- 2015: The investment scope for foreign central banks and monetary authorities, international financial organizations and sovereign wealth funds was expanded to include repos [repurchase agreements], bond borrowing and lending, bond forward rate swaps, and forward rate agreements.

- 2016: The interbank bond market opened up to more types of foreign institutions, including commercial banks, insurance companies, securities companies, fund management companies, other asset management companies and investment products issued by these institutions to clients, as well as other medium to long-term investors recognized by the PBOC (such as pension funds, charity funds, and endowment funds). The PBOC also launched a registration filing scheme applicable to all types of foreign institutional investors and removed the quota limitation.

Up to speed with 2016 developments

On February 17, 2016, the PBOC issued Announcement [2016] No.3 (Announcement 3), which clarifies the scope and requirements for foreign investors to invest in the interbank bond market, as well as the system of trading and the role of settlement agents.

On May 27, 2016, the Shanghai Head Office of the PBOC issued the Implementing Rules for Administration of the Record Filing of the Investment on the Interbank Bond Market by Foreign Institutional Investors (Filing Rules) which explain in detail the record filing administration of foreign institutional investors in the interbank bond market. The State Administration of Foreign Exchange (SAFE) also released the Circular on Foreign Exchange Control Issues Relevant to the Investment on the Interbank Bond Market by Foreign Institutional Investors (FX Circular) to regulate the foreign exchange registration, remittance and exchange of capital funds.

On the same day, China Central Depository & Clearing (CCDC), CFETS and the Shanghai Clearing House (SHCH) also jointly issued the Operational Guidelines for the Entry to the Interbank Market Network and Account Opening of Foreign Institutions (Entry Guidelines) for foreign institutional investors wishing to trade on the interbank bond market.

SHCH revised the Guidelines for the Registration, Custody, Clearing and Settlement in Connection with the Cross-border Bond Transactions of the Shanghai Free Trade Zone (SHCH Guidelines) that month as well. And in September, CCDC issued its Guidelines on the Bond Trading Services of the China (Shanghai) Free Trade Zone (CCDC Guidelines). Both CCDC and SHCH provide bond registration, depository and settlement services for the market.

China's interbank bond market is primarily regulated by the PBOC. PBOC Shanghai is responsible for the registration filing of foreign institutional investors and post-filing administration and surveillance of foreign investors and settlement agents. SAFE oversees the remittance and exchange of capital by foreign investors.

The National Association of Financial Market Institutional Investors (NAFMII), CFETS, CCDC and SHCH also monitor transactions on an ongoing basis and report to the PBOC accordingly.

Qualified foreign investors

Foreign institutional investors eligible to invest in the interbank bond market include:

• foreign banks, insurers, securities brokers, fund managers and other financial institutions;
• investment products issued by the above-mentioned financial institutions;
• other medium or long-term institutional investors (such as pension funds charity funds and donation funds) recognized by the PBOC; and
• QFIIs and RQFIIs.

While the new policy set in the PBOC's Announcement 3 is applicable to QFIIs and RQFIIs, the FX Circular issued by SAFE stipulates that QFIIs and RQFIIs investing in the interbank bond market must follow the existing foreign exchange rules that apply to them, meaning that QFIIs and RQFIIs are still subject to restrictions surrounding the remittance and exchange of currency.

According to Announcement 3 and various FAQs issued by the PBOC, qualified foreign investors may:

• trade bonds in the interbank bond market; and
• based on their hedging needs, enter into transactions such as: |
  • bond lending;
  • bond forwards;
  • forward interest agreements; and
  • interest rate swaps.

Accessing the market

Settlement agent appointment

While a formal license or prior approval from the regulators is no longer required, foreign institutions wishing to invest in the interbank bond market must appoint an onshore settlement agent that is licensed by the PBOC. The agent is responsible for verifying the qualifications of a foreign institutional investor.

The key services provided by a settlement agent include:

• filing with the PBOC Shanghai Head Office on behalf of eligible investors;
• assisting with the opening, updating and/or cancelling of onshore cash and bond accounts;
• providing bond trading and settlement agency services in accordance with the instructions of foreign institutional investors; and
• providing asset custodian services.

Record filing with PBOC

The filing form, which is submitted by the settlement agent to the Shanghai Head Office of the PBOC, contains basic information such as the offshore investor's estimated level of investment and the agreement signed between the agent and its foreign client. PBOC Shanghai will then issue a record filing notice within 20 calendar days upon receiving the application. The notice will be valid for three months.

