FTSE Russell will not include China in its flagship government bond index, citing market liquidity and foreign exchange concerns in the country’s $5tn government debt market.
The index provider, which released the results of its annual fixed income country classification review on Thursday in New York, said measures taken by Beijing to improve foreign investor access to its government bonds “mark significant progress” towards China achieving inclusion in FTSE Russell’s flagship World Government Bond index.
But it noted that index users “have provided feedback that they would like to observe further improvements to secondary market liquidity, and increased flexibility in [foreign exchange] execution and the settlement of transactions”.
The move comes despite China making gradual reforms to allow greater market access and the inclusion this year of Chinese government bonds in the rival Bloomberg Barclays Global Aggregate index, the first such move by a major index provider.
That move could spur foreign capital flows into Chinese government debt of $150bn by 2021, according to S&P Global Ratings. Earlier this month, JPMorgan Chase also announced Chinese bonds would be included in its emerging market government bond indices.
“It’s a bit of a surprise that [China] wasn’t included [in FTSE Russell’s WGB index],” said Paul Sandhu, head of Asia-Pacific multi-asset quant solutions and client advisory for BNP Paribas Asset Management. “The market trend is inclusion and people see that China is a significant part of the global market — it moves markets whether you’re invested in it or not.”
Analysts at Citigroup have estimated that China’s inclusion in the WGB index could spur passive inflows of about $120bn into the country’s government debt.
Foreign investors, while welcoming recent reforms, frequently point to persistent uncertainties when it comes to investing in onshore Chinese government debt.
Bond holdings in China are highly concentrated among a circle of large government institutions that rarely trade them. Commercial banks also tend to buy and hold bonds to maturity instead of trading them or acting as market-makers, which can cause liquidity strains. There are also concerns about a lack of foreign exchange hedging services onshore.
But that has not stopped substantial inflows of foreign money into China’s bond market this year. At the end of August, foreign holdings of Chinese debt through Hong Kong’s bond connect programme totalled more than Rmb2tn ($280bn), up more than a third from the end of 2018.
Becky Liu, China fixed-income strategist at Standard Chartered, said that the FTSE Russell decision could further sour sentiment in China’s bond market and lead to a modest rise in bond yields, which move opposite to prices, in the short term.
But she added that StanChart now saw a very high probability for Chinese bonds to be included in FTSE Russell’s WGB index in the index provider’s 2020 review, with actual inclusion to begin in 2021.
“The key is that specific requirements were raised and the suggestions are also positive to China’s bond market developments,” Ms Liu said. “We expect progress to be made in these areas.”
FTSE Russell said China remained on the index provider’s watch list for a potential upgrade and said it “looks forward to engaging with the [People’s Bank of China] further on how the outstanding criteria might best be addressed”.