Swap Connect: a new channel, a new chapter
Oct 25, 2022
10 mins

China’s onshore bond market ranks as the second largest in the world and features prominently in the largest global bond indexes, with an 8% weighting in the Bloomberg Barclays Global Aggregate Bond Index as of 2022.”

In recent years, China’s bond market has opened up to international investors through the launch of CIBM Direct and Bond Connect. International capital flows into the onshore bond market have grown markedly, particularly via Bond Connect.

As international investors’ exposure to China’s onshore bond market has grown, so has their need for risk management tools. International investors have access to offshore interest rate swaps but the newly-announced Swap Connect, when implemented, will give them access to the onshore interest rate swap market.

In this deep-dive into Swap Connect, we explore how it will work, what benefit it will bring to investors and what impact it will have on the RMB internationalisation process and Hong Kong’s position as an international financial centre.

Key Takeaways
Swap Connect is the latest chapter in the ongoing story of the Connect programmes which, after starting in 2014, have created investment and diversification opportunities across asset classes for international and Mainland Chinese investors, driven two-way capital flows between Mainland China and international markets and strengthened Hong Kong’s role as a superconnector connecting China and the world.
Swap Connect will be a whole new Connect channel and the world’s first derivatives market access scheme allowing international investors to trade and clear onshore RMB interest rate swaps in Mainland China without changing their existing trading and settlement practices.
In its initial stage, Swap Connect will connect Hong Kong and international investors with Mainland China’s interbank interest rate swap market through a Northbound route.
Swap Connect will provide the risk management tools for China’s bond markets that are increasingly demanded by the growing pool of international investors trading onshore China fixed income.
Onshore interest rate swaps (IRS) may potentially be a better, more cost-effective risk management tool than offshore IRS, since onshore IRS products are more closely correlated to key benchmarks in the onshore fixed income market, and our analysis shows they exhibit lower volatility, and have significantly tighter bid-ask spreads.
Swap Connect also supports the internationalisation of the RMB and strengthens Hong Kong’s position as an international financial centre with unique connectivity to China.
Swap Connect: What is it and how will it work?

Swap Connect will be a new mutual access programme between Hong Kong and Mainland China’s interbank interest rate swap markets.

An interest rate swap is an OTC interbank forward interest rate derivatives contract in which one stream of future interest payments is exchanged for another based on a specified principal amount.

In its initial stage, Swap Connect will connect Hong Kong and international investors with Mainland China’s interbank interest rate swap market through a Northbound route.

In time – and subject to further development and official regulatory approval – the programme will expand to include a Southbound channel, linking Mainland investors with the Hong Kong interest rate swap markets. Swap Connect will be the world’s first derivatives market access scheme allowing international investors to trade and clear onshore RMB interest rate swaps in Mainland China without changing their existing trading and settlement practices.

Swap Connect is run in partnership by China Foreign Exchange Trade System (CFETS), Shanghai Clearing House (SHCH) and HKEX through its clearing subsidiary OTC Clearing Hong Kong Limited (OTC Clear).

OTC Clear will provide central clearing services for offshore investors, while SHCH will provide central clearing services to onshore investors.

The clearing link under Swap Connect is innovative by design as it directly connects OTC Clear to an onshore platform, significantly cutting down on the intermediary process involved in clearing and settlement.

Offshore investors and onshore dealers execute trades and match these on CFETS.
CFETS sends the clearing request to both OTC Clear and SHCH.
SHCH provides the final clearing status confirmation to both OTC Clear and CFETS.
Offshore investors will face OTC Clear once the trade is cleared.

HKEX’s OTC Clear service plays an important role for international investors and Mainland Chinese swap market makers as a central counterparty (CCP) helping mitigate the risks involved in transacting interest rate swaps.

Since actual interest rate movements are constantly changing, they create financial transaction risk, and also potential default risk of counterparty of such transactions.

Central clearing directly reduces counterparty risk, thus protecting market participants in the event of default. In other words, CCPs act as risk managers, transparently keeping collateral of financial transactions from the original trading counterparties to secure the trades, and reduce risk exposure.

Swap Connect: What are the benefits?

Swap Connect will offer a simple and seamless solution because international investors will soon be able to execute trades in the onshore IRS market under conditions they are familiar with.

The drive to connect China and the world has been strong in recent decades, though China’s market regulatory regime and infrastructure in many ways remain distinct different from other parts of the world.

As an example of this, the central counterparty clearing houses in China are still working on recognition for their services in several international jurisdictions.

With Swap Connect, investors will be able to execute IRS trades through Hong Kong’s internationally-familiar and trusted market, as they complete trades offshore simply with the use of renowned trading platforms.

More than that, Swap Connect targets to handle trades within minutes to provide clearing certainty to market participants, which is also an international standard.

As international investors gain increasing exposure in the China markets through Stock Connect and Bond Connect, Swap Connect will join a diverse and vibrant suite of offshore RMB products and services, providing more investment and risk management tools to international investors around the world.

