newbaccarat| The nominal principal of the transaction is close to 1.77 trillion yuan. What has the "Swap Connect" brought to foreign investors?

21st Century Economic report reporter Chen Zhi reporting from Shanghai

Since the official launch of "swap" on May 15, 2023Newbaccarat"swap" is increasingly becoming an important interest rate risk hedging tool for many foreign capital to invest in domestic bonds.

The so-called "swap" means that foreign investors can participate in the mainland interbank financial derivatives market through the interconnection of financial infrastructure between the two places, and carry out interest rate risk hedging and hedging operations for their holdings of RMB bond assets such as Chinese treasury bonds.

According to data released by the central bank on May 13, by the end of April this year, 58 foreign institutional investors had entered the market under the "swap" channel, including foreign sovereign institutions, commercial banks, securities companies, asset management companies and other types of qualified institutional investors, covering more than 10 countries and regions. A total of more than 3600 RMB interest rate swap transactions have been reached, with a total nominal principal of nearly 1.Newbaccarat.77 trillion yuanNewbaccaratThe average daily trading volume increased from less than 3 billion yuan in the first month of launch to more than 12 billion yuan in April this year. Since the launch of the "swap", the debt held by foreign institutions in China's bond market has increased by nearly 800 billion yuan.

"this means that the swap is becoming an indispensable interest rate risk hedging tool for foreign capital to invest in domestic bonds in China." An emerging market investment fund manager told reporters. In the past, foreign capital mainly hedged the interest rate risk of domestic RMB bonds through overseas financial derivatives. however, overseas financial derivatives generally have some problems, such as illiquidity, low settlement efficiency, large spread quotation (raising the corresponding risk hedging cost) and so on. After the introduction of "swap", more and more foreign capital have tried to use "swap", and achieved a good effect of interest rate risk hedging.

He told reporters that even though the upside-down range of Sino-US interest rate spreads widened to about 250 basis points last year, through the "swap", the upside-down range of Sino-US interest rate spreads corresponding to the holding of domestic bonds by some foreign capital was less than 200 basis points. effectively alleviate the pressure of forced reduction of domestic bond holdings caused by the expansion of Sino-US interest rate spreads, so that China's bond investment strategy maintains a high degree of continuity and yield robustness.

"at present, more and more foreign capital is studying the combination of interest rates and exchange rate derivatives to create a return on RMB bonds no less than the yield on US debt." The emerging market investment fund manager pointed out.

A Hong Kong bond investment fund manager believes that at present, the most active participants in the "swap" are long-term capital such as foreign central banks and sovereign wealth funds, because they use Chinese bonds as specific reserve assets. in turn, the "swap" is used as an important tool to hedge the interest rate risk of bond positions. In order to attract more different types of foreign capital to participate in investment, the relevant departments also need to provide "swap" contract products that are more standardized and in line with international operating practices, to meet their risk hedging and liquidity management requirements between different types of assets.

In response to the demands of some investors at home and abroad, such as the lack of duration management function under the "swap" and the proposal to increase standardized contracts to optimize cash flow management, the relevant departments have responded positively.

On May 13, the people's Bank of China, the Securities and Futures Commission of Hong Kong, and the Hong Kong Monetary Authority, on the basis of fully summing up the operation experience of the "swap" and conscientiously listening to the opinions and suggestions of investors at home and abroad, support the further optimization of the "swap" mechanism. These include the introduction of interest rate swap contracts (IMM contracts) with the international money market settlement day as the payment cycle, in line with the mainstream international transactions; the introduction of historical starting interest contracts with contract compression services and supporting support; and the extension of "swap" fee concessions for another year. Measures such as full reduction of clearing fees for domestic and foreign investors through "swap".

A number of industry insiders pointed out that this will attract more different types of foreign capital to participate in "swap" transactions, especially for various overseas asset management institutions and hedge funds that require higher matching requirements for trading closing and capital liquidity management. standardized contracts and contract compression services will further reduce capital occupation costs and expand their scope of risk hedging transactions in international financial markets. To make their RMB bonds more valuable.

Zhang Jinqiu, vice president of HSBC China and co-director of Capital Markets and Securities Services, pointed out that after the official launch of the northbound "swap", with the further development of the domestic bond market, the increasing variety of bonds, and the continuous improvement of the risk hedging mechanism, more foreign capital will flow into the domestic RMB bond market, especially long-term capital. This not only provides an opportunity for international investors to share the dividends of China's economic development, but also helps to further diversify the investor structure of China's bond market.

