After MSCI’s recent announcement on the inclusion of China A-Shares in its Emerging Markets Index and other major global indexes, the inaugurated launch of the long-awaited Bond Connect scheme today marks another significant breakthrough in China’s capital market development, coinciding with the celebration of the twentieth anniversary of the formal establishment of the Hong Kong Special Administrative Region.

Bond Connect is a new mutual access scheme for offshore investors to access the mainland China bond market (“Northbound Trading”) and for onshore investors to access the Hong Kong bond markets (“Southbound Trading”) through a market infrastructure linkage between the mainland China and Hong Kong.

The initial phase of Bond Connect only supports Northbound Trading. Southbound Trading will be explored at a later stage. This article will primarily examine the key features and legal issues relating to Northbound Trading.

King & Wood Mallesons had the honour of acting as the legal adviser to the China Foreign Exchange Trade System & National Interbank Funding Centre (“CFETS”) in developing this ground-breaking initiative. If your institution is considering investing through, or offering services relating to, Bond Connect, we would be delighted to advise on the key legal issues and/or assist with the relevant documentation.

A list of the key rules and regulations relating to Bond Connect are set out in Schedule 1.

Recap on the current state of the China bond market

Market size and structure

The mainland China bond market is the third-largest in the world after the US and Japan[1], comprising the China interbank bond market (commonly referred to as “CIBM”) and an exchange-traded bond market. In May 2017, the amount of bonds issued in the PRC market amounted to a total of RMB 2.9 trillion, with a depository balance amounted to RMB 67.1 trillion[2].


CIBM is an over-the-counter wholesale market, which accounts for over 90% of outstanding value and 80% of trading settlement of the mainland China’s overall bond market. Participants in CIBM include mainly financial institutions and also various investment vehicles, including pension funds, mutual funds and private equity funds.

Exchange-traded bond market (Shanghai Stock Exchange and Shenzhen Stock Exchange)

The exchange-traded bond market is retail-oriented, and accounts for less than 10% of the mainland China’s overall bond market.

Over the past decade, China has made significant progress in developing its bond market, with measures ranging from steadily liberalising interest rates to gradually easing capital controls.

As of the end 2016, foreign holdings of China’s domestic bonds have reached a new high of RMB852.6 billion (approximately USD125.7 billion), 13% higher than the previous year.

Clearing and settlement for the mainland China bonds

There are three central securities depositories for the mainland China’s bond market as below:

  • China Central Depository & Clearing Co., Ltd (“CCDC”) and Shanghai Clearing House (“SCH”) are responsible for custody and settlement for the CIBM; and
  • China Securities Depository and Clearing Corporation (“CSDC”) is the custodian, settlement and clearing house for the exchange-traded bond market.

Snapshot of the infrastructure and key participants of Bond Connect

This diagram illustrates the infrastructure, and interaction between the key participants, of Bond Connect. We have included a brief explanation of the key roles and functions of each party involved in Bond Connect below.

[click on image to view a larger version]


The “settlement link” refers to the settlement and custody of CIBM securities conducted under Bond Connect through a clearing and settlement linkage between CMU in Hong Kong (as the offshore custodian and settlement agent for eligible offshore investors) and CCDC and SCH (as the onshore custodian and clearing institutions in the mainland China) effecting the settlement and custody of CIBM securities under Bond Connect.


The “trading link” refers to the trading platform for eligible offshore investors to input trading orders from outside China connected to CFETS for Bond Connect transactions. HKEx and CFETS will cooperate with international bond trading platform(s) to provide electronic trading services and platforms (“Access Platforms”) to enable direct trading between eligible offshore investors and market makers providing quotations in the mainland China from the CFETS system. As of the date of this article, it has been reported that Tradeweb is the first Access Platform offering the trading link to CFETS’ CIBM.


