Recently, People's Bank of China (PBC) has released The Interim Measures for the Administration of Mutual Bond Market Access between Mainland China and Hong Kong SAR (PBC Announcement No. 1 [2017]). Relevant official from PBC answered related questions from the media.

1. What types of foreign investors are eligible according to the requirements of the Interim Administrative Measures of the PBC?

Answer: The scope of eligible foreign investors under the Bond Connect is consistent with the scope of foreign investors who are permitted to directly participate in the market and open an account, as stipulated in Notice on Investing in China’s Interbank Market by Foreign Central Banks, International Financial Organizations and Sovereign Wealth Funds with RMB (PBC Document No.220 [2015]), Announcement of Relevant Issues to Further Facilitate Foreign Institutional Investors with investment in China’s Interbank Market (PBC Announcement No.3 [2016]), and other documents.

Currently, eligible foreign investors include: foreign central banks or monetary authorities, sovereign wealth funds, international financial organizations, Qualified Foreign Institutional Investors(QFII), RMB Qualified Foreign Institutional Investors(RQFII); financial institutions including overseas registered commercial banks, insurance companies, securities companies, fund management companies and other asset management institutions, together with the investment products legally issued to the customers by the above institutions, as well as pension funds, charity funds, endowment fund and  other mid-term and long-term institutional investors recognized by PBC.

2. Which institutions can file on behalf of foreign investors and how to do the filing?

Answer: Institutions approved by the PBC to file on behalf of foreign investors include the China Foreign Exchange Trade System (CFETS), onshore custodians, and interbank bond market settlement agents. For filing, materials can be directly submitted to the above mentioned institutions or their overseas cooperative institutions. The list of settlement agents can be found at PBC’s official website (http://www.pbc.gov.cn/jinrongshichangsi/147160/147171/147358/3287818/3294233/3281969/index.html).

The Shanghai Head Office of PBC will formulate specific filing guidelines for foreign investors.

3. What is the business scope for foreign investors under the Northbound Trading?

Answer: Qualified underlying bonds for foreign investors under the Northbound Trading are all types of bonds traded in Mainland China’s Interbank Bond Market (CIBM), including treasury bonds, local government bonds, government-backed institution bonds, policy bank bonds, commercial bank bonds, non-banking financial institution bonds, debt financing instruments of non-financial enterprises, enterprise bonds and asset-backed securities, etc.

Overseas investors of the Northbound Trading can either invest in the underlying bonds via subscription from the primary market or trading in the secondary market.

In terms of trading instruments, at the moment, only cash bond trading is available for foreign investors through the Northbound Trading. In the future, trading instruments will include bond repo, bond lending and borrowing, bond forwards, interest rate swaps and forward rate agreements, etc.

4. What are the qualified offshore and onshore custodians in the Interim Administrative Measures?

Answer: At present, the offshore custodian is the Hong Kong Monetary Authority (referring to the Central Moneymarkets Unit, or CMU). The onshore custodians include China Central Depository and Clearing Limited (CCDC) and Shanghai Clearing House (SHCH).

5. What is the meaning of foreign investors and bond holders?

Answer: The Bond Connect adopts the nominee holding arrangement which is widely used in international markets. Foreign investors refer to the actual beneficiaries of the bonds under such an arrangement or end investors who do not hold bonds in their own names on behalf of others. Bond holders include the ones who hold bonds for their own and the ones who hold others’ bonds in their names (i.e., nominees). Nominees should be custodians, such as custodian banks and central securities depositories. The nominees and actual bond holders herein follow international rules and carry the same meaning with the ones under the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect.

6. How will foreign investors exercise relevant rights under the nominee holding arrangement?

Answer:  The fifth article in The Interim Measures requires that the offshore custodians should open nominee account(s) with the onshore custodians to record the aggregate bond balance held under the nominee holding structure. This specifies that foreign investors under the Northbound Trading should hold bonds through CMU and enjoy the rights and interests of the bonds they have purchased through the Northbound Trading.

The way that foreign investors exercise the rights of creditors as the actual beneficiaries should be arranged based on the Hong Kong SAR laws and regulations with regard to the nominees. The actual beneficiaries under the Northbound Trading should exercise rights over the bond issuers through the nominee, namely the CMU.

7. How do foreign investors exercise legal rights in Mainland China? Will the certificates of bond ownership issued by CMU be recognized?

