Following the People’s Bank of China (“PBOC”) issued the Interim Measures for the Administration of Mutual Access between the Mainland and Hong Kong Interest Rate Swap Markets (the “Measures”), on May 15, 2023, the scheme of mutual access between the Mainland and Hong Kong interest rate swap markets ("Swap Connect") was officially launched. Initially Swap Connect will be available for Northbound Trading only. The China Foreign Exchange Trade System (CFETS), the Shanghai Clearing House (SHCH), and OTC Clearing Hong Kong Limited (a subsidiary of Hong Kong Exchanges and Clearing Limited) provide joint support for domestic and foreign institutions to engage in Northbound Trading. On the first day of the launch, 162 transactions were made by domestic and foreign institutions, with a total notional principal of RMB 8.259 billion1. Northbound Swap Connect provides foreign institutions that trade in China’s bond market with tools to manage the interest rate risk of their bond portfolios, and promotes mutual access between Mainland and Hong Kong capital markets.
The Measures are generally consistent with the consultation draft version. With the addition of the Futures and Derivatives Law of the People's Republic of China as the higher-level legal basis for the Measures, Article 4 states that foreign institutional investors (who satisfy the requirements of the PBOC and have completed filing with the PBOC for access to the interbank bond market), shall conduct Northbound Trading for risk management purposes. This is consistent with the existing requirements for foreign institutions that trade hedging instruments in the interbank bond market.
For more details regarding Northbound Swap Connect, including the scope of eligible foreign investors, trading participants, transaction documentation, and trading and clearing procedures, please refer to our translation of the Q&As with respect to the Interim Measures for the Administration of Mutual Access between the Mainland and Hong Kong Interest Rate Swap Markets provided by the PBOC. We will continue to monitor the situation and keep our clients apprised of the latest developments.
PBOC Q&A with respect to
the Interim Measures for the Administration of Mutual Access between the Mainland and Hong Kong Interest Rate Swap Markets
Q:What do eligible overseas investors need to meet the People's Bank of China (“PBOC”) requirements?
A:Overseas investors that meet the requirements set out in the Circular of the People's Bank of China on Issues Concerning Investments in the Inter-bank Market by Foreign Central Banks, International Financial Organizations, and Sovereign Wealth Funds with Renminbi (Yin Fa  No.220), the Announcement of the People's Bank of China on Relevant Issues Concerning Further Improving Investments in the Inter-bank Bond Market by Foreign Institutional Investors (PBOC Announcement  No.3), the Interim Measures for the Administration of Mutual Access between the Mainland and Hong Kong Bond Markets (PBOC Decree  No.1) and other administrative documents, and have completed filing with the PBOC for access to the interbank bond market, may participate in the Northbound Swap Connect in accordance with the Interim Measures for the Administration of Mutual Access between the Mainland and Hong Kong Interest Rate Swap Markets (the "Measures").
Q:What agreements can be used by domestic and overseas investors under Northbound Swap Connect?
A:According to the Measures, before conducting Northbound Trading, domestic and overseas investors may enter into a master agreement or other agreements recognized by the PBOC with their counterparties, including the NAFMII Master Agreement, the ISDA Master Agreement, and the Cleared Derivatives Execution Agreement (the "CDEA Agreement"). Domestic investors shall file with the China Foreign Exchange Trading System (“CFETS”) regarding whether an agreement has been concluded, the agreement type and other information. The National Association of Financial Market Institutional Investors (“NAFMII”) is currently formulating the Swap Connect master agreement, which will be available to domestic and overseas investors after its official release.
Q:What is the permissible investment scope for overseas investors under Northbound Swap Connect?
A:Presently, overseas investors under the Northbound Swap Connect may trade renminbi interest rate swaps that are qualified for centralized clearing in the interbank market.
Q:What are the recognized overseas electronic trading platforms and domestic electronic trading platforms mentioned in the Measures? What is required of the counterparties and the trading models for overseas investors?
A:The recognized overseas electronic trading platforms under the Northbound Swap Connect presently are TradeWeb and Bloomberg. Other electronic trading platforms may be recognized in the future based on market demand. CFETS is the recognized domestic electronic trading platform.
To facilitate overseas investors to trade renminbi interest rate swaps, Northbound Swap Connect transactions may be conducted between domestic investors (i.e., Swap Connect Dealers) and overseas investors with reference to the relevant arrangements of Bond Connect. A list of Swap Connect Dealers is available on the CFETS website.
A Northbound Swap Connect transaction will be concluded through the domestic electronic trading platform and shall be confirmed upon the conclusion of the transaction. Overseas investors may send trading instructions to the domestic electronic trading platform through the PBOC-recognized overseas electronic trading platform and the domestic electronic trading platform and conclude transactions with Swap Connect Dealers.