HKEx and Bond Connect Company will provide administrative services to eligible offshore investors (such as passing on the eligible offshore investors’ applications to CFETS)


Offshore eligible investors will input trade orders and instructions through the trading link provided by Access Platform located outside China to CFETS’ trading system in China


CMU (as the offshore clearing system for Northbound Trading) will provide bond registration, custody and clearing/settlement services to CMU members in Hong Kong


CFETS will match and execute trade orders from eligible offshore investors routed through the Access Platform


CCDC/SCH (as the onshore clearing systems for Northbound Trading) will provide bond registration, custody and clearing/settlement services to CMU in China, as the onshore clearing system


CNAPS/ CIPS/ RCPMIS are the RMB payment systems for remittance of cross border RMB between CMU and SCH/CCDC and reporting of RMB payments


Hong Kong Settlement Banks will offer FX/RMB conversion services to eligible offshore investors who intend to use FX for Northbound Trading

As at the date of this article, the Hong Kong settlement banks appointed to offer RMB clearing and conversion services for Bond Connect are: Industrial and Commercial Bank of China (Asia) Limited, China Merchants Bank Hong Kong Branch, Standard Chartered Bank (Hong Kong) Limited, Citibank Hong Kong Branch, Hang Seng Bank Limited, Agricultural Bank of China Limited Hong Kong Branch, China Construction Bank (Asia) Co., Ltd, Wing Fung Commercial Bank Co., Ltd. Hong Kong Branch, CITIC Bank (International) Limited, Hongkong and Shanghai Banking Corporation Limited.

Trading and settlement of bonds under Bond Connect – what do market participants need to know?

Home rules principle

Bond Connect will abide by the relevant laws and regulations of the bond markets of Hong Kong and the mainland China[4]. Foreign investors investing in the CIBM through Northbound Trading will be subject to the CIBM bond market regulations in China. This is similar to the principles applicable to foreign investors investing in CIBM through the existing QFII/RQFII regimes.

Eligible investors

According to the Bond Connect Interim Trading Rules, CFETS will determine the eligibility of offshore investors according to the criteria set out in PBOC Notice No. 3 of 2016 and PBOC Notice No. 220 of 2015 (please check our previous article for more information).

Offshore investors eligible to trade through Bond Connect include:

Institutional investors

Financial institutions such as commercial banks, insurance companies, securities companies, fund management companies or asset management companies incorporated outside of mainland China

Investment products lawfully sold by the above-mentioned financial institutions to their clients

Medium and long term institutional investors recognized by the PBOC including senior funds, charity funds and donation funds


Institutional investors based in Hong Kong, Macau and Taiwan

Central bank institutions

Foreign Central Banks

International Financial Organisations

Sovereign Wealth Funds

Eligible bonds under Northbound Trading

Eligible offshore investors under Northbound Trading may conduct spot trading of all cash bonds currently traded in the CIBM (for example, national bond, local-government debt, central bank bond, financial bond, corporate credit bonds, inter-bank deposit receipts and asset-backed securities)[5]. Based on the published rules, eligible offshore investors will have access to the primary and secondary bond market through Northbound Trading[6].

It is expected that the scope of eligible products may expand to include transactions such as bond repurchasing, bond lending, bond forwards, interest rate swap and forward rate agreements in the future, although these products are not permitted under the existing scope of Northbound Trading.

No specific investment quota limit

According to the rules and regulations published to-date, there is no investment quota limit for Northbound Trading.

Application procedure

Eligible offshore investors are required to comply with the following filing procedure with the PBOC Shanghai headquarter to trade through Bond Connect[7]:

What are the trading days and hours for Northbound Trading?

Trading days: CIBM trading days in mainland China (regardless of whether it is public holiday in Hong Kong)

Trading hours: 9:00 am to 12:00 pm and 13:30 pm to 16:30 pm (Beijing time)

How is a spot bond trade concluded under Northbound Trading?

Trades under Northbound Trading will be executed through a “request for quotation” mechanism between an eligible offshore investor and an onshore market maker at CFETS, subject to a minimum order size of RMB1 million (approximately USD147,520). Broadly speaking, the procedure for concluding a spot bond trade under Northbound Trading is as follows:

Custody, clearing and settlement arrangement for Northbound Trading

The basic arrangement for the custody, clearing and settlement arrangements for Northbound Trading are as follows:

(a) All registration, custody, clearing and settlement services in respect of Bond Connect trades are provided jointly by:

(b) Gross DvP settlement method

Northbound Trading transactions will be cleared and settled on a gross and delivery versus payment (“DvP”) basis[11].