Answer: The rights of beneficiary owners to initiate legal proceedings under the nominee holding arrangement is not explicitly stipulated or prohibited by Mainland China laws. Just like the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect, we understand that CMU, as the nominee of foreign investors, shall be registered as the bond holder that can exercise relevant rights of creditors and initiate legal proceedings. According to Article 119 of the Civil Procedure Law, the plaintiff shall be a citizen, legal person, or an organization that have direct interest in the case. If foreign investors are able to provide evidence that they have direct interest in the case as the beneficiary owner of the bonds, they may file a lawsuit in the mainland courts in their own name.

According to Article 3 of the Interim Measures, relevant trading and settlement activities should comply with the regulatory provisions and business rules in the place where the trading and settlement take place; according to Article 5, the offshore custodians should open nominee account(s) with the onshore bond custodians to record the aggregate bond balance held under this nominee holding structure. Therefore, proving of the foreign investors as the beneficiary owners of the bonds should follow the laws and relevant rules in Hong Kong SAR. Correspondingly, if the laws and relevant rules of Hong Kong SAR recognize the bond owner certificates issued by CMU and its participants as legitimate evidence of securities entitlement of foreign investors, we shall respect this arrangement.

8. What are the relevant requirements and procedures for foreign investors to participate in the issuance and subscription in the CIBM through Northbound Trading?

Answer: When issuers issue bonds in the CIBM through auction or book building, foreign investors that meet the requirements of the PBC may subscribe bonds through the Northbound Trading. Offshore custodians can hold subscribed bonds on behalf of foreign investors via the nominee account(s) opened with the onshore custodian institutions. The details of the above arrangement can be referred to in the relevant rules and business guidelines issued by onshore and offshore custodian institutions. For the next step, we will continue to promote further alignment with international rules and business procedures to facilitate foreign participation in China’s bond market.

9. What are the offshore and onshore electronic trading platforms referred to in Article 7 in the Interim Measures? What are the requirements for the trading counterparties and trading models of foreign investors?

Answer: Currently, the offshore electronic trading platforms such as Tradeweb. Bloomberg and other trading platforms can be connected to the Northbound Trading when preparation work is completed; the onshore electronic trading platform includes CFETS. To facilitate foreign investors to trade onshore bonds, the Northbound Trading follows the widely adopted international practice in which the foreign investors will trade with onshore dealers (including market makers and potential market markers). The list of market makers and potential market makers is available on CFETSs official website. The CFETS and Hong Kong Exchanges (HKEX) have jointly established the Bond Connect Company Limited to provide services for foreign investors involved in the Northbound Trading.

10. How do foreign investors make payments in bond trading?

Answer: To improve cross-border RMB settlement efficiency and support the development of real economy and international trade, the PBC has built the Cross-border Interbank Payment System (CIPS) which will be fully developed in two phases. The completed CIPS Phase I adopts real-time gross settlement to process the remittance of clients and financial institutions, which marks a breakthrough in cross-border interbank payment arrangements in terms of operation time, clearing paths and message standards and can be recognized as the “fast lane” of RMB cross-border settlement. CIPS Phase II is now under construction, and it will further extend operating time and provide flexible processing methods so as to provide more convenient fund settlement services for cross-border bond trading.

To support Bond Connect, CIPS Phase I introduced relevant financial market infrastructures as direct participants to the system, and made adjustments to detailed business rules to meet fund settlement demands of cross-border bond trading. Foreign investors shall conduct fund settlement for cross-border bond transactions through CIPS, and the PBC will take corresponding measures to ensure the smooth fund settlement under the Bond Connect.

11. What does it mean that foreign investors can invest with their proprietary RMB?

Answer: Foreign investors can invest with the RMB that they have accumulated, raised or exchanged in off-shore markets.

12. Which is the RMB clearing bank in Hong Kong SAR and which are the offshore RMB participating banks in Hong Kong SAR approved to trade in Mainland China’s Interbank Foreign Exchange Market?

Answer: According to relevant regulations and arrangements of cross-border RMB business, Bank of China (Hong Kong) Limited is the clearing bank for RMB business in Hong Kong SAR. According to the Announcement No.40 [2015] jointly issued by the PBC and State Administration of Foreign Exchange (SAFE) and relevant regulations on market access released by CFETS, the offshore RMB participating banks in Hong Kong SAR approved by CFETS to trade in Mainland China’s Interbank Foreign Exchange Market include Industrial and Commercial Bank of China (Asia) Limited, Hong Kong Branch of China Merchants Bank, Standard Chartered Bank (Hong Kong) Limited, Hong Kong Branch of Citibank, Hang Seng Bank Limited, Hong Kong Branch of Agricultural Bank of China Limited, China Construction Bank (Asia), Hong Kong Branch of Bank SinoPac, China CITIC Bank International Limited, and HSBC Limited.

