Swap Connect

Swap Connect is a new mutual access programme between Hong Kong and Mainland China interbank derivatives markets. The programme will begin with the Northbound channel of Swap Connect (“Northbound Swap Connect”), which aims to connect over-the-counter derivatives trading, clearing of eligible Northbound onshore CNY interest rate swap products (“Northbound Swaps”) between offshore investors and onshore dealers. The service is provided by three market infrastructure providers: China Foreign Exchange Trade System (“CFETS”), Shanghai Clearing House (“SHCH”) and OTC Clearing Hong Kong Limited (“OTC Clear”).

As per the Interim Measures for the Administration of Mutual Access between the Mainland and Hong Kong Interest Rate Swap Markets published by the People’s Bank of China (“PBOC”), the Southbound channel of Swap Connect is out of scope at the initial launch of the programme and the related rules will be separately formulated in due course.

Northbound Swap Connect will initially cover CNY Interest Rate Swaps (“IRS”) benchmarked to 7-day Repo (“FR007”), SHIBOR 3-Month (“Shibor 3M”) and SHIBOR Overnight (“Shibor O/N”).

Onshore investors refer to onshore IRS dealers in the China Interbank Bond Market (“CIBM”) as set out in CFETS’ list of market makers. They would need to be both a participant of SHCH’s RMB interest rate swap centralised clearing service and a CFETS Swap Connect market maker.

Offshore investors refer to institutional investors from Hong Kong and other countries and regions who meet the relevant requirements of the PBOC, have been granted access to the CIBM (such as Bond Connect or CIBM Direct investors) and have obtained Northbound Swap Connect trading permission from CFETS. They would also need to be either an OTC Clear clearing member (“CM”) or a client of an OTC Clear CM.

Daily trading and clearing quotas are set to limit the overall risk exposure of Swap Connect to a manageable level.

A daily trading quota of RMB 20 billion on net notional principal amounts is set on Northbound Swaps. CFETS monitors Northbound trades on a real-time basis and will suspend the acceptance of same direction trades once the net notional size has exceeded the daily trading quota. If the net notional size is lowered to a level below the quota before market close, trade acceptance will resume until the daily trading quota is exhausted again. The daily trading quota may be adjusted as and when appropriate based on market conditions in the future.

A clearing quota (i.e. total interoperable risk exposure limit) of RMB 4 billion is set by SHCH and OTC Clear at the initial stage of Swap Connect, with reference to market liquidity, default management and cost of funding. Trade novation will not proceed and the clearing request in respect to a trade will be rejected immediately if the additional risk exposure of net positions between SHCH and OTC Clear brought by such trade causes the clearing quota to be exceeded. The clearing quota could be adjusted based on the latest market condition and will be announced to public.

Bilateral agreements are not a mandatory requirement to trade in Northbound Swap Connect, however investors can still enter into one based on their needs.

Examples of PBOC recognized agreements would include NAFMII master agreement, ISDA master agreement, Cleared Derivatives Execution Agreement (“CDEA agreement”), and the dedicated Swap Connect Cleared Derivatives Agreement (“Swap Connect Agreement”) which is jointly developed by NAFMII and HKEX.

Participants may refer to the following links for more information on the Swap Connect Agreement:

• Introduction to the Swap Connect Agreement
• Swap Connect Cleared Derivatives Agreement (2024 Version)
• Special License Filing Record Template (applicable to non-member of NAFMII only)

To access clearing and settlement services, offshore investors can either become a Swap Connect eligible OTC Clear direct CM or appoint a Swap Connect-eligible OTC Clear CM for client clearing services. Offshore investors would need to submit OTC Clear operational forms for approval.

Northbound Swap Connect clearing days shall follow the trading calendar of the Mainland China interbank interest rate swap markets. Clearing hours will be from Beijing time 09:00 – 12:00 and 13:00 – 17:30.

Upon trades being matched and executed on CFETS, CFETS will send the clearing request to both SHCH and OTC Clear for clearing and novation on a real-time basis. SHCH will be the CCP to its clearing participants and OTC Clear will be the CCP to its CMs.

OTC Clear will adopt the end-of-day Variation Margin on Northbound Swaps determined by SHCH based on the curve and day end prices constructed by SHCH on each Northbound Clearing Day. PAI and coupon calculated by SHCH will also be employed by OTC Clear for settlement. PAI will be calculated using SHIBOR overnight rate for Northbound Swaps.

CMs can refer to the settlement reports published by OTC Clear in OASIS at around 22:00 HKT for the settlement amount in RMB for Northbound Swaps value on the next Northbound Clearing Day.

