FIMA Research Center University of Hawai'i 1 The Chinese Government Bond Market: Opportunities and...

FIMA Research Center University of Hawai'i

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The Chinese Government Bond Market: Opportunities

and ChallengesS. Ghon Rhee, K. J. Luke Distinguished Professor S. Ghon Rhee, K. J. Luke Distinguished Professor

of International Finance and Bankingof International Finance and BankingUniversity of Hawai’iUniversity of Hawai’i

The CSRC/OECD Second International Roundtable The CSRC/OECD Second International Roundtable on the Chinese Securities Marketon the Chinese Securities MarketJune 6-7, 2002, Shanghai, ChinaJune 6-7, 2002, Shanghai, China


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Idiosyncratic Features of the CGB Market (I) 1.1. Benchmark Interest RatesBenchmark Interest Rates

a. Deposit interest rates are serving as a. Deposit interest rates are serving as benchmark?benchmark?b. Deposit interest rates are one of the last b. Deposit interest rates are one of the last set of interest rates under controlset of interest rates under controlc. Why very little differences are observed c. Why very little differences are observed between savings bonds and book-entry between savings bonds and book-entry bond yields?bond yields?Savings Bonds:Savings Bonds: Syndicated UnderwritingSyndicated Underwriting

Book-Entry Bonds:Book-Entry Bonds: Uniform Price Auction Method Uniform Price Auction Method


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Bond Issues in 2001 (Billion RMB)

T-BondsRMB 488.40

(64%)

F-BondsRMB 259.00

(34%)

E-Bonds RMB 14.70

(2%)

Bond Balance in 2001 (Billion RMB)

F-BondsRMB 853.45

(34%)

E-BondsRMB 100.86

(4%)

T-BondsRMB 1561.80

(62%)


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Status of T-Bonds Issued in 2001

Unit: Billion yuanUnit: Billion yuan

Assigned Assigned Issue IssueTypeType Secondary MarketSecondary Market Amount Amount

Book-EntryBook-Entry 308.35 308.35 BondsBonds

Inter-Bank Market Inter-Bank Market 212.35 212.35Exchange Market Exchange Market 96.00 96.00

Savings BondsSavings Bonds OTC Market OTC Market 180.00180.00TotalTotal 488.35488.35


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Idiosyncratic Features of the CGB Market (II)

2.2. Multipartite Structure of Government Multipartite Structure of Government Bond MarketsBond Markets a. Dual Supervisory Structure of Primary Marketa. Dual Supervisory Structure of Primary Market

T-Bonds and E-Bonds: T-Bonds and E-Bonds: MOFMOF

F-Bonds:F-Bonds: PBCPBC

b. Tripartite Structure of Secondary Marketb. Tripartite Structure of Secondary MarketInter-Bank Market under PBCInter-Bank Market under PBC

Over-the-Counter (OTC) Market under PBCOver-the-Counter (OTC) Market under PBCExchange Market under CSRCExchange Market under CSRC

C. Meaning of the OTC Market in China? C. Meaning of the OTC Market in China?


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Trading Value of Government Bonds

(1996-2001)

0

500

1000

1500

2000

2500

3000

3500

4000

4500

1996 1997 1998 1999 2000 2001

Spot Inter-Bank Spot Exchange REPO Inter-Bank REPO Exchange


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Idiosyncratic Features of the CGB Market (III)

3.3. Secondary Markets: Money Market rather Secondary Markets: Money Market rather than Bond Market than Bond Market

Inter-bank Market:Inter-bank Market: REPOs are bond collateral REPOs are bond collateral loans among banksloans among banks

Exchange Market:Exchange Market: REPOs are short-term REPOs are short-term loansloans among securities among securities companiescompanies

Money Market in China has been developed without T-Money Market in China has been developed without T-Bills and the financing function for corporate working Bills and the financing function for corporate working capital is missing capital is missing the working capital needs of corporations Financing the working capital needs of corporations


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Idiosyncratic Features of the CGB Market (IV)

4.4. Missing Links in the MarketMissing Links in the Market

a. T-Bills: a. T-Bills: Maturity Structure of Bonds Issued in 2001Maturity Structure of Bonds Issued in 2001

