Investment regulation - China - China Interbank Bond Market
Background
The China Interbank Bond Market (CIBM) was formed in June 1997 when the People’s Bank of China (PBOC) mandated all commercial banks to move their repo and bond trading out of the stock exchanges and into an interbank market operating through an electronic trading system. The major debt instruments traded in the CIBM are government bonds, PBOC bills, and other financial debts.
On 16 August 2010, the PBOC released a circular on the pilot program for foreign institutions’ investment (using RMB fund) in the CIBM. Three types of foreign institutions were allowed to invest in CIBM (2010 PBOC Pilot Program):
- Type 1: Foreign central banks or monetary authorities
- Type 2: RMB clearing banks in Hong Kong SAR and Macau SAR
- Type 3: Overseas participating financial institutions engaging in RMB cross-border trade settlement
Central banks, SWFs and International Financial Organisations
In July 2015, PBOC released “Notice on Foreign Central Banks, Monetary Authorities, International Financial Organisations and Sovereign Wealth Funds to invest in the China Inter-bank Bond Market using RMB Fund” (2015 PBOC Notice). Key revisions are summarised as follows:
- Relevant foreign investors can appoint PBOC or licensed settlement bank for CIBM trading and settlement.
- The application process is changed from approval to registration.
- The investors are allowed to trade bonds, repo, bond lending, bond forwards, IRS and FRAs and other trading instruments permitted by PBOC.
Overseas Institutional Investors
On 24 February 2016, PBOC released Announcement [2016] No.3 regarding ‘‘Investment of Overseas Institutional Investors in the Inter-bank Bond Market” (2016 PBOC Announcement). Key revisions are summarised as follows:
- Eligible investors type
- Financial institutions that meet the requirements set out in this Notice and registered outside People’s Republic of China, including commercial banks, insurance companies, securities companies, fund management companies and other asset management institutions;
- Investment products lawfully launched by the aforesaid institutions;
- Other mid-term and long-term institutional investors such as pension funds, charity funds and endowment funds etc.
- Investor eligibility requirement
- Incorporated in accordance with relevant laws of its domiciled country/region
- Have a sound governance structure and adequate internal control mechanism; No significant penalties imposed by regulatory authorities on its bond investment business in the last three years due to violation of laws or regulations
- Fund comes from legitimate source
- Able to identify and undertake risks in bond investment
- Other requirements set by PBOC
- Quota approval is no longer required at individual investor level.
- The application process is changed from approval to registration.
- The settlement agent will examine and verify the eligibility of the overseas institutional investors as per PBOC’s provisions. Settlement agent can only accept the entrustment from qualified overseas institutional investors.
- It laid out the eligibility and responsibility of the settlement agents, who may take on the custodian role.
On 27 May 2016, PBOC Shanghai and SAFE issued the following documents concerning overseas institutional investors investing in the CIBM, further to the release of the aforementioned PBOC announcement [2016] No.3:
- The 'Implementation Details on the Registration Management of Overseas Institutional Investors Investing in the Inter-bank Bond Market' issued by PBOC Shanghai (the 'PBOC Implementation Details').
- The 'Notice on Issues Concerning Foreign Exchange Administration for Overseas Institutional Investors Investing in the Inter-bank Bond Market' issued by SAFE.
- The 'Q&A on matters concerning overseas institutional investors investing in CIBM' issued by PBOC.
Key points are summarised as follows:
- Settlement agents shall perform their duties to verify the qualification of the overseas institutional investors based on the principles of Know Your Customer, Know Your Business and due diligence.
- If the fund injection is less than 50% of the anticipated investment size registered with PBOC within nine months from the date on which the registration is completed, the overseas institutional investor should refile the information such as the anticipated investment size etc.
- Should the overseas institutional investor need to change its registration information or exit then CIBM, it shall entrust the settlement agent to promptly submit application and relevant documents to PBOC Shanghai Head Office.
