Diversity and Transparency: Addressing Hong Kong bond market’s Achilles heel

Developing HKD-denominated bond market does not necessarily go hand in hand with promoting the city as an international bond market and there needs to be a balance, experts argue. (Photo credit: Chris Lusher)


Hong Kong has to strike a balance when developing its financial capital market by “satisfying local demand while looking ahead to up our game as an international financial centre,” states Peter Tam, Chief Executive of the Hong Kong Federation of Insurers (HKFI). Initiatives can be taken mutually by the government and the market to meet aspirations for the development of the local bond market and Hong Kong’s status as an international financial centre in the Asia Pacific region. Taking advantage of China’s growing green and vanilla bond markets and the advancement of financial technology (Fintech) to promote secondary trading are all ways to deepen and broaden Hong Kong’s bond market.

 

The demand for Hong Kong dollar denominated debt securities

Addressing the demand and concerns of local investors, in particular insurance companies and the pension fund under the Mandatory Provident Fund (MPF) schemes, the current Hong Kong dollar denominated instruments do not facilitate long-term investments. Insurance companies conduct asset-liability matching to deliver on their promises when a claim matures, life insurance tends to be a long-term investment with maturity dates spanning from an average of 20-30 years. “We are always looking for safer long-term options, bonds would certainly be a very good choice for us,” says Tam, the current yield curve of Hong Kong dollar denominated papers ends at tenors of 15 years which is not long enough to satisfy the sought-after long-term commitments.

Additionally, Hong Kong’s pension fund has accumulated over HK$ 600 billion, portfolio managers are looking to invest in safe and long-term bonds to reduce market fluctuations. Shifting current investments from volatile – as recognised by the market – equities to more stable but perhaps lower-yielding instruments. Moreover, there is a demand specifically for Hong Kong dollar denominated bonds as investors “don’t have to hedge against currency risks,” adds Tam, though multi-currency bonds such as US dollar denominated papers provide necessary duration and a variety of options, representing depth. This shows the demand to grow the local currency bond market, adding an institutional component on top of the current retail-orientated schemes under the Hong Kong Monetary Association (HKMA) such as iBonds and silver bonds.

30-year bonds do raise concerns due to the uncertainty of the USD and HKD peg relationship in 2047 as Hong Kong’s promised 50-year transition period ends. Joseph Wang, Chief Science Officer at Bitquant Research Laboratories, has another idea. “What is Asia going to look like in 2047?” he suggests. “I can envision more of what Hong Kong will be like in 30 years compared to other countries in Asia such as mainland China and Indonesia. Hong Kong has sort of been doing the same thing for the last 100 years.” The international investor consensus is that Hong Kong in 2047 will be a disaster, but for investors with knowledge of the local region, they have more confidence in a stable transition.

 

HKD denominated bond market vs Hong Kong bond market

Despite the demand for a deeper Hong Kong dollar denominated bond market, there is a priority towards developing Hong Kong as a multi-currency international financial centre. Since Hong Kong’s local economy is too small and the HKD currency is unattractive for international investors to hold, this prevents the growth of the Hong Kong dollar denominated bond market. Stephen Wong, Deputy Chief Executive Officer of Our Foundation Hong Kong states, “I think Hong Kong as a bond market in the world is small, because of some structural constraints. Looking at some numbers it is safe to say we are around 10 times smaller than London and 100 times smaller than New York.” This shows that Hong Kong should take advantage of its position and develop its multi-currency regional market and RMB offshore market (in addition to Dim Sum bonds).

Some of Hong Kong’s long-established unique attraction to international investors has spread across other financial centres in the Asia Pacific region, such as Singapore. The city still attracts international investors who particularly want to invest in mainland China (RMB market), due to the confidence investors have in the local legal and judicial framework. Additionally, financial services available in Hong Kong provide international investors with knowledge of the regional market and regulations. Wong explains, “Bond market growth in China is inevitable, one of the drivers is the green bond market as it is their national strategy.” He describes “jumping on the bandwagon” as potentially growing the offshore renminbi bond market, after the Dim Sum bond market dried up. The current focus can be on the green bond front, Wong states, “Hong Kong should take advantage of its strengths, in certification and assurance, which is a key part of the green bond market, as investors can gain comfort in knowing that the proceeds will go towards a green project.” International investors can use Hong Kong’s services that provide certification and assurance to gain transparency in their investment while promoting Hong Kong as a financial hub, especially for green bonds.

On top of the certification, assurance and respected legal/judicial framework, Hong Kong is a hub for international deals and has an effective English written law. Wang claims, “You want to sell Chinese green bonds to someone in Brazil. In Hong Kong, it is relatively easy to find someone who has really deep knowledge about Brazil and someone who has deep knowledge of Chinese bonds, and we have a coffee.” Going back to the legal framework, English written law promotes understanding of the buyer, providing confidence when investing in an unfamiliar project and region (such as mainland China for most international investors). Crypto-currency and bitcoin has also been suggested to be able to solve currency concerns when international investment takes place, and can be developed to promote confidence in buyers and sellers.

In addition, for an emerging issuer, Hong Kong provides a good environment for small innovation due to clear regulations. Wang adds, “If you are doing something reasonable, there’s always a way of structuring it so that you can do whatever you need to be done.” Applying to be an issuer is relatively easier in Hong Kong compared to other jurisdictions in the region.

Hong Kong has a passive and small government in comparison to its major competitor in the Asia Pacific region, Singapore, which has an active one. The Singaporean government has been proactive in creating offshore markets and subsidising local green bond issuers, covering the extra costs of certification, providing incentive to issue green bonds. Wang adds on a note regarding Hong Kong, “The people who ultimately drive things are outside the government.” This poses a problem as there is, Wang claims, “not a group of people who work as the leaders/innovators of FinTech.” In Hong Kong, there are no local big or substantial banks where there is a CEO in the city who sees it as part of their job to grow aspects of Hong Kong, Wang continues, “HSBC used to fill that role but they moved on to the UK and Hong Kong is not their main focus, someone will fill in that gap.”

 

FinTech and secondary market trading

Secondary market trading in the bond market has not changed much in the past 30 years, with 95% traded with Over-The-Counter (OTC) methods and 5% exchange traded. This may be due to regulatory pressures or low liquidity especially for long-term bonds which are traded around only 1-2 times a year. Traders using OTC methods use and rely on FinTech for data management, analytics, risk, portfolio and collateral management, price reporting and so on, as shown in a British Chamber of Commerce (BCC) paper. The aspects of data sharing, technology and price discovery in the market can be developed to increase liquidity and secondary market activity. The International Organisation of Securities Commissions released a report earlier this year showcasing the current developments and roles of FinTech in financial markets.

Looking ahead, the Hong Kong Monetary Authority has announced the release of Bond Connect which is cross-border platform which facilitates efficient trading by overseas institutional investors into mainland China’s bond market. The 2% overseas holding of the world’s third largest bond market by overseas investors allows room for a much stronger presence of international investors. Naturally, FinTech will be developed with the use of Bond Connect due to the nature of how the trades will be conducted.

In terms of a local green bond market and green initiatives, in addition to the HKMA’s current Environmental, Social and Governance (ESG) reporting guide, the government can take an initiative in issuing and investing in green bonds. Wong explains, “the HKMA is one of the largest institutional investors. For domestic issuers, MTR and other statutory bodies can take the lead, [there is] lots of room to explore.”

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James Johnston

James is a Harbour Times intern. He studies at the University of British Columbia majoring in Economics.