Advent of RMB ETFs opens new channel into China
Unlocking the cross-border marketplace for investors interested in RMB-denominated ETFs bodes well for future growth.
There has been a marked shift in international fund flows since the spring of 2016. Shunned for some years, emerging markets (EMs) are back in favour, and both debt and equity indices have chalked up impressive increases over the year to date.
Several factors are at work. Bond investors are seeking yield in a world where roughly $13 trillion of government bonds now offer negative yields. Equity investors have been encouraged by the upward revision of growth projections and the strengthening of key EM currencies.
The challenge for bond investors is the small and relatively illiquid nature of many EM bond markets. The one major exception is China, which not only ranks as the world’s third largest sovereign bond market but enjoys a credit rating higher than most other EMs.
The ten-year bond yields 2.7%, a multiple of the return available in the leading developed markets. Data from index provider FTSE Russell show that correlation with UK and European government bond markets has been falling since 2014 and is currently close to zero. A shorter average duration than European government bond markets offers some diversification.
International investors own less than 2% of China’s government bond market. The authorities are currently embarked on moves to open up the interbank bond market, with a removal of quotas for international investors.
For equity investors, the progressive opening up of China’s mainland market, combined with the likelihood that index-provider MSCI will eventually include some element of China’s A-share market in its EM indices, inevitably makes China a talking point in any re-allocation of funds to EMs.
China actively engaging international investors
All of this comes at a time when the Chinese authorities are building connections to international investors as never before. This is apparent in the relaxation of the qualified foreign institutional investors (QFII) scheme in February, expanded investment quotas, the development of the Hong Kong-Shanghai Stock Connect reciprocal investment arrangement and plans for a similar link giving investors access to the Shenzhen market by Christmas 2016. This will give international investors almost unfettered access to around 70% of the mainland market capitalisation.
Equally, the internationalisation of the renminbi (RMB) continues apace. It will shortly become a recognised reserve currency, with the International Monetary Fund set included the RMB in its special drawing rights in October 2017.
There is increasing offshore RMB bond issuance in the international structure, accounting for approximately 50% of the total market of EUR 107 billion. There has also been a significant expansion in the range of asset classes open to international investors. After establishing themselves in Hong Kong, mainland Chinese fund managers have started to open up in London, setting up UCITS mutual funds in Luxembourg or Dublin aimed at European investors.
RMB ETF – international issuance on the uptrend
Separately, a number of managers have launched a range of RMB-denominated exchange-traded funds (ETFs). They are listed in Europe on multiple exchanges and use the international settlement structure first established by Euroclear in 2013.
The first issue was in March last year when CCBI (part of China Construction Bank) and Commerzbank teamed up with Euroclear to launch the first-ever RMB-denominated money market ETF in international form. This provides access to a marketplace hitherto restricted to central banks, RMB clearing banks and selected investors such as sovereign wealth funds and foreign insurance companies.
In June this year, Fullgoal Asset Management (HK) Limited, the subsidiary of the Chinese asset manager, Fullgoal Fund Management Co. Ltd., launched its of Luxembourg-registered, RMBdenominated ETFs linked to the FTSE China Onshore Bond index and listed them on both London and Milan.
The funds offer investors exposure to three different sub-indices linked to government bonds, policy bank bonds (issued by three big state-owned banks) or a combination of the two spanning close to $ 2trillion of bonds. Over one and three years, the index has returned 6.07% and 15.75% respectively.
Seamless access to China’s mainland markets coupled with transparency and liquidity
To enable these issues to take place, Euroclear worked with the London Stock Exchange, Borsa Italiana and Euronext and offered them a settlement facility in RMB. Without the international settlement that is central to the Euroclear model, the issuers would have been obliged to list a domestic ETF on each exchange in the local currency.
Euroclear’s multi-currency model allows distribution of RMB product across Europe, something the Chinese issuers were keen to achieve. "Our model has evolved to allow issuance and distribution of different ETF RMB products in Europe" says Mohamed M’Rabti, Euroclear Director of Product Management.
Fullgoal Asset Management’s Michael Chow, Managing Director - Head of International Business says: “The Euroclear international structure makes it much easier for us to cross-list the onshore bond ETF on multiple exchanges, which is something we are definitely looking to do. Listing in London and Milan is just the start.”
“We want to be able to cross-list in any part of the world. The Euroclear international structure gives us flexibility and makes it easier for us to develop the business.”
From the point of view of investors, the arrival of RMB-denominated ETFs provides the flexibility to respond quickly to changing market circumstances. While the internationalisation of the RMB is accelerating, options for international investors to put money into onshore RMB investments are on the increase.