Q:Which domestic clearing institutions are recognized by the PBOC and which overseas clearing institutions are recognized by the Securities and Futures Commission (“SFC”)?
A:The Shanghai Clearing House ("SHCH") is the domestic clearing institution recognized by the PBOC, and OTC Clearing Hong Kong Limited (the "OTC Clear"), a subsidiary of Hong Kong Exchanges and Clearing Limited, is the overseas clearing institution recognized by the SFC.
Q:What are the main procedures for overseas investors to carry out centralized clearing?
A:Overseas investors may either apply to become a clearing member of the OTC Clear or entrust a clearing member that offers client clearing services of the OTC Clear, and sign a client clearing agreement with such member to clear the transactions on its behalf. After a transaction is concluded, the domestic and overseas clearing institutions will conduct a risk control inspection on the transaction, and centrally clear the transaction in a timely manner if the requirements for centralized clearing are satisfied. Overseas institutions shall settle margins and funds via the OTC Clear or its clearing members that offer client clearing services.
Q:How do domestic and overseas clearing institutions replace their derivatives transaction contracts under Swap Connect?
A:“Contract replacement” refers to a legal arrangement whereby the clearing institution, as the central counterparty, acts as the seller to the buyer and the buyer to the seller of a concluded transaction, and replaces the original contract with two new contracts with the buyer and seller respectively to settle the original obligations between the buyer and seller. Under Northbound Swap Connect, after a concluded transaction between an overseas participant and a domestic participant has passed the centralized clearing examination of the SHCH and the OTC Clear, the SHCH and the OTC Clear will replace the original contract on the same day, proceed the transaction for centralized clearing, and form three independent new contracts. These are the contracts between the overseas participant and the OTC Clear, the contract between the OTC Clear and the SHCH, and the contract between the SHCH and the domestic participant. The original contractual relationship between the overseas participant and the domestic participant will then no longer exist. Transactions that are not qualified for centralized clearing shall be handled as agreed by the parties to the transactions.
Q:How is the cross-border capital flow managed under Swap Connect?
A:Under Swap Connect, cross-border funds settlement between the SHCH and the OTC Clear is mainly conducted through the Cross-border Interbank Payment System (“CIPS”). In the meantime, the OTC Clear may open a renminbi basic deposit account and a renminbi Swap Connect special settlement account (the "NRA account") with a domestic bank, as a contingency settlement arrangement in extreme cases. The scope of receipts and the payments of an NRA account includes settlement funds for Swap Connect transactions, principal and interest and expenses of funds borrowed in an emergency for the settlement of Swap Connect transactions, as well as other income and expenditure that comply with PBOC regulations.
As part of the risk control arrangements for Swap Connect, the SHCH and the OTC Clear will establish a Swap Connect financial resource pool for the risk exposure between each other. The SHCH and the OTC Clear shall provide collateral to the Swap Connect financial resource pool, which is separate from the margins and settlement funds collected by each central counterparty from its clearing participants, and shall not be used to cover losses caused by the default of any members. Funds provided by the SHCH to the financial resource pool shall be deposited in a Swap Connect special account opened overseas in the name of the OTC Clear. Funds provided by the OTC Clear to the financial resource pool shall be deposited in a Swap Connect special renminbi/foreign currency account opened domestically in the name of the SHCH (the foreign currency account is "Capital Account – Client Funds Account of Non- Bank Financial Institutions" with account code 2417, and is used exclusively by relevant businesses of the OTC Clear that provide foreign currencies to the financial resource pool). Funds in the relevant accounts may be exempted from the requirements of cross-border debt registration and quota restrictions. The OTC Clear and the SHCH shall calculate the funds to be provided to the Swap Connect financial resource pool on a daily basis based on each other’s risk exposure, and handle the cross-border transfer of renminbi or foreign currency through domestic and overseas depositary banks.
Institutions that are obliged to report shall fulfill the reporting obligations in a timely manner. The SHCH and the domestic depositary bank for the financial resource pool shall file the cross-border renminbi receipts and payment information to the RMB Cross-Border Payment and Receipt Management Information System (“RCPMIS”); if a canceled transaction involves bilateral settlement compensations, the relevant domestic settlement bank shall file the cross-border renminbi receipt and payment information. The SHCH, domestic investors and other relevant entities shall fulfill their obligations to declare the balance of payments statistics, according to the relevant provisions. In principle, declarations on the balance of payments statistics for Swap Connect transactions and the financial resource pool shall be conducted by the SHCH collectively. For compensation and other transactions or fund receipts and payments that are not cleared via the SHCH, declarations on the balance of payments statistics shall be conducted by domestic investors and other relevant entities.
