Swap Connect – A New Addition to the Connect Family

Swap Connect will mark another milestone for Hong Kong as a “super-connector” between mainland China and the rest of the world, says Chong Liew.

Swap Connect is a mutual market access scheme between mainland China and Hong Kong SAR for the trading of over-the-counter (OTC) derivatives. Through trading and clearing links between the financial market infrastructures in both places, Swap Connect will enable overseas investors to participate in the mainland OTC derivatives markets (Northbound) and vice versa for onshore investors to participate in the Hong Kong OTC derivatives market (Southbound).

As the newest addition to the mainland-Hong Kong connect schemes following Stock Connect, Bond Connect and ETF Connect, Swap Connect is significant in that it offers overseas institutional investors access to the massive US$5 trillion renminbi (RMB) interest rate swap market onshore China.

For overseas institutional investors that are accessing the China Interbank Bond Market (CIBM) via Bond Connect, Swap Connect will give them access to the mainland interbank derivatives market for the very first time. On the other hand, for those overseas investors in the CIBM that already have access to the mainland interbank financial derivatives market (such as Direct Access investors, QFII investors, foreign central banks and sovereigns), Swap Connect will offer an alternative route of access allowing these overseas investors to trade through offshore trading platforms and clear with a Hong Kong central clearing counterparty (CCP) without going onshore to the mainland. To this end, Swap Connect would be a particularly attractive proposition to international investors that may already have existing arrangements with OTCC or its (intermediating) clearing members and who are familiar with the open and robust framework and standards for the trading and clearing of OTC derivatives in Hong Kong.

Under the trading link, offshore investors will be able to submit their requests for quotes and trading instructions to onshore dealers via the offshore trading platforms; onshore dealers will be able to reply to such requests or provide its own executable price quotations on the CFETS trading platform.

Overseas investors may trade interest rate swaps under Northbound Swap Connect only for “risk management purposes”.  These terms are not defined under the rules and regulations, although it should be clear that qualified overseas investors with direct exposures to CIBM investments should be able to use Swap Connect to manage such exposures.

Once a trade has been concluded by an offshore investor and an onshore dealer on the CFETS platform, it will be submitted to central clearing. Offshore investors will clear at OTCC either as a clearing member (CM) of OTCC or as a client of a CM through client clearing, while onshore dealers will clear at SHCH. To establish the clearing link between SHCH and OTCC, each of SHCH and OTCC has become a special clearing house participant of the other CCP.

CMs participating in clearing under Northbound Swap Connect will be required to post an additional type of margin with OTCC: participating margin.  Participating margin may be applied on a CM’s own default and on the default of SHCH and, absent such default, will be returned by OTCC if the CM has no outstanding Northbound Swap Connect house and client trades.

To ensure a stable operation of the onshore financial derivatives market, trading and clearing limits (which takes into consideration the size of foreign investment in the CIBM) will be imposed at launch of Northbound Swap Connect. At launch, the daily trading limit will be RMB20 billion; this limit applies to the net notional amount of all the Northbound Swap Connect interest rate swap transactions entered into by overseas investors. Once used up, only offsetting trades may be entered into for the remainder of the day. The daily clearing limit will be RMB4 billion, such limit being the exposure amount of the inter-CCP lockbox between SHCH and OTCC.

Swap Connect will mark yet another milestone for Hong Kong as a “super-connector” between mainland China and the rest of the world, following the introduction of Stock Connect in 2014 and Bond Connect in 2017. The addition of Southbound trading under Swap Connect (expected to be rolled out following the launch of Northbound trading) would complete the scheme by linking onshore investors to the Hong Kong financial derivatives market. The potential addition of new products (most notably repos) under this Swap Connect scheme would be a further exciting development for the market.

Click here to read more: Swap Connect – A New Addition to the Connect Family | Linklaters

By Chong Liew, Capital Markets Partner, Linklaters

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