But beyond access and efficiency benefits, access to onshore Swap Connect could potentially offer investors more from a risk-management perspective.

Swap Connect from a risk perspective

Because swaps reflect the market’s expectations for interest rates in the future, interest rate swaps have become an important risk management tool for fixed income market participants, including institutional investors and banks.

When financial institutions hedge interest rate risk on onshore bond holdings and express directional views on onshore RMB rates, they use either Onshore (CNY) or Offshore (CNH) Interest Rate Swaps (IRS).

Onshore products tend to be more closely correlated than offshore products with benchmarks and, looking at the rolling 60-day correlation of Onshore IRS and Offshore Non-Deliverable (ND) IRS against the benchmark Five-Year China Government Bond Bloomberg Index since 2017, Onshore IRS rates demonstrated consistently higher correlation to the benchmark than Offshore ND IRS swap rates. And the Onshore IRS also exhibited lower volatility over the same period.

Looking further into the risk distributions of the correlation relationships, the Value-at-Risk measure calculated of a portfolio hedged with Onshore IRS is significantly lower than with Offshore ND IRS. This analysis is a powerful argument for accessing the Swap market directly through a future SwapConnect.

Further, by comparing contract liquidity profiles for the Onshore IRS and Offshore ND IRS instruments, our analysis showed significantly tighter bid-ask spreads for the Onshore IRS, which may potentially mean lower transaction costs for investors for onshore instruments, as well as the benefit of a closer hedge.

Swap Connect: Why now?

Swap Connect addresses the strong appetite from both international investors looking for exposure to China’s sizeable onshore bond market and onshore China investors looking for a wider range of investment options in Hong Kong.


From the perspective of international investors, China’s onshore bond market now ranks as the second largest in the world and now features prominently in the largest global bond indexes1, with an 8% weighting in the Bloomberg Barclays Global Aggregate Bond Index as of 2022.

International capital flows into the onshore bond market have thus grown markedly in recent years, with a steady increase in both Bond Connect volumes and international investors’ onshore bond holdings, the latter of which have grown to RMB 4.1 trillion in December 2021 from RMB 0.9 trillion in June 2017.

By allowing international investors to access the onshore CNY interest swap market, it makes onshore CNY bonds more attractive to hold and invest as investors can manage CNY interest rate risk better.

With the expansion of foreign investments in the onshore bond market, there is growing demand for tools to manage interest rate risks associated with bond investments, chief among them interest rate swaps.

While international investors may hedge their onshore holdings in the offshore interest rate swap market, the onshore interest rate market provides a much deeper liquidity pool.

Just in the past two years, between 2020 and 2021, the CNY interest rate swap market swelled from US$4.4 trillion to US$5 trillion, according to data compiled by Clarus Financial Technology2.

By linking international investors to now the second most liquid interest rate swap market in the APAC region, Swap Connect provides international investors with access to a more accurate tool to hedge CNY interest rate bond investments as Swap Connect provides access to onshore CNY interest rate swap market while HKEX provides CCP OTC clearing services to those trades, as well as ever more choice to integrate their offshore and onshore hedging strategies

At the same time, the programme supports momentum to diversify the investor base in China’s onshore bond market, in which domestic banks and fund institutions continue to be the most active players3, while promoting the use of offshore RMB to invest in the onshore market.

Swap Connect: What’s the bigger picture?

While Swap Connect has clear and direct benefits for investors, it also supports the broader RMB internationalisation process that aims to elevate RMB as an international currency used extensively in global trade settlement, cross-border investment and national reserves.

The opening up of China’s capital market to international participants and the development of a vibrant and liquid offshore RMB market are both key to this process.

While the Chinese economy is on the way to becoming one of the largest, if not the largest in the world, the RMB’s share of global payments is still at around two percent4  and in 2022 it makes up between two and three percent in global foreign exchange reserves.5

As the largest offshore RMB market handling over 70% of the offshore RMB payments6, Hong Kong has played a significant role in promoting the internationalisation of the currency. A wide range of RMB assets have been made available for international investors, including Mainland stocks and debt securities through the Connect programmes.

Swap Connect adds to this ever-widening ecosystem of RMB products and supports the use of offshore RMB to invest in the onshore interest rate swap market, further propelling RMB internationalisation.

Additionally, the programme creates a robust infrastructure for cross-border RMB payment and settlement, allowing international investors to execute trades while they remain offshore and using rules and mechanisms that they are familiar with.

Swap Connect: What does it mean for Hong Kong?

Swap Connect will be the only platform in the world that provides international investors with a direct link to the Mainland China onshore interest rate swaps market.

That the programme is possible speaks volumes about Hong Kong’s unique status as an international financial centre and as a superconnector with an important role in facilitating the internationalisation of Chinese capital.

In providing an indispensable channel for effective risk management, Swap Connect will develop a unique synergy with Bond Connect in supporting the growing share of international participation in the onshore bond market.

With time, a mature ecosystem of regional and international players within the fixed income and currency space will likely take shape, further propelling the expansion of the Chinese bond market and the internationalisation of the RMB.