Using "swap" to hedge interest rate risk

A number of people from overseas investment institutions have bluntly said that the introduction of the "swap" has effectively solved the difficult problem of interest rate risk hedging that has been troubling foreign capital to invest in China's domestic bonds.

Specifically, first, many overseas investment institutions require investment teams to "cooperate" with corresponding interest rate risk hedging tools when investing in emerging market bonds, and the introduction of "swap" effectively fills this gap. However, compared with overseas derivatives involved in interest rate risk hedging in RMB bonds, "swap" products provide lower spread quotations and settlement efficiency by virtue of the higher trading activity in the domestic interbank interest rate derivatives market. solve their interest rate risk hedging pain points.

The aforementioned emerging market investment fund managers told reporters that before the introduction of the "swap", they could only choose overseas TRS derivatives (Total Return Swap, total income swaps) or offshore market NDIRS products (Non-Deliverable Interest Rate Swap, non-deliverable interest rate swaps) to hedge the relevant interest rate risk. However, the hedging effect of the interest rate risk of RMB bonds generated by these offshore RMB interest rate swap instruments is not as good as expected.

The reason is that, first, many offshore RMB interest rate swap products are settled in US dollars, so that foreign capital has to face additional exchange rate risks; second, most offshore RMB interest rate swap products are non-deliverable, so even if foreign capital "bet on" the direction of interest rate fluctuations through these derivatives, they cannot lock in their own interest rate risk hedging returns through position delivery. Third, many offshore RMB interest rate swap products are over-the-counter transactions and centralized settlement, resulting in poor liquidity of derivatives, unable to meet the liquidity management requirements of foreign capital positions.

"after the introduction of the swap, they specifically studied the trading mechanism of the swap and the trading activity and settlement efficiency of financial derivatives between domestic banks, and found that the hedging effect of interest rate risk was significantly better than that of overseas." He pointed out. At present, they are proposing to hedge the interest rate risk of RMB bond positions through a "swap", which can be quickly implemented with the approval of the Fund Investment Committee.

In the view of many people in the industry, the advent of "swap" has also increased the stability of foreign capital holding RMB bonds.

Under the influence of monetary policies such as the Federal Reserve maintaining high interest rates and the relevant Chinese departments cutting reserve requirements since last year, the upside-down spread between Chinese and US interest rates (the difference between the yields of 10-year Sino-US Treasuries) once widened to 250 basis points. In the past, many foreign capital could only reduce their holdings of Chinese treasury bonds to avoid risk, but after the advent of "swap", they locked in the interest rate risk of Chinese treasury bonds through "swap". As a result, the "actual" upside-down range of the Sino-US interest rate spread corresponding to their RMB bond holdings is far lower than the market price, ensuring that they have the strength to hold RMB bonds for a long time to obtain a sound investment return. Instead of buying and selling frequently and changing positions, it increases transaction costs and engulfs investment income.

In particular, bond spread trading was once hot since the end of last year, and the "swap" also played an important role.

The so-called bond spread trading is mainly due to the market's expectation at the end of last year that the Fed's rapid interest rate cut would narrow the upside-down spread between China and the United States, coupled with the greater appreciation potential of the RMB against the US dollar. after hedging the forward exchange rate of the US dollar against the RMB in the domestic foreign exchange market, more and more foreign capital has increased their positions in short-term Chinese treasury bonds such as one-year bonds. Because they found that if you take into account the return on the appreciation of the renminbi and the future price of Chinese bonds, the real rate of return on holding one-year Chinese Treasuries has exceeded that of US Treasuries over the same period.

"during the hot period of bond spread trading, the swap can effectively hedge the risk of interest rate fluctuations in RMB bonds caused by possible interest rate cuts by relevant Chinese departments, so that the safety and profitability of foreign capital investing in domestic bonds in China can be better guaranteed." The aforementioned emerging market investment fund manager said.

In his view, today's "swap" has become a new booster to attract more foreign capital to invest in China's domestic bond market.

Over the past year, HSBC (China) has promoted the "swap" business to foreign investors through offline and online channels and has continued to provide liquidity to the market, Mr Zhang said. Positive feedback from foreign investors and active trading. At present, HSBC (China) has concluded interest rate swap transactions with a number of foreign central bank institutions, commercial banks and asset management institutions, and involves a variety of floating benchmark interest rates and deadlines. help foreign investors effectively hedge interest rate risk.

