Q: What is the background of launching Swap Connect?
A: In recent years, China has elevated opening-up of the interbank bond market. Notably, the launch of Northbound Bond Connect and Southbound Bond Connect since 2017 marked two major milestones in China’s financial market opening-up. In 2021, RMB-denominated bonds traded by overseas investors totaled RMB11.47 trillion. As of end-2021, RMB-denominated bonds held by overseas investors recorded RMB4 trillion, accounting for approximately 3.5 percent of all bonds under custody in the entire market. As overseas investors' bond holdings expand and trading activities grow brisker, their demand for managing interest rate risks via derivatives is on the rise.
In the interbank derivatives market, the RMB interest rate swap has been a primary instrument since its launch in 2006. After years of steady and sound development, its trading volume has gradually increased among a more diverse group of participants, making it an effective tool for risk management. In 2021, the trading volume of RMB interest rate swap totaled RMB21.1 trillion. To provide overseas investors with a more convenient access to interbank interest rate swaps and other derivatives, the People’s Bank of China (PBC) has been steadily opening up the interbank interest rate derivatives market. Leveraging the sound financial cooperation between the Mainland and Hong Kong, the PBC is aimed at applying a financial infrastructure connection facility similar to Bond Connect, allowing overseas investors to participate in the domestic RMB interest rate swaps market through Chinese and overseas electronic trading platforms as well as connection facilities provided by central counterparty clearing houses.
Q: What benefits will the launch of Swap Connect bring?
A: First, it will help overseas investors manage interest rate risks. Swap Connect will allow overseas investors to manage risks via interest rate swaps, reduce the impact on the bond value they hold from interest rate fluctuations, smooth cross-border capital flows, and further promote the RMB internationalization.
Second, it facilitates the development of domestic interest rate derivatives market. Swap Connect will boost the differentiated demands from overseas institutions and satisfy such demands with highly-efficient electronic trading and close connection of transaction and clearing procedures, which will enhance market liquidity, advance the development of the interbank interest rate derivatives market, and contribute to a virtuous circle.
Third, it is conducive to the consolidation of Hong Kong’s status as an international financial center. As an important measure to open up China’s financial derivatives markets, the launch of Swap Connect is a concrete step to implement the decision outlined in the 14th Five-Year Plan to enhance Hong Kong’s role as both an international asset management hub and a global risk management center. It will help increase the attractiveness of Hong Kong as an international financial center and deepen financial cooperation between the Mainland and Hong Kong.
Q: What are the innovations that Swap Connect has made under the current interbank derivatives market framework?
A: In line with the roadmap for the future development of the interbank derivatives market, Swap Connect has drawn on the existing practices and overall framework of the bond market’s opening-up and aligned itself with the latest development in overseas derivatives markets. Based on electronic trading and central counterparty clearing, it optimizes current processes and makes clearing more efficient.
Under Swap Connect, domestic and overseas investors may connect via electronic trading platforms to carry out transactions without altering their existing trading practices. Meanwhile, Swap Connect has innovated the connection mechanism of derivatives clearing houses, with two central counterparties jointly providing domestic and overseas investors with centralized clearing services for RMB interest rate swaps. As such, both domestic and overseas investors may, provided that they follow laws and regulations of the Mainland and Hong Kong, have a convenient access to trading and centralized clearing of RMB interest rate swaps.
Q: What are the considerations and measures for risk prevention in Swap Connect?
A: Effective risk prevention is the foundation for high-quality development of the financial derivatives market and a core principle for us to promote Swap Connect. Under Swap Connect, our main measures to prevent risks include:
First, we will ensure orderly trading and control overall market risks. Under Swap Connect, transactions are conducted between quoting institutions to maintain market stability. Referring to Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect, Swap Connect, in its initial stage, will carry out aggregate control to prevent market risks while satisfying investors’ needs for risk management.
Second, we will reinforce risk management arrangements between financial market infrastructures in the Mainland and Hong Kong. In view of current international practices in financial derivatives trading, clearing, settlement, and risk management, we will integrate electronic trading with central counterparty clearing and make arrangements for a robust and reasonable system connection to ensure that Swap Connect strictly abide by the macro-prudential principle. To that end, Swap Connect will adopt the whole-process and multi-layered risk control measures, focus on preventing cross-market risk spillover, and build up a solid safety net.
Third, we will deepen regulatory cooperation. The PBC will maintain close contact with Securities and Futures Commission (SFC) of Hong Kong and HKMA, sign a memorandum of understanding on regulatory cooperation, and enhance cooperation on information sharing and emergency response.
Q: Is there a timetable for implementing Swap Connect?
A: We will implement Swap Connect under the overall planning and arrangements of China’s financial market opening-up. For now, the PBC will work with SFC and HKMA to develop institutional arrangements, strengthen regulatory cooperation and information sharing, guide relevant financial market infrastructures to get prepared in rules, businesses and technologies, while enhancing market communication and cultivation, and urging market participants to make pre-trade preparations. We expect Swap Connect to be officially launched in six months.
