The new Swap Connect channel aims to bring a more streamlined experience for overseas traders.
By James Sun, Head of Asia, Tradeweb Markets
China’s Swap Connect Highlights Shared Global Market Connectivity Objectives
The launch of China’s Northbound Swap Connect, first signaled by the authorities last summer, represents another welcome development in the country’s efforts to further align derivatives supervision and regulation with the rest of the world. As with its Bond Connect program, China has mandated the trading of interest rate swaps to be fully electronic. The consolidation of electronic clearing to the onshore jurisdiction will also bring important risk management gains.
Of course, China has every interest in adopting the most advanced tools available, particularly because its currency is not yet fully convertible. As a result, Chinese authorities need to use whatever means they have at their disposal to manage around the ways in which its market diverges from international practices.
Fully electronic trading, for one such measure, allows for better access to information around transactions, all of which are recorded and reported in a way that allows Chinese regulators, but also investors, to gain a real-time read on how markets are doing. This in turn facilitates more effective macro-prudential management. To be clear, this is the direction in which financial regulators and market participants around the world agree on, not just in China.
One of the great lessons learned from the Great Financial Crisis of 2008 was just how opaque and complex global derivatives markets had become vis-à-vis the rules that had been set up to govern them. This lack of visibility grew so rapidly that the build-up of risk nearly took down the entire global financial system.
In the years that followed, a flurry of new rulemaking produced the likes of the Dodd-Frank and MiFID regimes, as well as the retirement of the LIBOR benchmarking system, all of which significantly tightened up requirements around price disclosure and transaction reporting. The gradual shift in trading habits from bilateral voice trading onto electronic platforms has since also played an important role in preventing financial risks and ensuring market transparency.
Out with the old, in with the new
In 2022, the total amount of onshore interest rate swap transactions reached 21 trillion renminbi ($3 trillion), according to People’s Bank of China data. Overseas participation has been minimal, due mostly to clearing inconveniences that amounted to little international interest in the onshore swaps market.
The new Swap Connect channel aims to bring a more streamlined experience for overseas traders that conforms to their existing trading habits. Between the opening up of the rate swaps market and new futures products coming online under a forthcoming futures regime, overseas investors looking to hedge interest rate risk will soon have a complementary set of tools to deploy, much like they have when trading in the developed markets.
They will also have the benefit of accessing the liquidity pools that can be found in China’s domestic market. One major implication of Swap Connect is that bond market participants overseas will be able to hedge interest rate risk more effectively by using instruments that are more reflective of their true currency exposure and are consistent with Chinese interest rates.
Overall, by providing access to better hedging tools, Swap Connect will greatly contribute towards further opening up China’s domestic bond market, currently the world’s second largest, to more international investment. This well-established “Connect” mechanism represents a very effective means of harmonising the Chinese financial ecosystem with international best practices, including a fully electronic trading workflow.
Learning from the Bond Connect experience
In 2017, my company, Tradeweb Markets, worked with the China Foreign Exchange Trade System (CFETS) to become the first overseas electronic trading platform to access the Northbound route of Bond Connect. In September 2021, we worked with CFETS again to launch the Southbound Bond Connect, helping Chinese investors participate in international bond markets via Hong Kong. Our efforts, alongside Chinese agencies and partners, were driven by a shared vision to enhance the execution process for overseas stakeholders in China’s domestic markets, and to unite the best practices available anywhere in the world.
Today, Chinese bonds already take up significant weightings in a variety of global bond indices, making this market increasingly significant for global bond investors. In fact, as of late 2022, the number of foreign institutional investors exceeded 3,500, more than 13 times compared with 2017. The scale of debt holdings reached over 3 trillion yuan, triple that of 2017.
Over time, as we examine utilisation and volumes data for Swap Connect, I believe we will observe the deeply connective effect this program will have on the broader integration of markets, similar to its Bond Connect sibling.
Over time, if we pay attention to utilisation and volumes data for Swap Connect, I believe we will observe the deeply connective effect this program will have on the broader integration of markets, similar to its Bond Connect sibling.
After all, the goals of market transparency and sound financial regulation are held in common by regulators and market participants around the world, and Swap Connect certainly has the potential to help China’s derivatives markets accomplish them.
James Sun is Head of Asia at Tradeweb Markets Inc. (Nasdaq: TW), a leading global operator of electronic marketplaces for rates, credit, equities and money markets.