2 years: 4% of total issues2 years: 4% of total issues3 years: 34%3 years: 34% 5 years: 21%5 years: 21%7 years: 14%7 years: 14% 10 years: 16%10 years: 16%

15 years: 3% 15 years: 3% 20 years: 8%20 years: 8%

b. Interest Rate Risk Hedging Instrumentsb. Interest Rate Risk Hedging InstrumentsBond Futures: Bond Futures: Banned in 1995 Banned in 1995 Short-term Interest Rate Futures: Not Available Short-term Interest Rate Futures: Not Available


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Idiosyncratic Features of the CGB Market (V)

4.4. Missing Links in the Market-ContinuedMissing Links in the Market-Continued

c. Foreign Participation in Primary and c. Foreign Participation in Primary and Secondary Markets Secondary Markets

d. Asset-Backed and Mortgage-Backed d. Asset-Backed and Mortgage-Backed Securities Securities

e. Municipal Bondse. Municipal Bonds Revenue Source: 1/2 from Municipal Revenue Source: 1/2 from Municipal

GovernmentsGovernments Expenditures: 2/3 by Municipal GovernmentsExpenditures: 2/3 by Municipal Governments


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Recommendation 1: Benchmark Interest Rates Make T-Bond Yields Serve as Benchmark Interest Rates

a. Stop MOF’s practice of setting a range of bidding spreads at the primary market auctionb. Introduce T-Billsc. Create Balanced Maturity Structured. Make all T-bond issues fungible


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Multipartite Structure of Government Bond Markets

A Comprehensive Plan for the Government Bond Market Development Will Be Useful to Eliminate Multipartite Structures in Primary and Secondary Markets

a. Regulatory Harmonization and Functional Delineation among PBC, MOF, and CRSC b. Consolidation of PBC’s Primary Market for F- Bonds and MOF’s Primary Market for T-Bonds and E-Bondsc. Consolidation of Inter-Bank Market and Exchange Market


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Recommendation 2: Consolidation of Primary Market

Under the current structure, PBC does not serve as “ears and hands” of MOF.a. PBC as the Fiscal Agent for All Government Bonds?b. CSRC as the Market Regulator for Both Primary and Secondary Market?c. Clearing & Settlement by PBC: DVP for All Government Bonds d. Fungible Issuese. Regularity of Issue Cycle


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Recommendation 3:Consolidation of Tripartite Secondary Market

Mere functional integration cannot achieve consolidation of three markets into a single marketa. Inter-bank market will remain as money market because commercial banks don’t have incentives for spot market transactions b. Exchange market has limitations because automated trading system can not offer pre-trading negotiations and personal relationships among bond dealers……Korea’s Experience c. OTC market should trade book-entry bonds (not savings

bonds) with all types of financial institutions participating


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Korea Stock Exchange’s Experience

Unit: $ billionUnit: $ billion

Exchange Market .Exchange Market .

YearYear Gov’t BondsGov’t Bonds Corp BondsCorp Bonds TotalTotal OTC MarketOTC Market19971997 $0.14 $0.14 $2.25 $2.39 $82.27 $2.25 $2.39 $82.27

1998 5.42 7.46 12.88 359.171998 5.42 7.46 12.88 359.17

1999* 1999* 248.87248.87 10.32 259.19 658.32 10.32 259.19 658.32

2000 18.58 2.88 21.46 736.362000 18.58 2.88 21.46 736.36

2001 9.45 1.56 11.01 1,066.44 2001 9.45 1.56 11.01 1,066.44

*KSE Introduced inter-dealer broker system for government *KSE Introduced inter-dealer broker system for government bond trading in March 1999bond trading in March 1999


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Underlying Forces for the US Government Bond Market Expansion in 1980s

a.a. Introduction of Financial Futures and OptionsIntroduction of Financial Futures and Optionsb.b. Active Trading of Treasury Securities on a Active Trading of Treasury Securities on a

When-Issued BasisWhen-Issued Basisc.c. Expansion of REPO transactionsExpansion of REPO transactionsd.d. Introduction of the Separate Trading of Introduction of the Separate Trading of

Registered Interest and Principal of Registered Interest and Principal of Securities Securities (STRIPS)(STRIPS)


