Line chart of 10-year government bond yields (%) showing that Chinese yields remained stable when the Fed cut rates

China and the US are building bridges in financial services

A day after US President Donald Trump announced a new initiative to thwart Beijing’s alleged efforts to “steal” US technology, senior Chinese finance officials and Wall Street bankers sat down for a conference call.

A participant in the China-US Financial Roundtable, established two years ago at a time of increasing trade tensions between the world's two largest economies, said it was a fairly "generic" forum aimed at "promoting goodwill." "and to improve financial integration between the US two largest economies in the world.

But the forum, convened on October 16, according to four people briefed on the discussions, also highlights a rare positive front in Sino-US relations: finance as Beijing seeks to accelerate market reforms and foreign affairs Attracting capital.

In the first eight months of this year, the proportion of Chinese onshore bonds held by foreign institutional investors rose by more than 20 percent year-on-year to Rmb 2.8 billion (USD 421 billion), according to Fitch Ratings. According to Refinitiv, foreign investors made around 12 percent of all purchases of Chinese government and bank bonds this year.

Regardless, Wall Street groups like BlackRock, Citigroup and JPMorgan Chase have received approval in recent months to expand their businesses in China.

The increased financial flows and regulatory approvals coincided with loose central bank policy elsewhere, depressing bond yields, which are propping global portfolio allocation to historic lows. The 10-year yield on Chinese government bonds is 3.18 percent versus 0.8 percent in the US.

"Money is starting to flow into China because they are looking for that revenue," said Hayden Briscoe, head of fixed income, Asia Pacific, UBS Asset Management. "It's a really interesting point in the story – the Chinese have opened up and you have the rest of the world in dire straits."

"Economic needs certainly take precedence over political concerns," added Eswar Prasad, an expert on China's financial system at Cornell University. "Ultimately, no matter what the political masters say, private capital and private financial institutions will be more responsive to economic incentives."

Industry executives say Beijing is motivated in part by geopolitical concerns. "China wants to prevent possible US financial sanctions in connection with deteriorating relations," said a China-based manager of a major global fund manager. “That's why you're seeing a flood of openings right now. When you integrate into global financial markets and speed up the coupling by opening up to foreign actors, you reduce US leverage. "

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The executive added that the more business Wall Street does in China, the greater the incentive for the U.S. investment banking industry to work with the Trump administration to ease tensions with Beijing.

Wall Street organizations participating in the forum since September 2018 include Blackstone, Citadel, Fidelity, Goldman Sachs, JP Morgan, and Morgan Stanley. The meeting, held two weeks ago, was originally scheduled to take place in Washington in April, but has been postponed due to the coronavirus pandemic.

American attendees say they made it clear to their peers that the anti-China sentiment Trump was fueling is broad-based and will not go away even if he loses next month's election to Joe Biden.

Privately, Chinese officials argue that they are merely accelerating a longer-term agenda geared towards the needs of their own market.

Let's be honest, even if Trump should be re-elected. . . These are institutional capital flows with a longer time horizon. You look beyond short-term uncertainty

Last week's roundtable included sessions on technical market reforms and broader Sino-US relations, according to participants. Guest speakers included Kevin Rudd, former Australian Prime Minister and Sinologist, and Jeffrey Bader, who advised Barack Obama, former US President, on Asian security issues.

A senior Chinese government official who asked not to be identified said the greater financial openness would help regulators address major challenges. These include poor corporate governance in many domestic companies, a lack of industry innovation, and an underdeveloped regulatory system. "We hope that the introduction of foreign players will help address these issues," said the official.

The manager of the fund added that such goals and Beijing's longer-term goal of making the renminbi a reserve currency against the dollar “are impossible if you rely solely on the Bank of China – it needs the JPMorgans, BlackRocks and Vanguards so that it is successful ”.

Outside of China, the renminbi only makes up about 3 percent of central bank reserves, compared to 62, 20 and 5.7 percent for the dollar, euro and yen, respectively.

From the perspective of overseas investors, China's bond market has just gotten too big to ignore, especially given the higher yields it offers.

In two decades, China's onshore bond market has quadrupled to about $ 14 billion, overtaking Japan to become the second largest in the world. However, foreign investors remain underrepresented. JPMorgan Asset Management estimates that the percentage of onshore government bonds overseas has increased from 2 percent to 9 percent in recent years, but remains well below the 15-30 percent that foreign investors typically hold in other Asian markets.

Chinese government bonds were added to one of the world's top bond indices last month, paving the way for around $ 140 billion in inflows.

"When you look at a big market like China that is opening up, you don't want to wait for everyone else to invest in it – you want to be the first man," said Adam McCabe, head of fixed income, Aberdeen Standard Investments.

"Let's face it, even if Trump were to be re-elected… These are institutional capital flows with a longer time horizon. They look beyond short-term uncertainty."

Additional coverage from Sun Yu, Sherry Fei Ju and Jamil Anderlini