On Friday (May 05), Hong Kong and China’s central banking authorities announced the launch of Swap Connect, a pioneering initiative that opens up institutional entry to the region’s interbank interest rate swap markets.
Scheduled to go live from May 15, the scheme marks the world’s first derivatives mutual market access programme and builds on plans first announced in July last year by regulators, the Hong Kong Monetary Authority (HKMA), the Hong Kong Securities and Futures Commission (SFC) and the People’s Bank of China (PBOC).
The development of the programme follows the success of earlier schemes, Stock Connect and Bond Connect, which launched in 2014 and 2017 respectively, and were made available to the investment community via infrastructure provided by Hong Kong Exchanges and Clearing (HKEX).
“The sentiment is positive,” said Vivian Yiu, partner at Morrison Foerster and FinanceAsia Editorial Board Member.
“The mutual market access programme speaks to stronger connectivity between Hong Kong and mainland China and is part of Hong Kong’s efforts to cement and solidify its position as an international financial hub,” she told FA.
To facilitate the new programme, HKEX clearing subsidiary, OTC Clear, worked with the China Foreign Exchange Trade System (CFETS) and Shanghai Clearing House (SHCH), to construct the underlying clearing and settlement infrastructure necessary for successful operation.
“This type of interoperability between clearing houses has never been attempted before and represents a ‘first of its kind’ in the derivatives market globally,” Terry Yang, Hong Kong-based partner at Clifford Chance said, expressing optimism about the scheme’s likely uptake.
“There has been significant attention from market participants on understanding how this clearing link will work, each competing to be the first financial institution to be ready to trade and clear through it.”
The internationalisation of renminbi
The initiative is set to launch with a northbound channel that will offer international investors participation in China-based interest swaps at very initial stage, all of which will be priced, settled and cleared in renminbi.
Yang explained that the scheme will first cover fixed-to-floating renminbi interest rate swaps based on three types of reference rate: a Shanghai Interbank Offered Rate (SHIBOR) of three months (3M) based on 10-year maturity; an overnight (O/N) SHIBOR levy based on three-year maturity; and a seven-day interbank repurchase rate (FR007) based on 10-year maturity.
He added that the programme supports the policy objectives of the Chinese authorities to increase international investor participation in the onshore bond market, which remains low in spite of being the second largest bond market globally.
“Market participants have highlighted the difficulty of hedging interest rate and FX risks as one of the challenges when investing in PRC (People’s Republic of China) bonds. Swap Connect is designed to address this issue.”
“It continues the trend of renminbi internationalisation, by allowing international investors easier access to hedging tools related to renminbi,” he said.
Amid a backdrop of heightened geopolitical tensions, recent attention has turned towards the rising power of renminbi, as the US continues to grapple with the threat of systemic failure in the banking sector and works to prevent an impending debt-ceiling default.
In February, the PBOC signed an agreement with Brazil’s central bank to establish direct cross-border trading in renminbi, circumventing use of the US dollar. In March, former Goldman Sachs economist, Jim O'Neill, called for more markets from the Brics bloc (Brazil, Russia, India, China and South Africa) to work to curtail the US dollar's dominance.
In a note to media, Monish Tahilramani, head of Markets and Securities Services for Asia Pacific at HSBC, said the Swap Connect programme would mark “an important complement to Bond Connect and a positive sign that onshore markets continue to open up.”
Southbound set to follow
The initial phase of rollout – the duration of which remains unspecified – will see the implementation of daily trading and clearing limits. Trading will be capped at RMB20 billion (US$2.89 billion) while the daily clearing quota will be no greater than RMB4 billion, with subsequent adjustment “as and when appropriate based on market conditions,” the joint announcement detailed.
Southbound trading, which will open the scheme to mainland-based investors seeking access to Hong Kong’s international derivatives market, is set to follow “in due course”.
Yiu shared that the trading quota limits “speak to a prudent and measured rollout approach to ensure stability.”
Additionally, she described the considered assessment of a reciprocal southbound arrangement as a display of caution.
In the bourse's related announcement, CEO of HKEX, Nicolas Aguzin, described Swap Connect’s launch as, "the latest chapter in our Connect story.”
The release detailed that the “superconnector and gateway between East and West” will draw on the the new scheme to “promote and progress its markets and the communities it supports for the prosperity of all.”
In the joint announcement, the HKMA described the development as “conducive to the consolidation and enhancement of Hong Kong’s status as an international financial centre.”
The HKMA declined to comment on Stock Connect's launch. The SFC and HKEX did not respond to requests for comment prior to publication.
