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The Chinese Government Bond Market: Opportunities and Challenges

The Chinese Government Bond Market: Opportunities and Challenges. S. Ghon Rhee, K. J. Luke Distinguished Professor of International Finance and Banking University of Hawai’i The CSRC/OECD Second International Roundtable on the Chinese Securities Market June 6-7, 2002, Shanghai, China.

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The Chinese Government Bond Market: Opportunities and Challenges

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  1. The Chinese Government Bond Market: Opportunities and Challenges S. Ghon Rhee, K. J. Luke Distinguished Professor of International Finance and Banking University of Hawai’i The CSRC/OECD Second International Roundtable on the Chinese Securities Market June 6-7, 2002, Shanghai, China

  2. Idiosyncratic Features of the CGB Market (I) 1. Benchmark Interest Rates a. Deposit interest rates are serving as benchmark? b. Deposit interest rates are one of the last set of interest rates under control c. Why very little differences are observed between savings bonds and book-entry bond yields? Savings Bonds:Syndicated Underwriting Book-Entry Bonds:Uniform Price Auction Method

  3. Status of T-Bonds Issued in 2001 Unit: Billion yuan Assigned Issue TypeSecondary MarketAmount Book-Entry 308.35 Bonds Inter-Bank Market 212.35 Exchange Market 96.00 Savings Bonds OTC Market 180.00 Total 488.35

  4. Idiosyncratic Features of the CGB Market (II) 2. Multipartite Structure of Government Bond Markets a. Dual Supervisory Structure of Primary Market T-Bonds and E-Bonds: MOF F-Bonds: PBC b. Tripartite Structure of Secondary Market Inter-Bank Market under PBC Over-the-Counter (OTC) Market under PBC Exchange Market under CSRC C. Meaning of the OTC Market in China?

  5. Trading Value of Government Bonds (1996-2001)

  6. Idiosyncratic Features of the CGB Market (III) 3. Secondary Markets: Money Market rather than Bond Market Inter-bank Market:REPOs are bond collateral loans among banks Exchange Market:REPOs are short-term loans among securities companies Money Market in China has been developed without T-Bills and the financing function for corporate working capital is missing the working capital needs of corporations Financing the working capital needs of corporations

  7. Idiosyncratic Features of the CGB Market (IV) 4. Missing Links in the Market a. T-Bills: Maturity Structure of Bonds Issued in 2001 2 years: 4% of total issues 3 years: 34% 5 years: 21% 7 years: 14% 10 years: 16% 15 years: 3% 20 years: 8% b. Interest Rate Risk Hedging Instruments Bond Futures: Banned in 1995 Short-term Interest Rate Futures: Not Available

  8. Idiosyncratic Features of the CGB Market (V) 4. Missing Links in the Market-Continued c. Foreign Participation in Primary and Secondary Markets d. Asset-Backed and Mortgage-Backed Securities e. Municipal Bonds Revenue Source: 1/2 from Municipal Governments Expenditures: 2/3 by Municipal Governments

  9. Recommendation 1:Benchmark Interest Rates Make T-Bond Yields Serve as Benchmark Interest Rates a. StopMOF’s practice of setting a range of bidding spreads at the primary market auction b. Introduce T-Bills c. Create Balanced Maturity Structure d. Make all T-bond issues fungible

  10. 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-Bonds c. Consolidation of Inter-Bank Market and Exchange Market

  11. 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 Issues e. Regularity of Issue Cycle

  12. Recommendation 3:Consolidation of Tripartite Secondary Market Mere functional integration cannot achieve consolidation of three markets into a single market a. 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

  13. Korea Stock Exchange’s Experience Unit: $ billion Exchange Market . YearGov’t BondsCorp BondsTotalOTC Market 1997 $0.14 $2.25 $2.39 $82.27 1998 5.42 7.46 12.88 359.17 1999* 248.87 10.32 259.19 658.32 2000 18.58 2.88 21.46 736.36 2001 9.45 1.56 11.01 1,066.44 *KSE Introduced inter-dealer broker system for government bond trading in March 1999

  14. Underlying Forces for the US Government Bond Market Expansion in 1980s a. Introduction of Financial Futures and Options b. Active Trading of Treasury Securities on a When-Issued Basis c. Expansion of REPO transactions d. Introduction of the Separate Trading of Registered Interest and Principal of Securities (STRIPS)

  15. Sequence of Government Bond Market Reforms: French Experience a. Bond futures market (1986) b. Primary dealer system (1987) c. Interdealer broker network (1987) d. Purely competitive auctions (1987) e. REPOs (1991) f. STRIPS (1991) Brossard, Philippe, 1998, The French Bond Market: Enhancing Liquidity, A paper presented at a World Bank Workshop on the Development of Government Bond Markets, June 11-12, Seoul, Korea.

  16. Clearing and Settlement for Government Bonds Australia: Reserve Bank Information and Transfer System Hong Kong: Central MoneyMarkets Unit Japan : BOJ Financial Network System(BOJ-NET) Singapore: Government Book-Entry System China: China Government Securities Depository Trust & Clearing Co.

  17. When-Issued Trading • Most advanced markets allow trading during the period between the time a new issue is announced and the time it is actually issued. a. Ranging from one week to two-weeks (US market) b. As short as two days (France) • When-issued trading functions like trading in a forward market. • Major Benefits a. Minimize price and quantity uncertainties. b. Lower underwriting risk c. Increase revenue from the new issue

  18. Recommendations onInfrastructure Building for the CGB Market (I) 1. Interest Rate Risk Hedging Instruments Is Repeat of Pre-1995 Bubble Valid Concern? 2. PBC-Based C&S System Clearing: Multilateral netting basis Settlement: DVP through PBC-wire system Anonymity Is China Government Securities Depository Trust & Clearing Co. up to the Task? 3. Introduction of When-Issued Trading

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

  20. Benefits of the Separate Trading of Registered Interest and Principal of Securities (STRIPS) • By introducing STRIPS, the MOF can provide the market with highly liquid zero-coupon bonds and notes. • As a result, STRIPS will: a. expand the investor base b. improve tracking of effective yield curve c. allow institutional investors to reduce reinvestment risk.

  21. Recommendations onInfrastructure Building for the CGB Market (II) 3. Bond Fund a.Types and Amount of Assets held by Individual Investors b. Institutionalization of Individual Bond Holdings 4. Inter-Dealer Broker System a. Brings market makers together b. Disseminates to the market via telephone, screen or a combination of the two c. Promote secondary market liquidity, depth, transparency 5. STRIPS

  22. Mahalo for You Attention!

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