by Hayden Briscoe, Head of Fixed Income, Asia Pacific
Bloomberg's inclusion of Chinese onshore bonds into its main global index from April 2019, subject to certain conditions, isn't about market access - the market has been open for years.
We regard it as a "big bang" moment because it will force further reforms, compel international investors to take notice, and expand China's onshore markets into the second largest in the world in coming years.
In a world with little yield but attractive nominal and real yields onshore in China, this should prove to be an excellent investment opportunity for investors, who ought to prepare accordingly.
It's not about access
Fund managers may say that China's bond market is new territory, but we have been investing there for several years.
Starting in 2013, we invested through quotas on the China Interbank Bond Market, then without restrictions when limits were removed in 2017.
Today, the interbank market is open to all investors with a local custodian account and approval is straightforward.
Bond Connect offers an alternative to investors not resourced in the region with an onshore setup and also provides direct access to the markets.
It's about inclusion
From April 2019, Bloomberg has proposed to begin a 20-month process of adding over 300 bonds from policy banks and the government into its Bloomberg Barclays Global Aggregate Bond index benchmark.
The index providers have stipulated some aspects of settlement and tax clarification are requirements before the full implementation.
When completed, international investors that track the benchmark will have to allocate to China's onshore markets, and that amounts to a large commitment because the bonds included will account for an estimated 5.49% of the total index, or an projected market value of $2.94 trillion, according to Bloomberg data as of January 31, 2018.(1)
Three reasons why this is a 'Big Bang' for China's bond markets
The announcement came slightly earlier than we expected, but we think this is testament to both China's market access reforms in the past five years and overseas investors' demand for Chinese fixed income.
We see the index inclusion announcement as a big bang moment for Chinese fixed income for three main reasons.
Firstly, we believe other major indices will follow suit. Bloomberg's announcement demonstrates that international indices recognize China's steps to open its bond market and we expect other benchmark providers, like the Citibank World Government Bond Index, to surely follow.
Secondly, the RMB internationalization process will accelerate. We've had SDR inclusion, MSCI A share inclusion, central banks and sovereign wealth funds publicly announcing allocations to the RMB and Chinese bonds, countries becoming official clearing hubs for RMB, and new RMB-priced oil futures contracts starting
The reforms have been vast and the pace of reform continues to surprise on the upside. The bond inclusion from this perspective looks like a natural progression in a long list of opening-up measures already in place in China's financial markets.
Finally, the move will trigger a large-scale reallocation of capital to China's onshore markets.
Put simply, index tracking investors will have to shift their allocations to meet the benchmark weights when Chinese bonds are included, both in Bloomberg's index and other benchmarks.
Accelerating the transformation in China's onshore markets
Onshore markets have already been growing rapidly, reaching RMB 63 trillion (USD 9.7 trillion) at the end of December 2017, as China has moved from a bank-led financing system to one where capital markets play an increasing role.
Exhibit 1: China Onshore Bonds Outstanding (RMB trillions), Jan 2008-Jan 2018