Regulations on Foreign Institutions' Investment in China's Bond Market

In order to further expand the two-way opening of the financial market, the People's Bank of China and the State Administration of Foreign Exchange jointly issued the Provisions on the Administration of Funds of Foreign Institutional Investors Investing in the Chinese Bond Market (hereinafter referred to as the Provisions) a few days ago, improving and clarifying the requirements for the administration of funds of foreign institutional investors investing in the Chinese bond market. The promulgation of the Provisions is conducive to further facilitating foreign institutional investors' investment in China's bond market and enhancing the attractiveness of China's bond market to foreign institutional investors.
Jiang Fuwei, an associate professor of the School of Finance of CUFE, said in an interview with China Trade News that this provision can be seen in combination with the announcement on Further Facilitating the Investment of Foreign Institutional Investors in China's Bond Market issued in May this year. The announcement of this provision is actually the implementation and adjustment of the policy announced in May, and the provisions are mainly applicable to overseas institutions investing in China's bond market.
It can be seen that, on the basis of integrating the existing foreign exchange management requirements, the Provisions mainly unifies the cross-border management of funds of overseas institutional investors, specifically clarifies the requirements for business registration, capital exchange, cross-border revenue and expenditure, foreign exchange hedging, etc., and further facilitates overseas institutions to invest in the Chinese bond market.
Jiang Fuwei believes that, on the whole, the promulgation of the Regulations shows that the overall opening up process of China's bond market is gradually developing from breadth to depth. At present, it is more focused on further improving the convenience of overseas institutions to participate in China's bond market, expanding the investment scope of overseas institutions, and starting to lay out how to improve the stickiness of stock funds, which is conducive to improving the willingness and enthusiasm of overseas institutions to participate in China's bond market and attracting foreign capital to China, It reflects China's determination to promote the opening up of the bond market.
Compared with the previous regulations, it is worth noting that the Regulations, based on the principle of keeping the currency of the outward and inward funds consistent, have removed the restriction on the outward proportion of investment in a single currency. In addition, for overseas institutional investors who simultaneously remit "RMB+foreign currency" for investment, the limit on the proportion of accumulated foreign currency remittances has been raised from 1.1 times to 1.2 times. The above proportion is also flexible, and can be further relaxed for overseas investors who have invested in China's bond market for a long time.
The regulations on the consistency of outward and inward currencies existed before. Wu Xiaoli, an associate professor of the School of Finance at the Central University of Finance and Economics, said in an interview that the regulation is mainly to prevent cross-border arbitrage of RMB. There are domestic RMB market and overseas RMB market in which the exchange rate is often different, which may bring arbitrage opportunities. For example, some investors have remitted their funds into China in the form of RMB, then converted them into US dollars at the domestic exchange rate, remitted them out of China, and then converted them into RMB at the overseas market exchange rate. This arbitrage transaction may affect China's foreign exchange reserves. The introduction of the new regulations appropriately relaxed the outward remittance scale of normal investors, which can effectively improve the convenience of overseas institutional investors' outward remittance of funds and better meet their outward remittance needs. This will certainly be welcomed by overseas investors, and will attract more investors and more funds to China, especially long-term investors. This is of great significance for maintaining the stable and healthy development of China's financial market.
In Jiang Fuwei's view, the original intention of this change is to emphasize the principle of real demand, encourage foreign investors to invest more in the Chinese bond market, and at the same time, it can effectively curb speculative behavior and prevent foreign investors from carrying out cross currency arbitrage activities.
In addition, through comparison, it can be found that the draft of the Regulations issued in September 2020 stipulates that the number of domestic financial institutions directly conducting foreign exchange derivatives transactions with the same foreign institutional investor should not exceed 3. However, the official version of the Regulations released this time has removed this quantitative limit. In this regard, Jiang Fuwei believes that this change can, on the one hand, increase the number of counterparties of overseas institutions, enhance their trading autonomy, and further enhance their enthusiasm to participate in China's bond market investment; On the other hand, it can also increase the price competition between counterparties, which is conducive to foreign investors to obtain more reasonable hedging prices, so as to better establish the concept of exchange rate risk neutrality in the market.
Wu Xiaoli said that foreign investors usually face exchange rate risk when investing in China. Investors usually buy derivatives to hedge exchange rate risk. Swaps or options are generally used for hedging. Both instruments are OTC derivatives. These derivatives are not standardized derivative contracts in the exchange, but customized by financial institutions according to customer needs. When selecting the counterparty, foreign investors should first consider the cost, and then the service. Of course, the most active RMB market is in China, so it is theoretically the most cost-effective for financial institutions in China to buy derivatives. However, in the past, due to policy restrictions, overseas institutions could only act as counterparties with settlement agents. Due to the lack of competition, the derivatives prices and related services obtained by overseas institutions in domestic financial institutions are not ideal. This time, overseas institutions can choose any counterparty in China's financial institutions. Through the competition between domestic institutions, the derivatives prices of overseas institutions will be lowered and their services will be improved. The removal of this restriction in the new Regulations is widely welcomed by foreign investors, attracting them to conduct derivatives transactions with financial institutions in China, creating new revenue channels for financial institutions in China, expanding the business scope of financial institutions in China, and improving the business capability of financial institutions in China.