End of day settlement obligations from Northbound Swaps will be netted with the existing settlement obligations. The CM is required to fulfil the settlement obligations with OTC Clear by 11:00 HKT, which is the same as existing practices. OTC Clear will pay CMs no later than 17:00 HKT for RMB settlements.

The Inter-CCP Margin covers the loss arising from a CCP’s default (i.e. SHCH’s or OTC Clear’s default). The Inter-CCP Margin shall be sized on each Northbound Clearing Day based on the higher of the Inter-CCP Margin calculated by SHCH and OTC Clear. The Inter-CCP Margin Amount shall be contributed by SHCH and OTC Clear on a 50/50 basis.

No. The Inter-CCP Margin will be separated from CMs’ margin and guarantee funds, and will only be used in the event of a CCP’s (SHCH or OTC Clear) default.

No. SHCH and OTC Clear are not required to contribute to each other’s guarantee fund.

Similar as current practice towards CMs, the CCP would jointly determine the intraday risk limit on each other based on funded resources and risk appetite. In an event that the intraday risk limit imposed by CCPs to each other is exceeded, or the relevant CMs’ collateral is insufficient, the new risk increasing trades might not be accepted for clearing on such clearing day. SHCH and OTC Clear will review the intraday risk limit on a regular and ad hoc basis, if the risk exposure of daily clearing volume is approaching or reaches the intraday risk limit.

Swap Connect has seen stable operations, steady increases in market participants and improving liquidity since its launch in May 2023.

However, some offshore investors have indicated that the absence of International Monetary Market (“IMM”) contract and trade unwinding solutions limit their participation in Swap Connect.

Commonly, offshore asset management firms use IMM contracts to manage their risk positions and asset allocation. Following such market feedback, IMM contracts will be introduced to Swap Connect.

For trade unwinding, OTC Clear will introduce backdated trade and compression services for Northbound Swap. Following the enhancement, Swap Connect participants can unwind their Northbound Swap position by executing a backdated trade and solo compression service.

These new product features and services further align China interest rate swap market standards with the international interest rate swap market.

Starting from 20 May 2024, Northbound Swap Connect will be support the following product features / services:

Onshore dealers and offshore investors can check with the China Foreign Exchange Trade System (“CFETS”) and third-party trading platforms, respectively, for further details about the new product features.

CNY is the settlement currency of the upfront payment, settlement date is the trade date + one business day (T+1) and follows the trading calendar of the Mainland China interbank interest rate swap markets.

If a trade with an upfront payment is rejected and resubmitted on T+1, the settlement date of the upfront payment will be postponed to T+2, accordingly (T-day being equal to both trade date and the first rejection date).

For the trade specification of a Swap Connect IMM trade, investors can refer to the Product Manual of Swap Connect from CFETS, or article 5.1 in Shanghai Clearing House (“SHCH”) Clearing Guidelines. There will be no holiday adjustment for the effective date of IMM Northbound Swap, whereas the payment and maturity dates will be adjusted by the “modified following” convention.

Offshore investors can execute a backdated trade with the same trade economics, but different direction, as the original trade they intend to unwind, with one of the Northbound Swap Connect market makers.

Once the upfront payment of the backdated trade has been settled, offshore investors can raise the solo compression request to OTC Clear and compress the relevant transactions.

The offshore compression will be handled between offshore investors and OTC Clear, and there will be no impact to cleared transactions between the SHCH and onshore market makers.

Onshore participants can raise the compression request within the central clearing risk tolerance through CFETS and executed by SHCH.

Onshore compression and offshore compression will be executed separately. The Swap Connect offshore solo compression process is the same as the process applied to other standard rate derivatives products cleared at OTC Clear. For details, please refer to the OTC Clear Solo Compression User Guide. 

Offshore investors can participate in Northbound Swap Connect to manage CNY interest rate risk exposure arising from their own investments or those of their affiliates in the China Interbank Bond Market, bond repurchases, and other financing activities such as loans and securities and futures investments. 

Offshore investors can also hedge their CNY interest risk from relevant client transactions through Northbound Swap Connect. Offshore investors should have appropriate risk appetite identification capabilities, strong risk management awareness, sound risk management frameworks and detailed acknowledgements of corresponding investment risks.  

CFETS, SHCH and OTC Clear will further extend the fee holiday period for another year. Trading, registration and maintenance fees will be waived. Furthermore, the Swap Connect compression fee will be waived at the initial launch of the service. For details of the fee holiday, please refer to the member notice or clearing circular issued by CFETS, SHCH and OTC Clear.