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What to make of China awarding two licences to US institutions in the same week? The news raises interesting questions about China-US relations, the development of China’s bond markets and the future of Sino-foreign joint ventures.
On Monday, JPMorgan Chase received approval for a licence to underwrite corporate bonds in China’s interbank bond market. The following day, Citi received a Type A bond settlement agent licence, again for the interbank bond market.
They are two different licences for two different purposes, but in both cases they represent the first US bank to be given such an opportunity.
The coincidence looks irresistible: does it mean that, even as the Trump administration takes the US down a more isolationist path and potentially even towards a trade war, China is in fact increasing US access to its domestic markets in a show of good faith?
Well, not so fast. Understanding the significance, or lack of, in this sequence first requires us to look more closely at China’s domestic bond markets and the institutions that regulate them.
It could certainly have been delayed had China chosen to do so for foreign policy reasons, or simply to make a point
China’s bond markets, already the third largest in the world (Rmb64.27 trillion, or $9.3 trillion, as of December) and only getting bigger, are nonetheless deeply fractured.
There is the exchange bond market, sometimes known as the listed bond market, regulated by the China Securities Regulatory Commission, and the interbank market, or over-the-counter market, which is, overall, regulated by the People’s Bank of China (PBoC). In sum, the market is about 90% interbank and 10% exchange.
However, the interbank market then divides into several different components. Corporate bonds are regulated by the National Association of Financial Market Institutional Investors (NAFMII). Enterprise bonds are governed by the National Development and Reform Commission. And government bonds are regulated by the ministry of finance.
So the first thing to realize is that the two licences have been issued by different people: NAFMII for JPMorgan and the PBoC for Citi. It is perhaps unwise to assume a great level of coordination between Chinese regulators, which is one reason many local and western banks would welcome the long-discussed possibility of a single unified regulator.
Still, discussions do take place between the US and China on financial services on the mainland, and access is very much a point of negotiation; this tends to reach the news whenever people believe there is a chance that foreign investment banks might be given the right to gain full control of their securities joint ventures, something that has obstinately failed to transpire for a decade now.
And in June it was said that two US banks would receive licences in the interbank market. So perhaps the formalization of that timing is not insignificant; to put it another way, it could certainly have been delayed had China chosen to do so for foreign policy reasons, or simply to make a point.
The move is also interesting because it takes place at a time when China has utterly changed its attitude toward capital flight outside of the mainland, and is far more restrictive of it happening than it used to be.
Panda bonds
Why is that relevant? Because look at what JPMorgan is going to do with that underwriting licence. With the best will in the world, it is not going to start lead managing corporate bonds for CNOOC right away. Local houses have that tied up and there’s not much money in it anyway.
JPMorgan’s niche is going to be bringing international companies in to China to raise RMB – known as panda bonds – which will in almost all cases then lead to those companies wanting to swap the funds back out to dollars again.
So far, panda bonds have been used mainly by sovereigns such as South Korea or, at a provincial level, British Columbia, but there would be great appetite by foreign companies if it became a little easier to do, and the swap rate right now would make borrowing highly attractive.
Is China saying, by giving JPMorgan the licence, this is what it wants to encourage?
In Citi’s case, the licence is what China head of securities services Harry Peng calls “the life cycle of a trade, from research, sales and trading to custody, clearing and settlement”.
Citi’s edge here is clearly for qualified foreign institutional investors, meaning non-Chinese institutions buying Chinese securities, so here the idea of capital flight is not an issue, but it still represents a move for greater cross-border engagement with Chinese money at a time when all policy seems, for the moment, to be going the other way.
JV coffin
One more point to think about is whether China giving licences to banks in their own name spells another nail in the coffin of the joint venture structures; JPMorgan abandoned its own JV last year anyway. It should be said that these are bank licences rather than securities licences, and so not quite the same thing that the JVs do, but the direction is interesting.
Whatever the deeper issues around the awards, both banks reacted with delight, and any improvement in access is to be welcomed.
And why not: China’s bond market could be the biggest in the world one day, and isn’t far from overtaking Japan for second spot soon – and while these licences don’t allow either bank to do everything, at least they are a sign of progress.