Q:How does quota management under Northbound Swap Connect apply?
A:To ensure the stable operation of the market, and taking into account overseas investors’ investments in the interbank bond market, at the initial stage, the daily net trading amount for the whole market shall not exceed RMB 20 billion (i.e., the daily net notional principal amount of all the interest rate swap contracts traded by all overseas investors under Northbound Swap Connect shall not exceed RMB 20 billion); and the clearing amounts shall not exceed RMB 4 billion (i.e., the Swap Connect financial resources pool corresponding to the risk exposure of the net positions between SHCH and OTC Clear shall not exceed RMB 4 billion). The quotas may be adjusted based on market developments in the future, and will be disclosed to the public.
Q:What are the specific provisions relating to renminbi purchase and sale business that Hong Kong-based clearing banks should comply with?
A:The relevant administrative documents governing renminbi purchase and sale business include the Circular of the People's Bank of China on Clarifying Issues Concerning Cross-Border Renminbi Business (Yin Fa  No. 145), the Circular of the People's Bank of China on Adjusting the Administration of Renminbi Purchase and Sale Business (Yin Fa  No. 321), the Circular of the People's Bank of China on Expanding the Scope of Renminbi Purchase and Sale Business (Yin Fa  No. 250), the Announcement of the People's Bank of China and the State Administration of Foreign Exchange ( No. 40), the Circular of the General Office of the People's Bank of China on Matters Relating to Strengthening the Macro-Prudential Administration of Overseas Financial Institutions Entering into the Interbank Foreign Exchange Market for Renminbi Purchase and Sale Business (Yin Ban Fa  No. 143), the Circular of the People's Bank of China on Issues Relating to Improving the Administration of Renminbi Purchase and Sale Business (Yin Fa  No. 159) and the Announcement on Matters Relating to Improving the Access to the Interbank Foreign Exchange Market by Overseas Participating Banks and Overseas Clearing Banks for Renminbi Purchase and Sale Business (Zhong Hui Jiao Announcement  No. 42).
The existing arrangements that are applicable to overseas clearing banks and overseas participating banks, such as business modes, product categories, and information reporting, shall apply to Hong Kong-based clearing banks’ closing out of its foreign currency positions in the domestic interbank foreign exchange market. According to the Measures and the administrative provisions on renminbi purchase and sale business, Hong Kong-based clearing banks shall, when closing out its foreign currency positions in the domestic interbank foreign exchange market, ensure that the related overseas investors shall exchange currencies based on their real and reasonable needs for Northbound Swap Connect transactions.
Q:What is the meaning of “overseas investors using foreign exchanges to trade shall in principle exchange the money for foreign currency through the Hong Kong-based clearing bank upon the expiration of the transactions or the cessation of their participation in Northbound Swap Connect”?
A:To make it easier for overseas investors holding foreign currency to invest in the mainland interbank financial derivatives market via Northbound Swap Connect, overseas investors are allowed to exchange foreign currency at Hong Kong-based clearing banks, and the Hong Kong-based clearing banks may close out its foreign currency positions in the domestic interbank foreign exchange market. In the initial stage, overseas investors may choose one Hong Kong-based clearing bank. When handling foreign currency exchange business for overseas investors, Hong Kong-based clearing banks shall properly examine and verify the authenticity of the transactions, to ensure that the exchanged funds are used for Northbound Swap Connect transactions. The RMB funds obtained upon maturity of Northbound Swap Connect transactions may be used for investment. If the RMB funds are used for investments other than Northbound Swap Connect transactions, investors shall convert them back to foreign currencies at the Hong Kong-based clearing banks.
Q:What are the Northbound Swap Connect trading reporting requirements?
A:Domestic and overseas investors and relevant financial market infrastructures shall report relevant Northbound Trading data to the Trade Repository that is recognized by the PBOC. CFETS is the PBOC-recognized Trade Repository for Northbound Swap Connect data. Where domestic and overseas investors enter transactions through the CFETS, there is no need to report them separately. The PBOC and other relevant regulators may, based on their needs, collect data relating to overseas investors’ investment activities from the relevant financial market infrastructure.
Q:Will relevant ancillary business rules be issued after the promulgation of the Measures?
A:Following the promulgation of the Measures, the domestic electronic trading platform and domestic and overseas clearing institutions will formulate and release ancillary business rules and other documents.
Q:What are the plans for Swap Connect?
A:The PBOC will expand eligible investment products, adjust trading and clearing quotas, and optimize trading and clearing arrangements in due course, depending on market developments, to provide more convenient and efficient risk management tools for overseas investors. Mainland and Hong Kong regulatory authorities will explore Southbound Swap Connect in due course, taking into account various factors and following the principles of risk control, reciprocity and mutual benefit.