Inclusion in major government bond index could generate $140B for China: Goldman Sachs

September 9, 2020.

Inclusion in an important global government bond index could generate as much as $140 billion in additional inflows for China, according to a research note from .

Global benchmark provider Russell will reveal on Sept. 24 whether China will be included in its World Government Bond Index. And Goldman Sachs analysts Danny Suwanapruti and Maggie Wei said in a report Tuesday that while China’s inclusion in the WGBI is a close call, it is likely Chinese government bonds will be included, with a target rate of 5.7 percent.

“This could generate around [$140 billion] of additional index-related inflows, assuming all index trackers follow the index and do not opt out,” according to the analysts’ report.

The WGBI measures the performance of fixed-rate, local-currency, investment-grade government bonds, according to FTSE Russell. It comprises sovereign debt from more than 20 countries, denominated in a variety of currencies.

Because of a likely 12-month grace period, inclusion would likely start in October 2021 and then be phased in over 20 months through May 2023, the analysts said.

“Investor feedback we heard is that while there has been notable progress on tradability and market access, it is still not comparable to other WGBI peer markets,” the research note said. The analysts added that China would have to continue with certain reforms and satisfy other criteria by September 2021, or the inclusion date could be postponed. 

In a March 2020 interim review, FTSE Russell acknowledged the Chinese regulator’s efforts to improve accessibility for outside investors, specifically citing efforts to allow investors to trade FX with three counterparties, as opposed to just one; the ability to choose a longer retirement cycle; flexibility in handling failed trades; and more reopenings to help improve secondary market liquidity. FTSE Russell will continue to monitor these enhancements.

Chinese regulators rolled out new draft rules in early September to make it easier for foreign financial institutions to access the country’s $15.4 trillion bond market, the second-largest in the world after the U.S. market. 

Suwanapruti and Wei said that several investors have raised questions about whether U.S.-China relations could affect China’s inclusion in the index. However, geopolitics are unlikely to affect index decisions, they said, because they are not part of FTSE Russell’s criteria. But tensions could affect investment preferences of end investors, which has an indirect effect on asset managers who give feedback to index providers, they noted.

China has been liberalizing its bond market during the past few years, and the pace of inflows has picked up quickly, from $30 billion to $50 billion per year in 2016 through 2017, to around $70 billion to $90 billion in 2018. The increase followed the news in April 2019 that China would be included in the Bloomberg Barclays Global Aggregate Index. In January 2020, China was included in JPMorgan’s Government Bond Index-Emerging Markets index.

According to the Goldman Sachs report, the FTSE WGBI is the remaining major index that could include China. 

“From a flow perspective, FTSE will likely be the most impactful index, since it has a large [assets under management] tracking the index (around $2.5 trillion), its investor base is very passive and comprises just government bonds,” the analysts’ report said.

Barclay’s Global Aggregate Index has a similar AUM, but its clients are more active and it includes government, quasi-government and corporate bonds, the report said. The JPM GBI-EM index has a smaller AUM. 

“Simply put, inclusion in the FTSE WGBI is the hardest to get into,” the analysts said.

— Additional reporting by Reece Wallace

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