(c) Payment mechanics

Payments (including funding for bond trades concluded via Bond Connect and interest accrued from such bonds) are made on a real-time gross basis between CMU and SCH/CCDC through Cross-Border Interbank Payment System (CIPS)[12].

(d) Settlement finality

Both SCH and CCDC have published rules to recognise the finality of settlements made via SCH/CCDC.

How do eligible offshore investors fund the purchase price for a bond trade under Northbound Trading?

Eligible offshore investors can either use Offshore RMB (CNH) or FX converted into Onshore RMB (CNY) to purchase a CIBM bond under Northbound Trading.

Using Offshore RMB (CNH)

Eligible offshore investors using their own Offshore RMB to fund its bond investments through Northbound Trading do not need to appoint an RMB Participating Bank or open a segregated RMB capital account.

Using Onshore RMB (CNY) through FX conversion

An eligible offshore investor can use FX (in whole or in part [12]) to fund its bond investments through Northbound Trading. An eligible offshore investor intending to use FX to fund its purchase of CIBM bonds under Northbound Trading must open a segregated RMB capital account with an eligible RMB Participating Bank in Hong Kong to convert its FX into Onshore RMB.

There are certain restrictions in using Onshore RMB to fund its Northbound Bond Connect trades, including:

Eligible offshore investors may, through CMU members, conduct FX risk hedging with RMB Participating Banks.

Positions generated by RMB Participating Banks from providing FX/RMB conversion services can be unwound on the onshore interbank foreign exchange market[14].

Who owns the legal and beneficial title to the bonds invested through Bond Connect?

Trading in CIBM bonds through Bond Connect is settled in SCH or CCDC. The holding of CIBM bonds acquired through Bond Connect involves multiple levels of ownership, which arises from the clearing and settlement arrangements for CIBM bonds as summarised below:

HKMA (as the registered holder of the CIBM bonds) is entitled to exercise its rights as against issuers of the bonds (through SCH/CCDC). Prior to exercising a bond holder’s rights against the relevant CIBM bond issuer, HKMA (as the nominee holder for eligible offshore investors under Northbound Trading) will consult with the eligible offshore investors and take actions accordingly[16].

The CMU nominee holding arrangement is similar to the nominee holding arrangement under Stock Connect. To understand the ownership issues regarding CIBM bonds acquired through Bond Connect, we need to look at two levels of holding:

  • holding by HKMA as the “nominee holder”; and
  • holding by the eligible offshore investors through CMU members as the “beneficial owners” of the CIBM bonds.

At the SCH/CCDC level in the mainland China, the CIBM bonds traded through Bond Connect are registered in the name of HKMA as the registered holder and legal holder of such bonds under PRC law. The CIBM bonds are held by HKMA in its capacity as the nominee of the eligible offshore investors under Northbound Trading.

At the CMU level, the CIBM bonds acquired through Bond Connect are allocated to, and recorded as separate holdings of, the relevant CMU members (either as their proprietary investment or, as client assets in their custody role).

The diagram below illustrates the nominee holding structure under Northbound Trading:

Key points to note

How does an eligible offshore investor enforce its rights in CIBM bonds invested through Bond Connect?

PBOC has indicated in a recent Bond Connect press conference that an eligible offshore investor could either enforce rights in the bonds through HKMA/CMU or in its own name in accordance with the applicable laws in Hong Kong. The SCH Rules expressly provide that eligible investors “enjoy the rights and interests of the [bonds] according to applicable laws[17].

Hong Kong law recognises that investors hold the beneficial interest in bonds acquired for them by their custodian (i.e. CMU members and HKMA). Eligible offshore investors (as beneficial owners of the bonds) should be able to exercise their rights in CIBM bonds in accordance with the laws and regulations of Hong Kong regarding nominee holders and custody arrangements.

Under PRC law, the plaintiff to a legal claim is any citizen, legal person or any other organisation with a direct interest in the claim[18]. Subject to an eligible offshore investor providing evidence that it is the ultimate beneficial owner of the relevant CIBM bonds (i.e. certificate/proof provided by CMU and CMU members showing that such eligible offshore investor is the legitimate beneficial owner under Hong Kong law), the offshore investor should be entitled to bring a legal claim in its own name in the PRC courts[19].