Registration filing with SAFE

According to the FX Circular, within the validity period of the record filing notice issued by the PBOC Shanghai Head Office, a foreign institutional investor must register with SAFE's capital account information system through its appointed settlement agent.

When handling the registration for a foreign investor for the first time, the agent must check whether the system has the principal information of the investor. In the absence of such data, the settlement agent must apply to the local SAFE bureau for an institutional code and complete the registration on behalf of the foreign investor.

The agent must open dedicated foreign exchange accounts, and the funds in these accounts may not be used for any purpose other than investing in the interbank bond market.

Accounts opening, management and termination

The settlement agent manages the account opening applications on behalf of its clients (such as a renminbi deposit account and bond trading account)—on a separate basis—with CFETS, CCDC and SHCH.

Each eligible investor, including investment products issued by foreign institutional investors, will have its own individual bond account with CCDC and/or SHCH. In addition, bonds held in these accounts will be segregated from the assets of the settlement agent and CCDC/SHCH.

CFETS, CCDC and SHCH will complete the account opening procedures within three working days after receiving all documents from the settlement agent.

The settlement agent manages the foreign investor's daily transactions and conducts mandatory reporting to regulators in accordance with applicable PRC laws.

When exiting from China's interbank bond market, the settlement agent must submit an application form to CFETS, CCDC and SHCH for terminating the account.

Fund remittance and repatriation

Foreign investors may choose to remit their investment capital into China in renminbi or foreign currency.

Although Announcement 3 sets out that QFIIs can choose the scale of investment at their own discretion, if a foreign investor fails to remit at least 50% of the intended investment amount within nine months from the date of completion of filing with the PBOC Shanghai Head Office, it will be required to resubmit the relevant information regarding the intended investment amount.

To repatriate proceeds out of China, the FX Circular requires that the proportion of accumulated foreign exchange and renminbi funds under outward remittance by a foreign institutional investor must basically be consistent with that under inward remittance, with a fluctuation of no more than 10%.

The initial repatriation is exempt from the above ratio, provided that the total amount of capital to be repatriated offshore does not exceed 110% of the foreign currency or renminbi amount remitted into China.

Shanghai FTZ

On May 9, 2016, SHCH launched a cross-border renminbi bond scheme in the Shanghai Free Trade Zone (FTZ), creating a new market for onshore/offshore renminbi bond issuers and investors.

Investors can trade Shanghai FTZ renminbi bonds directly, or via onshore banks holding an interbank bond settlement agent license or offshore international custodians in cooperation with SHCH.

Shanghai FTZ renminbi bonds can also be purchased through commercial bank counters, which is only applicable to Shanghai FTZ-incorporated banks that have filed with the PBOC and have established network connections with SHCH.

Pending clarity

Despite these significant advances, the exact supervision measures for regulating the interbank bond market require further clarification by the authorities.

Also, while the connection between SHCH/CCDC and offshore international custodians enables foreign investors to open renminbi bond settlement accounts at their local securities depositories without having to deal directly with SHCH/CCDC, the language used in the SHCH and CCDC Guidelines is still quite vague and further implementing rules have yet to be issued.

On December 22, 2016, Ma Jun, chief economist of the PBOC's research bureau, said that the central bank and other departments will work to improve rules to enhance foreign investment access to the market, specifically pledging to specify rules and tax policies surrounding the remittance of investment and returns.

Liberalization outlook

The series of developments in 2016, such as the removal of investment quotas and the new and simple registration filing process, together with the existing QFII and RQFII schemes, have significantly eased foreign institutional investors' access to the Chinese bond market.

Broadening foreign participation in the domestic bond market will boost capital inflows—an ongoing challenge as more than $760 billion left the country last year—and the prospects of the renminbi as a medium to long-term global investment and reserve currency.

Jiejiang Wu and Lijie Bai
Jingtian & Gongcheng, Beijing

2016 was a landmark year for China's financial reform. After the IMF's decision to include the renminbi in the Special Drawing Rights (SDR) basket, PRC policy makers took another major step to internationalize the currency and liberalize capital market access by further opening up the $8 trillion renminbi interbank bond market to offshore investors.

Nearly all types of foreign institutional investors are now qualified to access the domestic bond market. The People's Bank of China (PBOC) has also abolished investment quota controls and simplified the application procedure to record filing.

Bond market opening: A quick timeline

The opening up of the interbank bond market for foreign institutional investors can be summarized by the following regulatory moves by the PRC authorities:
- 2010: The PBOC launched a pilot scheme to allow foreign central banks, monetary authorities, renminbi clearing banks in Hong Kong and Macao, and offshore banks participating in cross-border trade renminbi settlement to invest in the onshore interbank bond market (limited to cash bonds only).

