Using RMB bonds as collateral for OTC derivatives

Abstract

Using Renminbi (RMB) bonds, especially Chinese Government bonds (CGB), as collateral for both onshore and cross-border over-the-counter (OTC) derivatives is a hot topic following China switching to a netting jurisdiction in August 2022. Since then, Chinese financial institutions are required to exchange initial margin and variation margin with offshore counterparties for dealing cross-border derivatives. As the market infrastructure for using RMB bonds as collateral for cross-border OTC derivatives transactions is not well established and RMB bonds are not extensively accepted by foreign counterparties as eligible collateral, Chinese financial institutions are unable to utilise their huge RMB bond holdings. At the same time, many foreign investors are allowed to access China’s onshore RMB bond market with RMB bond holding up to RMB 3.4tr, but are unable to use those inventories as collateral for their onshore and cross-border derivatives trading and other financial transactions. Using RMB bonds as collateral is also an initiative of RMB internationalisation. The purpose of this paper is to give an extensive explanation of the status of using RMB bonds as collateral in the Chinese market, point out challenges faced by market participants and provide suggestions to promote using RMB bonds as collateral for both onshore and cross-border derivatives transactions. This paper provides the full picture of China’s onshore RMB bond investment and bond collateral management along with the latest data. It also provides extensive analysis for deficiencies in respect of the RMB bond collateralisation. It concludes with suggestions for the future development of the Chinese market to use RMB bonds as collateral for both onshore and cross-border OTC derivatives.