In future, offshore RMB participating banks in Hong Kong SAR newly approved by CFETS to trade in Mainland China’s Interbank Foreign Exchange Market will automatically become settlement banks in Hong Kong SAR for Northbound Trading. The list of settlement banks in Hong Kong SAR is available on the website of CFETS.

13. What does it mean by “Investments made with foreign currencies and any money from matured or sold bonds not for further investments should in principle be converted into foreign currencies and remitted out through settlement banks in Hong Kong SAR”?

Answer: In order to facilitate foreign investors holding foreign currencies to invest in CIBM, foreign investors with foreign currencies can conduct foreign exchange transactions through bond holders in settlement banks in Hong Kong SAR, and the positions of the settlement banks in Hong Kong SAR arising from such transactions can be offset in Mainland China’s Interbank Foreign Exchange Market. For foreign currency conversion of the bond holders, the settlement banks in Hong Kong SAR should check the authenticity of the transaction (including but not limited to demanding the bond holders to specify the purpose of transaction and uses of funds) to ensure that the exchanged fund is used in Northbound Trading. RMB (including principal, gains and losses) from the matured or sold bonds can be used for bond investment. Otherwise, it should be converted into foreign currencies through settlement banks in Hong Kong SAR.

14. What do you mean by “For investments in foreign currencies, bond holders should open RMB cash accounts with a settlement bank in Hong Kong SAR for fund transfer and settlement under the Northbound Trading”?

Answer: For foreign investors who invest with proprietary RMB without currency conversion, they are not required to conduct fund transfer and settlement under the Northbound Trading through settlement banks in Hong Kong SAR.

For foreign investors who invest with foreign currencies, or with a mix of proprietary RMB and foreign currencies, fund transfer and settlement should be conducted through the bond holders’ accounts in a settlement bank in Hong Kong SAR. In order to ensure all currencies converted by bond holders are used for the Northbound Trading and prevent illegal arbitrage on interest rates or foreign exchanges, bond holders are required to open RMB cash accounts with settlement banks in Hong Kong SAR specifically for Northbound Trading transfer and settlement.

Given the upcoming launch of Northbound Trading, if settlement banks in Hong Kong SAR are not able to open a specialized RMB cash accounts for bond holders before the launch date, bond holders are allowed to temporarily use the RMB cash accounts that they have already opened and a specialized RMB cash accounts with the settlement banks in Hong Kong SAR should be opened as soon as possible; for bond holders temporarily using RMB cash accounts that already exist, settlement banks in Hong Kong SAR should manage sub-accounts separately with clear records of cash flows under the Northbound Trading, and make sure all converted currencies are used for bond investment under the Northbound Trading.

15. Which documents contain rules that settlement banks in Hong Kong SAR should abide by on RMB  transactions?

Answer: So far, regulation and rules on RMB transactions include PBC Notice on Relevant Issues of Cross Border RMB Business (Yinfa [2011]No.145), PBC Notice on Adjustments of RMB Purchase and Sale Business Management (Yinfa [2013] No.321), PBC Notice on Expansion of RMB Purchase and Sale Business (Yinfa [2015] No.250), Announcement by PBC and SAFE ([2015] No.40) , Circular of PBC General Administration Department on Relevant Issues of Strengthening Macro-Prudential Management over Foreign Financial Institutions in Entering the Interbank FX Market for RMB Purchases and Sale Business (Yinbanfa [2016] No.143), Announcement on Relevant Issues of the Entrance of Overseas Participating Banks into China’s Interbank FX Market Regarding RMB Purchases and Sales Business (CFETS [2016] No.7).

Coverage of RMB purchase and sale transactions has expanded from commodity trade, service trade and direct investment to bond investment. When settlement banks in Hong Kong SAR hedge the resulting positions on the Mainland China’s Interbank Foreign Exchange Market, the existing framework on business models, products and reporting arrangements for offshore clearing banks and participating banks should be adopted. According to the Interim Administrative Measures and the rules of RMB purchase and sale transactions, on hedging positions in the Mainland China’s Interbank Foreign Exchange Market, settlement banks in Hong Kong SAR should ensure that the currency conversion and foreign exchange hedging conducted by relevant foreign investors are based on real and reasonable demand under the Northbound Trading.

16. Will any other supporting rules be released after the release of the Interim Measures?

Answer: To implement the Interim Measures, relevant electronic trading platforms, onshore and offshore custodians will formulate and publish detailed supporting rules and operation guidelines subject to the approvals of relevant regulators in the Mainland and Hong Kong SAR. Trading rules by CFETS and detailed business rules on registration, custody, clearing and settlement by relevant custodian institutions will be published soon.