- 2012: The interbank bond market was opened to foreign insurance companies in Hong Kong, Singapore and Taiwan.

- 2013: Qualified foreign institutional investors (QFIIs) and renminbi qualified foreign institutional investors (RQFIIs) were allowed to access and invest in the interbank bond market within an approved quota (limited to fixed income bonds only). All trading was to occur through the China Foreign Exchange Trade System and National Inter-bank Funding Center (CFETS), which is the trading execution facility for the bond market.

- 2015: The investment scope for foreign central banks and monetary authorities, international financial organizations and sovereign wealth funds was expanded to include repos [repurchase agreements], bond borrowing and lending, bond forward rate swaps, and forward rate agreements.

- 2016: The interbank bond market opened up to more types of foreign institutions, including commercial banks, insurance companies, securities companies, fund management companies, other asset management companies and investment products issued by these institutions to clients, as well as other medium to long-term investors recognized by the PBOC (such as pension funds, charity funds, and endowment funds). The PBOC also launched a registration filing scheme applicable to all types of foreign institutional investors and removed the quota limitation.

Up to speed with 2016 developments

On February 17, 2016, the PBOC issued Announcement [2016] No.3 (Announcement 3), which clarifies the scope and requirements for foreign investors to invest in the interbank bond market, as well as the system of trading and the role of settlement agents.

On May 27, 2016, the Shanghai Head Office of the PBOC issued the Implementing Rules for Administration of the Record Filing of the Investment on the Interbank Bond Market by Foreign Institutional Investors (Filing Rules) which explain in detail the record filing administration of foreign institutional investors in the interbank bond market. The State Administration of Foreign Exchange (SAFE) also released the Circular on Foreign Exchange Control Issues Relevant to the Investment on the Interbank Bond Market by Foreign Institutional Investors (FX Circular) to regulate the foreign exchange registration, remittance and exchange of capital funds.

On the same day, China Central Depository & Clearing (CCDC), CFETS and the Shanghai Clearing House (SHCH) also jointly issued the Operational Guidelines for the Entry to the Interbank Market Network and Account Opening of Foreign Institutions (Entry Guidelines) for foreign institutional investors wishing to trade on the interbank bond market.

SHCH revised the Guidelines for the Registration, Custody, Clearing and Settlement in Connection with the Cross-border Bond Transactions of the Shanghai Free Trade Zone (SHCH Guidelines) that month as well. And in September, CCDC issued its Guidelines on the Bond Trading Services of the China (Shanghai) Free Trade Zone (CCDC Guidelines). Both CCDC and SHCH provide bond registration, depository and settlement services for the market.

China's interbank bond market is primarily regulated by the PBOC. PBOC Shanghai is responsible for the registration filing of foreign institutional investors and post-filing administration and surveillance of foreign investors and settlement agents. SAFE oversees the remittance and exchange of capital by foreign investors.

The National Association of Financial Market Institutional Investors (NAFMII), CFETS, CCDC and SHCH also monitor transactions on an ongoing basis and report to the PBOC accordingly.

Qualified foreign investors

Foreign institutional investors eligible to invest in the interbank bond market include:

• foreign banks, insurers, securities brokers, fund managers and other financial institutions;
• investment products issued by the above-mentioned financial institutions;
• other medium or long-term institutional investors (such as pension funds charity funds and donation funds) recognized by the PBOC; and
• QFIIs and RQFIIs.

While the new policy set in the PBOC's Announcement 3 is applicable to QFIIs and RQFIIs, the FX Circular issued by SAFE stipulates that QFIIs and RQFIIs investing in the interbank bond market must follow the existing foreign exchange rules that apply to them, meaning that QFIIs and RQFIIs are still subject to restrictions surrounding the remittance and exchange of currency.

According to Announcement 3 and various FAQs issued by the PBOC, qualified foreign investors may:

• trade bonds in the interbank bond market; and
• based on their hedging needs, enter into transactions such as: |
  • bond lending;
  • bond forwards;
  • forward interest agreements; and
  • interest rate swaps.

Accessing the market

Settlement agent appointment

While a formal license or prior approval from the regulators is no longer required, foreign institutions wishing to invest in the interbank bond market must appoint an onshore settlement agent that is licensed by the PBOC. The agent is responsible for verifying the qualifications of a foreign institutional investor.