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Sequence of Government Bond Market Reforms: French Experience

a.a. Bond futures market (1986)Bond futures market (1986)b.b. Primary dealer system (1987)Primary dealer system (1987)c.c. Interdealer broker network (1987)Interdealer broker network (1987)d.d. Purely competitive auctions (1987)Purely competitive auctions (1987)e.e. REPOs (1991)REPOs (1991)f.f. STRIPS (1991)STRIPS (1991) Brossard, Philippe, 1998, The French Bond Market: Enhancing Liquidity, A paper Brossard, Philippe, 1998, The French Bond Market: Enhancing Liquidity, A paper

presented at a World Bank Workshop on the Development of Government presented at a World Bank Workshop on the Development of Government Bond Markets, June 11-12, Seoul, Korea.Bond Markets, June 11-12, Seoul, Korea.

Clearing and Settlement for Government BondsAustralia:Australia: Reserve Bank Information andReserve Bank Information and Transfer Transfer

System SystemHong Kong:Hong Kong: Central MoneyMarkets UnitCentral MoneyMarkets Unit

JapanJapan :: BOJ Financial Network System(BOJ-BOJ Financial Network System(BOJ-

NET)NET)Singapore:Singapore: Government Book-Entry SystemGovernment Book-Entry System

China:China: China Government Securities Depository China Government Securities Depository Trust & Clearing Co.Trust & Clearing Co.

When-Issued Trading

Most advanced markets allow trading during the Most advanced markets allow trading during the period between the time a new issue is period between the time a new issue is announced and the time it is actually issued.announced and the time it is actually issued.a.a. Ranging from one week to two-weeks (US Ranging from one week to two-weeks (US

market) market) b.b. As short as two days (France)As short as two days (France)

When-issued trading functions like trading in a When-issued trading functions like trading in a forward market.forward market.

Major BenefitsMajor Benefitsa.a. Minimize price and quantity uncertainties. Minimize price and quantity uncertainties. b.b. Lower underwriting riskLower underwriting riskc.c. Increase revenue from the new issue Increase revenue from the new issue


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Recommendations on Infrastructure Building for the CGB Market (I)

1.1. Interest Rate Risk Hedging InstrumentsInterest Rate Risk Hedging Instruments

Is Repeat of Pre-1995 Bubble Valid ConcernIs Repeat of Pre-1995 Bubble Valid Concern??

2.2. PBC-Based C&S SystemPBC-Based C&S SystemClearing: Multilateral netting basis

Settlement: DVP through PBC-wire system

Anonymity

IIs China Government Securities Depository Trust & s China Government Securities Depository Trust &

Clearing Co. up to the Task?Clearing Co. up to the Task?

3.3. Introduction of When-Issued TradingIntroduction of When-Issued Trading


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Types and Amount of Assets Held by Individual Investors (2001)

Bonds648.4 (6%)

Cash1255.1 (11%)

Stocks867.8 (8%)

Margin Deposits221.6 (2%)

Insurance193.2 (2%)

Bank Deposits

8,051.3 (71%)


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Benefits of the Separate Trading of Registered Interest and Principal of Securities (STRIPS)

By introducing STRIPS, the MOF can By introducing STRIPS, the MOF can provide the market with highly liquid zero-provide the market with highly liquid zero-coupon bonds and notes. coupon bonds and notes.

As a result, STRIPS will:As a result, STRIPS will:a.a. expand the investor baseexpand the investor base

b.b. improve tracking of effective yield curveimprove tracking of effective yield curvec.c. allow institutional investors to reduce allow institutional investors to reduce

reinvestment risk. reinvestment risk.


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Recommendations on Infrastructure Building for the CGB Market (II)

3.3. Bond Fund Bond Fund

a.a. Types and Amount of Assets held by Individual InvestorsTypes and Amount of Assets held by Individual Investors b. Institutionalization of Individual Bond Holdings b. Institutionalization of Individual Bond Holdings

4.4. Inter-Dealer Broker System Inter-Dealer Broker System

a. a. Brings market makers togetherBrings market makers together

b. Disseminates to the market via telephone,b. Disseminates to the market via telephone, screen or a screen or a combination of the two combination of the two

c. Promote secondary market liquidity, depth, transparencyc. Promote secondary market liquidity, depth, transparency

5.5. STRIPS STRIPS


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Mahalo for You Attention!

FIMA Research Center University of Hawai'i 1 The Chinese Government Bond Market: Opportunities and...

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