMB. He said that the current internationalization of RMB is more reflected in the function of RMB as a trade settlement currency, while the function of RMB as an investment and financing currency still needs to be improved, and to further promote the internationalization of RMB, it is necessary to deepen the openness of China's financial market. When the overseas RMB capital pool increases to a certain scale, there needs to be a matching RMB asset pool to provide enough investable RMB assets. Therefore, the launch of the "swap line" and the standing swap agreement between the People's Bank of China and the Hong Kong Monetary Authority in July 2022 are of great significance for promoting the internationalization of the RMB.