Chen Zhiming, general manager of the fixed income department of Citic Securities, said that since the launch of the "swap", Citic Securities has continued to provide quotations for foreign capital. So far, the trading volume of the "swap" brokered by Citic Securities has exceeded 400 billion yuan. Serve more than 10 overseas clients to help more foreign capital participate in the RMB bond market.

Overseas capital heated discussion on optimization measures

It is worth noting that the three "swap" optimization measures introduced by the relevant departments have also triggered a heated discussion on foreign capital.

"in particular, interest rate swap contracts (IMM contracts), which take the international money market settlement date as the payment cycle, are the most popular with foreign capital." The aforementioned emerging market investment fund manager told reporters.

The reporter learned that this kind of IMM contract is highly standardized-interest rate swap contracts usually take the international money market settlement date as the payment cycle, and the corresponding product factors such as interest starting date, payment date, payment cycle and maturity date are calculated by IMM settlement date, that is, interest starts on the third Wednesday of March, June, September and December every year, and is paid quarterly (the third Wednesday of March, June, September and December). It can greatly facilitate foreign capital to effectively "match" trading unwinding and cash flow management requirements.

"this will help more foreign asset managers and hedge funds to actively participate in the domestic RMB bond market." He spoke bluntly. The reasons are as follows: first, these foreign capital have relatively high recognition and usage habits of IMM contracts, and the corresponding investment decision-making process is shorter; second, the above IMM contracts can effectively support foreign capital to carry out macro interest rate risk swaps in different countries through standardized contracts to meet the diversified interest rate risk hedging needs of their own global bond portfolios. Third, such IMM contracts can also optimize the reconciliation process between these foreign asset managers and hedge funds, making them feel that the convenience of clearing "swap" transactions has increased sharply, and they are more active in participating in domestic bonds and interest rate risk hedging transactions.

The reporter also learned that many overseas investment institutions have a strong interest in the contract compression services proposed by the relevant departments and their supporting historical interest-bearing contracts.

Behind this, under the original "swap" operation mechanism, foreign participants are often subject to the quota problem, and it is difficult to effectively terminate the relevant transactions in advance after the "swap" transaction is concluded, resulting in their trading enthusiasm is limited. After the launch of the contract compression service and its supporting historical starting interest contracts, foreign participants can enter into historical interest rate transactions with quotators to participate in contract compression, which can effectively reduce the nominal principal occupancy. It can also provide each other with the convenience of early termination of interest rate swap contracts and enhance the convenience and flexibility of foreign capital "swap" transactions.

The Hong Kong bond investment fund manager told reporters that contract compression has always been a centralized clearing value-added service provided by international clearing institutions for a wide range of global investors. If the foreign capital compresses the interest rate swap contracts that are bought and sold in the opposite direction, the contract elements conform to the matching rules and have been included in the centralized liquidation through the "swap" contract compression service, it can not only reduce the number of duration contracts and nominal principal, but also facilitate them to better manage the scale of the duration contract business. Therefore, after the launch of the contract compression service, the enthusiasm of foreign capital to participate in "swap" and domestic RMB bond transactions has further increased, attracting more foreign funds with different investment strategies to flow into the domestic bond market.

In Chen Zhiming's view, the introduction of IMM contracts, historical interest rate contracts, and contract compression services will to a greater extent promote the integration of the RMB interest rate swap market with the international market, which will not only meet the diversified bond investment and trading needs of foreign investors, but also promote the professional competence of domestic investors and promote the opening of the financial market to the outside world.

Hu Wentao, head of Asia-Pacific and Middle East macro products and joint trading director of the Global Financial Markets Department of Oriental Exchange Bank, said that the continuous optimization of the "swap" mechanism is making offshore banks and other financial institutions continue to improve their market-making ability in RMB interest rate swaps. When offshore market makers hedge the risk of domestic interest rate derivatives through the "swap" channel, offering more competitive quotations to customers will undoubtedly significantly reduce the operating cost of foreign capital hedging interest rate risk. and achieve more accurate bond position maturity management.

He believes that with the launch of new functions such as IMM contracts, historical interest contracts, and contract compression services, in the future, overseas participants will not only get quotes for interest rate derivatives with long-term interest rates, but will also increase the operational convenience of early delivery and settlement of stock transactions, thus better assisting foreign participants in managing interest rate risks. In particular, IMM contracts will make foreign capital more personalized to design interest rate risk hedging schemes, making the cash flow of derivatives more in line with their own exposure, while historical interest-bearing contracts and contract compression services can make the portfolio of foreign investors clearer and effectively reduce the burden of settlement and settlement credit risk.