- The ratio of foreign currency and RMB in overseas institutional investors’ accumulated outward remittance shall basically be in-line with that of the accumulated inward remittance, and the fluctuation should be within +/-10%. The first repatriation can be conducted without following such ratio; however, the repatriation amount (regardless of foreign currency or RMB) cannot exceed 110% of the accumulated inward remittance.
On 27 February 2017, SAFE released Circular on Issues Concerning CIBM OIIs’ FX Risk Control, allowing OIIs under PBOC [2016] No.3 Announcement to trade over-the-counter FX derivatives (including FX forward, FX swap, currency swap and option, etc.) in China through their settlement agent bank:
- OIIs must follow the “Trading on Actual Needs” principle when conducting the FX derivatives business.
- Such investment is for the purpose of hedging OIIs’ FX exposure arising from the inward remittance related to CIBM investment.
- FX derivatives exposure is reasonably correlated with the bond investment exposure.
- When the FX risk exposure varies due to the change in CIBM investment position, OIIs must adjust their corresponding FX derivatives exposure within five working days, in order to ensure the position is on actual needs purpose.
- The FX proceeds and payments arise from the FX derivatives investment should be settled in the Special Foreign Currency Account opened for facilitating CIBM investment.
On 19June 2018, PBOC Shanghai issued PBOC Shanghai Head Office Announcement [2018] No.2 to simplify the information collection and filing requirement of OIIs investment in CIBM. It is highlighted in the Announcement that:
- The registration form for CIBM Direct and Bond Connect is streamlined. For CIBM direct, the form is updated by removing the “Anticipated Investment Volume” and “Initial Investment Intention” (bond instrument type, investment horizon, etc.) fields for CIBM Direct with immediate effect.
- Previously, the investor must re-file the anticipated investment size with PBOC if the fund injection is less than 50% within nine months form the date on which the registration is completed. This is no longer required and relevant Article has been abolished.
On 29 March 2019, SAFE released FAQs Concerning Foreign Exchange Administration for Overseas Institutional Investors Investing in the Inter-bank Bond Market (Volume 2), to interpret the remittance and repatriation monitoring mechanism for investing in the China Inter-bank Bond Market as stated in Article 4 of Notice on Issues Concerning Foreign Exchange Administration for Overseas Institutional Investors Investing in the Inter-bank Bond Market (Huifa [2016] No. 12).
- OIIs that invest only with inward remittance in RMB should repatriate their invested principal and profit in RMB, with no limitations on the ratio.
- OIIs that invest only with inward remittance in foreign currency should repatriate their invested principal and profit in foreign currency, with no limitations on the ratio.
- For OIIs who invest with inward remittance in both RMB and foreign currency, the settlement agents should arrange relevant repatriation of RMB and foreign currency according to the ratio in-line principle. For operation efficiency, the settlement agents can choose either of the following two approaches.
Monitoring by ratio
The ratio of RMB and foreign currency in the OIIs’ accumulated outward remittance shall basically be in-line with that of the accumulated inward remittance, and the fluctuation should be within +/- 10% (please refer to “FAQs Concerning Foreign Exchange Administration for Overseas Institutional Investors Investing in the Inter-bank Bond Market (Volume 1)” in 2016 for reference).
The first repatriation in RMB and the first repatriation in foreign currency can be conducted without following such ratio, however, the first repatriation amount in RMB or foreign currency cannot exceed 110% of the accumulated inward remittance in RMB or foreign currency.
Monitoring by amount based on the inward remittance structure and return of CIBM investment
The amount of OIIs’ accumulated outward remittance in RMB cannot exceed 110% of the accumulated inward remittance amount in RMB; the amount of OIIs’ accumulated outward remittance in foreign currency cannot exceed 110% of the accumulated inward remittance amount in foreign currency.
OIIs’ outward remittance for bond investment liquidation from the inter-bank bond market (that is, exiting completely from onshore inter-bank bond market) can be conducted without the above monitoring.