The key services provided by a settlement agent include:

• filing with the PBOC Shanghai Head Office on behalf of eligible investors;
• assisting with the opening, updating and/or cancelling of onshore cash and bond accounts;
• providing bond trading and settlement agency services in accordance with the instructions of foreign institutional investors; and
• providing asset custodian services.

Record filing with PBOC

The filing form, which is submitted by the settlement agent to the Shanghai Head Office of the PBOC, contains basic information such as the offshore investor's estimated level of investment and the agreement signed between the agent and its foreign client. PBOC Shanghai will then issue a record filing notice within 20 calendar days upon receiving the application. The notice will be valid for three months.

Registration filing with SAFE

According to the FX Circular, within the validity period of the record filing notice issued by the PBOC Shanghai Head Office, a foreign institutional investor must register with SAFE's capital account information system through its appointed settlement agent.

When handling the registration for a foreign investor for the first time, the agent must check whether the system has the principal information of the investor. In the absence of such data, the settlement agent must apply to the local SAFE bureau for an institutional code and complete the registration on behalf of the foreign investor.

The agent must open dedicated foreign exchange accounts, and the funds in these accounts may not be used for any purpose other than investing in the interbank bond market.

Accounts opening, management and termination

The settlement agent manages the account opening applications on behalf of its clients (such as a renminbi deposit account and bond trading account)—on a separate basis—with CFETS, CCDC and SHCH.

Each eligible investor, including investment products issued by foreign institutional investors, will have its own individual bond account with CCDC and/or SHCH. In addition, bonds held in these accounts will be segregated from the assets of the settlement agent and CCDC/SHCH.

CFETS, CCDC and SHCH will complete the account opening procedures within three working days after receiving all documents from the settlement agent.

The settlement agent manages the foreign investor's daily transactions and conducts mandatory reporting to regulators in accordance with applicable PRC laws.

When exiting from China's interbank bond market, the settlement agent must submit an application form to CFETS, CCDC and SHCH for terminating the account.

Fund remittance and repatriation

Foreign investors may choose to remit their investment capital into China in renminbi or foreign currency.

Although Announcement 3 sets out that QFIIs can choose the scale of investment at their own discretion, if a foreign investor fails to remit at least 50% of the intended investment amount within nine months from the date of completion of filing with the PBOC Shanghai Head Office, it will be required to resubmit the relevant information regarding the intended investment amount.

To repatriate proceeds out of China, the FX Circular requires that the proportion of accumulated foreign exchange and renminbi funds under outward remittance by a foreign institutional investor must basically be consistent with that under inward remittance, with a fluctuation of no more than 10%.

The initial repatriation is exempt from the above ratio, provided that the total amount of capital to be repatriated offshore does not exceed 110% of the foreign currency or renminbi amount remitted into China.

Shanghai FTZ

On May 9, 2016, SHCH launched a cross-border renminbi bond scheme in the Shanghai Free Trade Zone (FTZ), creating a new market for onshore/offshore renminbi bond issuers and investors.

Investors can trade Shanghai FTZ renminbi bonds directly, or via onshore banks holding an interbank bond settlement agent license or offshore international custodians in cooperation with SHCH.

Shanghai FTZ renminbi bonds can also be purchased through commercial bank counters, which is only applicable to Shanghai FTZ-incorporated banks that have filed with the PBOC and have established network connections with SHCH.

Pending clarity

Despite these significant advances, the exact supervision measures for regulating the interbank bond market require further clarification by the authorities.

Also, while the connection between SHCH/CCDC and offshore international custodians enables foreign investors to open renminbi bond settlement accounts at their local securities depositories without having to deal directly with SHCH/CCDC, the language used in the SHCH and CCDC Guidelines is still quite vague and further implementing rules have yet to be issued.

On December 22, 2016, Ma Jun, chief economist of the PBOC's research bureau, said that the central bank and other departments will work to improve rules to enhance foreign investment access to the market, specifically pledging to specify rules and tax policies surrounding the remittance of investment and returns.

Liberalization outlook

The series of developments in 2016, such as the removal of investment quotas and the new and simple registration filing process, together with the existing QFII and RQFII schemes, have significantly eased foreign institutional investors' access to the Chinese bond market.

Broadening foreign participation in the domestic bond market will boost capital inflows—an ongoing challenge as more than $760 billion left the country last year—and the prospects of the renminbi as a medium to long-term global investment and reserve currency.

Jiejiang Wu and Lijie Bai
Jingtian & Gongcheng, Beijing