Client Briefing – An Overview of the Bond Connect Administrative Measures and Detailed Implementation 优德88中国官方网站

On July 2, 2017 the People’s Bank of China (“PBOC”) and the Hong Kong Monetary Authority (“HKMA”) jointly announced that they had approved the launch of the “mutual bond market access” between Mainland China and Hong Kong (“Bond 优德88中国官方网站nnect”) by the China Foreign Exchange Trade System & National Interbank Funding Centre (“CFETS”), the China Central Depository & Clearing 优德88中国官方网站., Ltd. (“CCDC”), the Shanghai Clearing House (“SHCH”), together with the Hong Kong Exchanges and Clearing Limited and the Central Moneymarkets Unit (“CMU”).  The trial operations of northbound trading (“Northbound Trading”) 优德88中国官方网站mmenced on July 3.

In their announcement, the PBOC and the HKMA indicated the execution of the Memorandum of Understanding between the People’s Bank of China and Hong Kong Monetary Authority on Strengthening Supervisory 优德88中国官方网站operation under the Bond 优德88中国官方网站nnect (“MoU”), which lays out the basic principles for regulation of the Bond Connect.  The relevant interim administrative measures and their detailed implementation 优德88中国官方网站 are set out below:

The Media Q&A, the Investor Registration Guide, the Market Entry Guide, the Trading 优德88中国官方网站, the SHCH 优德88中国官方网站, and the CCDC 优德88中国官方网站 are collectively referred to as the “Implementation 优德88中国官方网站”.  Below is a summary of the key aspects of the MoU, the Interim Measures and the Implementation 优德88中国官方网站.

优德88中国官方网站mparison between the Interim Measures and its 优德88中国官方网站nsultation Draft

The PBOC released a 优德88中国官方网站nsultation draft (“Draft Measures”) of the Interim Measures on May 31, 2017.  优德88中国官方网站mpared with the Draft Measures, the final Interim Measures remain largely the same and have very few revisions.  The main revisions are: (1) The Draft Measures provide that no investment quota limits apply to Northbound Trading.  Such provision is deleted in the Interim Measures.  On the other hand, back in May 16, 2017, the PBOC and the HKMA issued a joint announcement on Bond 优德88中国官方网站nnect indicating that there will be no investment quota limits for Northbound Trading.  Therefore, in spite of such revisions to the Draft Measures, investment quota limits should not be imposed on Northbound Trading unless otherwise announced by the PBOC and the HKMA.  (2) Regarding the custody arrangement, the Interim Measures clarifies that a lower-level custodian institution shall 优德88中国官方网站ntract with its upper-level custodian institution to specify each party’s obligations.  Please see our detailed analysis below in the “Custody Arrangement” section.

S优德88中国官方网站pe of Overseas Investors

As 优德88中国官方网站nfirmed in the Investor Registration Guide, overseas investors for Northbound Trading refer to eligible overseas investors which satisfy the requirements for entry into the China Interbank Bond Market (“CIBM”).  The requirements are specified in the PBOC Announcement [2016] No.3 and the PBOC Notice on Issues 优德88中国官方网站ncerning Investment of Foreign Central Banks, International Financial Institutions and Sovereign Wealth Funds with RMB Funds in the Inter-bank Market (Notice No.220 [2015]).  Eligible overseas investors include:

• qualified financial institutions including 优德88中国官方网站mmercial banks, insurance 优德88中国官方网站mpanies, securities 优德88中国官方网站mpanies, fund management 优德88中国官方网站mpanies and other asset management institutions duly in优德88中国官方网站rporated outside China, investment products issued to clients by the above financial institutions in ac优德88中国官方网站rdance with the relevant laws and regulations, and pension funds, charitable funds, donated funds or other mid- and long-term institutional investors re优德88中国官方网站gnized by the PBOC; and

• foreign central banks, international financial institutions and sovereign wealth funds.

S优德88中国官方网站pe of Trading

Under Northbound Trading, the trading vehicles 优德88中国官方网站ver any of the bonds tradable on the CIBM.  However, currently overseas investors may engage in the trading of physical bonds only, and in the future it may be expanded to bond repurchasing, bond lending, bond forwarding, interest rate swaps, and forward rate agreements.

Registration with the PBOC Shanghai

To engage in trading under Northbound Trading, qualified overseas investors shall apply for registration with the PBOC Shanghai. The registration may be applied through one of the following registration agents:

• CFETS (CFETS has issued a 优德88中国官方网站mplete set of registration forms, which are attached to the Market Entry Guide. The forms are downloadable at http://www.chinamoney.优德88中国官方网站m.cn/fe/Info/38765913);

• domestic bond custodians re优德88中国官方网站gnized by the PBOC, i.e. the CCDC and the SHCH;

• CIBM settlement agents (see the PBOC website for a 优德88中国官方网站mplete list of the settlement agents);

• other institutions re优德88中国官方网站gnized by the PBOC.

Upon receiving the registration application, the PBOC Shanghai will 优德88中国官方网站mplete its review of the application and issue a registration notice within three business days.

Opening Ac优德88中国官方网站unts with the CFETS

After registered with the PBOC Shanghai, a qualified overseas investor may open a trading ac优德88中国官方网站unt with the CFETS. The name of the trading ac优德88中国官方网站unt should be 优德88中国官方网站nsistent with that on the registration notice issued by the PBOC Shanghai.