Registration process
- Step I: Registration with PBOC
- Central Banks, Monetary Authorities, International Financial Organisations and Sovereign Wealth Funds’ registration with PBOC Beijing
The investor along with the support of the settlement agent will prepare, fill, complete and submit the registration form to PBOC Beijing. PBOC will provide feedback to the applicant via email within 10 working days upon receipt of registration form. - Overseas Institutional Investors’ registration with PBOC Shanghai
The settlement agent will examine the qualification of the overseas institutional investors based on the principles of “Know Your Customer”, “Know Your Business” and “Due diligence” per PBOC’s requirements.
The settlement agent will provide support to the investor to register Bond Settlement Agency Agreement (BSAA) and registration documents with PBOC Shanghai on their behalf.
PBOC Shanghai Head Office issues Registration Filing Notice to the applicant within 20 calendar days upon receipt of registration documents.
Once filing is completed, PBOC Shanghai will issue a “Filing Notification Letter”, which is a mandatory document for the account opening with CCDC, SCH and CFETS. The registration filing notice is valid for three months after its issuance. For re-submission of registration application, the investor shall provide an explanation.
- Central Banks, Monetary Authorities, International Financial Organisations and Sovereign Wealth Funds’ registration with PBOC Beijing
- Step II (ii): Opening Basic and Special RMB Account with PBOC
Central Banks, Monetary Authorities, International Financial Organisations and Sovereign Wealth Funds are only required to open Special RMB account with PBOC whereas overseas institution investors are to open both Basic and Special RMB accounts. - Step III (i): Opening bond account and DVP cash clearing account with China Central Depository and Clearing Co. Ltd. (CCDC)
CIBM investors need to open the bond account with CCDC to invest in CIBM. The settlement agent will submit the required documents to CCDC on behalf of CIBM investors.
In addition, on 5 September 2013, PBOC released the “Notice on the Implementation of Delivery Versus Payment (“DVP”) settlement method in CIBM” to further improve the market efficiency, prevent risk and promote a healthy market development. According to PBOC’s Notice, market participants (including CIBM investors) shall settle the bonds with DVP settlement method via DVP cash clearing account opened with CCDC. Therefore, clients need to apply to CCDC to open the DVP cash clearing account accordingly.
Once CCDC reviews the application documents and they are in good order, CCDC will proceed with account opening and issue a “Bond Account Opening Notification Letter” to the settlement agent. - Step III (ii): Open bond account and DVP cash clearing account with Shanghai Clearing House (SCH) (in parallel with Step III (i))
If investors would like to trade the fixed-income instruments (e.g. short-term commercial papers) listed at SCH, the settlement agent will assist these investors to open the bond account with SCH.
In addition, investors also needs to open the DVP cash clearing account with SCH by filling in the relevant section in the application form of SCH bond account opening form. - Step III (iii): Apply for trading in CFETS (in parallel wthe Step III (i) and (ii))
Investors need to apply to CFETS for trading in CIBM. The settlement agent will submit the required application documents upon receipt of good documents.
Trading restrictions
- According to 2015 PBOC Notice, Foreign Central Banks, Monetary Authorities, International Financial Organisations and Sovereign Wealth Funds are permitted to trade bonds, repo, bond lending, bond forwards, IRS and FRAs.
- According to the FAQs on PBOC Shanghai Head Office Notice [2016] No. 2, eligible overseas institutional investors can trade cash bonds in CIBM, as well as bond lending, bond forward, forward rate agreement and interest rate swap etc., solely for hedging purpose. Overseas RMB clearing banks and eligible participating banks can also trade bond repo.
- Once bond trade is executed, the deal cannot be cancelled or amended anymore.
- According to the Notice on Issues Concerning Foreign Exchange Administration for Overseas Institutional Investors Investing in the Inter-bank Bond Market issued by SAFE, the Settlement Agent shall perform the inward/outward remittance and settlement of foreign exchange for the Overseas Institutional Investors with business certificates generated upon registration and the contents of the control information form in the System. The ratio of foreign currency and RMB in the Overseas Institutional Investors’ accumulated outward remittance shall basically be in-line with that of the accumulated inward remittance, and the fluctuation should be within +/-10%. The first repatriation can be conducted without following such ratio, however, the repatriation amount in foreign currency or RMB cannot exceed 110% of the accumulated inward remittance.