What are the consequences if an eligible offshore investor is found to have contravened the relevant Bond Connect rules and regulations?

CFETS may investigate any actual or potential breach by eligible offshore investors of the Bond Connect trading rules and/or other rules and regulations relating to the CIBM.

Certain trading activity and behaviour will be more likely to be considered as “unusual” by CFETS[20].

What are the key takeaways for offshore service providers providing custody and settlement services for Bond Connect?

KYC procedures

The rules are clear that RMB Participating Banks providing FX/RMB conversion services to eligible offshore investors are generally expected to conduct the basic know-your-client procedures in respect of eligible offshore investors to whom it provides services to.

We recommend all RMB Participating Banks providing Bond Connect-related FX/RMB conversion services to obtain specific declarations from eligible offshore investors to whom it provides currency conversion services to that all Onshore RMB converted by the RMB Participating Bank must be used for settling Bond Connect trades (failing which must be re-converted to the original foreign currency).

Discrepancy in trading days

If the business days of the offshore service provider is not the same as the CIBM trading days (being the trading days for Bond Connect trades), such offshore service providers should ensure it obtains an acknowledgement from the eligible offshore investors to whom it provides Bond Connect-related services to that the services will only be provided to the eligible offshore investor during the working days and hours of the service provider.

What are the tax implications? Are eligible offshore investors required to pay PRC taxes (e.g. stamp duty or capital gain tax) in respect of its Northbound Trading activities?

We understand that the regulators have yet to publish rules on the tax implications on bond investments made through Northbound Trading.

Closing remarks

Foreign participation in China’s bond market has remained at around 2.52% of the PRC onshore market, and 3.93% of the sovereign debt market. This is significantly lower than other countries such as Japan, U.S. and even some emerging markets.

Bond Connect is another breakthrough after the launch of Stock Connect. We believe Bond Connect will play a significant role in:

  • advancing the level foreign participation in China’s domestic bond market; and
  • offering an improved and easily accessible market infrastructure to further broaden and deepen China’s bond market for global access.

This is an encouraging development after the recent inclusion of China A-shares in MSCI indexes. We have been working closely with the key parties involved in Bond Connect and expect to see further innovative developments in this ground-breaking programme.

Key rules and regulations applicable to Bond Connect (Up to [3] July 2017)

Bond Connect Interim Trading Rules

Interim Trading Rules for Bond Connect as set out in the Circular issued by CFETS and National Inter-Bank Funding Centre on 22 June 2017[21]

CCDC Implementation Notice

CCDC Notice of Implementation of PBOC’s Bond Connect Settlement Provisional Operation Instructions[22]

CCDC Rules

Rules on Registration of Bond Connect Custodial and Settlement Services issued by CCDC on 26 June 2017[23]

FAQ on Provisional Measures

FAQ on the Bond Connect Provisional Measures issued by the PBOC on 22 June 2017[24]

Joint Announcement

Announcement jointly published by PBOC and HKMA on 16 May 2017 confirming, amongst others, that it has approved the CFETS, HKEX, CCDC, SCH and CMU to collaborate in establishing mutual bond market access between Hong Kong and Mainland China through “Bond Connect”[25]

PBOC Filing Guidelines

Filing Guidelines for Bond Connect Northbound Foreign Investors circulated by PBOC Shanghai Headquarter on 22 June 2017[26]

PBOC Notice No. 220 of 2015

Notice of the People's Bank of China on Issues concerning Investment in the Inter-bank Market with RMB Funds by Foreign Central Banks, International Financial Organizations, and Sovereign Wealth Funds[27]

PBOC Notice No.3 of 2016

Notice of the People's Bank of China on further handling of issues concerning Investment in the Inter-bank Market by Foreign Institutional Investors[28]

Provisional Measures

Notice on the publication of the Bond Connect Provisional Measures issued by the PBOC on 21 June 2017[29]

SCH Business Guidelines

SCH Business Guidelines for Northbound Trading of Bond Connect (Trial Implementation) published by the SCH on 28 June 2017[30]

SCH Rules

Shanghai Clearing House Detailed Operation Rules for Registration, Custody, Clearing and Settlement of Bond Connect Cooperation between the Mainland and Hong Kong (Trial Implementation) published by the SCH on 23 June 2017[31]