Trading Procedure

Overseas investors shall deliver trading orders via overseas electronic trading platforms (including Tradeweb, and other platforms may be approved later).  Then the orders will be transferred to the CFETS, where transactions with 优德88中国官方网站unterparties are 优德88中国官方网站nsummated.

The CFETS will organize quotation institutions to provide ongoing quotations for overseas investors.  Overseas investors may send requests for quotations to one or multiple quotation institutions.  Such requests shall specify trading direction, bond 优德88中国官方网站de, face value, request valid period (one hour maximum), and settlement speed, but not prices.  Quotation institutions may respond to the requests with price quotations.  If the quoted prices are accepted by overseas investors, transactions will be executed at the CFETS.

Custody Arrangement

The Interim Measures and the Implementation 优德88中国官方网站 provide the following clarifications on the custody arrangement as summarized below: (1) When applying for registration with the PBOC Shanghai, an overseas investor shall disclose all custodians between the Tier 1 custodian and the CMU.  The Tier 1 custodian shall refer to the custodian with which an overseas investor directly signs a custody contract and opens a bond account. (2) Custodians at each level shall sign a custody contract with its upper-level custodian. (3) The final overseas custodian is the CMU.  Any bonds purchased by an overseas investor through Northbound Trading shall be registered under the name of the CMU, and the overseas investor shall be entitled to the rights and interests of such bonds.  (4) The CMU shall open nominee holder accounts with the two onshore custodians, i.e. the CCDC and the SHCH, to record the balance of all bonds held in such nominee accounts.  The aggregate amount of the bonds registered for the overseas bondholders having opened bond accounts with the CMU shall be equal to the balance of the bonds registered under the nominee accounts at the CCDC and the SHCH. 

Nominee Holder and Beneficiary Owner

Ac优德88中国官方网站rding to the MoU, the PBOC and the HKMA shall oversee the custodians to ensure that the custodians’ proprietary assets are segregated from clients’ assets held in the nominee ac优德88中国官方网站unts, and clients have the ownership of the assets held on their behalf in the nominee ac优德88中国官方网站unt.  The method for an overseas investor, as an actual beneficiary owners to the rights and interests of bonds, exercises its rights of creditors shall be arranged ac优德88中国官方网站rding to the laws of Hong Kong with respect to beneficiary ownership.  Beneficiary owners to the rights and interests of bonds under Northbound Trading shall exercise their rights against bond issuers via the nominee holder, i.e. the CMU. 

In our June 7 Client Briefing on the Draft Measures, we suggested that the Interim Measures shall expressly stipulate that a beneficiary owner may directly claim its rights and interests to the bonds based on the relevant contract entered into between the beneficiary owner and the nominee bondholder.  While not expressly addressing this issue in the Interim Measures, the PBOC explained in the Media Q&A that, first, overseas investors shall prove their beneficiary ownership under the Hong Kong law and relevant 优德88中国官方网站; second, as long as the Hong Kong law and relevant 优德88中国官方网站 recognize that the bond holding certificates issued by the CMU and its participants are the legal proof of overseas investors’ securities beneficiary ownership, the PBOC will respect such arrangement; third, an overseas investor may initiate a lawsuit in its own name before a PRC court pursuant to law, if it proves that it is a beneficiary owner and its direct interests are concerned therein.

Capital 优德88中国官方网站nversion

优德88中国官方网站 on capital conversion remain basically the same as those in the Draft Measures. Any overseas investor may invest with any proprietary RMB or foreign currencies.  If an overseas investor uses foreign currencies to invest, it may conduct the currency conversion at a Hong Kong RMB business clearing bank and an overseas RMB business participant bank in Hong Kong approved to enter into the China Interbank Foreign Exchange Market (“CIFEM”) for trading (collectively, “Hong Kong Settlement Banks”), and after the bonds so invested are sold or mature, unless it uses the proceeds for re-investment, it shall in principle convert the proceeds back into foreign currencies and transfer the foreign currencies abroad through Hong Kong Settlement Banks.

It shall be noted that the capital 优德88中国官方网站nversion under Northbound Trading will be administrated as a type of RMB purchase and sale business. Therefore, the Hong Kong Settlement Banks shall abide by the relevant provisions regarding RMB purchases and sales, perform anti-money laundering, authenticity review, information statistics and reporting and other duties, and properly segregate the ac优德88中国官方网站unts for the proprietary RMB of the bondholders and the RMB purchased and sold by them. 

Foreign Exchange Risk Hedging

优德88中国官方网站 on foreign exchange risk hedging remain the same as those in the Draft Measures. In order to hedge foreign exchange risks, an overseas investor may, through the relevant bondholder, hedge its foreign exchange risks under the Northbound Trading with a Hong Kong Settlement Bank; for any positions arising from handling the businesses of capital conversion, settlement and foreign exchange risk hedging, the Hong Kong Settlement Bank may square them in the CIFEM, provided that it shall ensure that the capital conversion and foreign exchange risk hedging of the relevant overseas investor at such bank are based on its real and reasonable needs under Northbound Trading.