China cracks down on under-the-table bond deals in latest attempt to reduce risk in markets
Regulators order institutions to sign written contracts in bid to stop practice of sale and repurchase agreements agreed informally and verbally
China has ordered financial institutions to sign written contracts for bond repurchases or forward transactions as it looks to crack down on the practice of entrusted bond holdings, which has been blamed for a US$2.4 billion bond scandal in 2016.
In a document issued by the central bank and the banking, securities and insurance regulators on December 29 and seen by the South China Morning Post, institutions were also ordered to report to regulators if their outstanding repurchase and reverse repurchase volumes exceeded certain limits.
The order is the latest coordinated effort among regulators to reduce leverage and risks in the financial markets, which China’s president, Xi Jinping, has identified as one of the biggest potential threats to the economy in 2018.
The entrusted bond structure allows brokers and funds to skirt existing limits on using borrowed money to invest in bonds.
By getting a third party to buy bonds with a promise they will be bought back, brokers and funds are effectively getting loans which boost their leverage and give them the capital to buy even more bonds.
Such deals are usually arranged informally and verbally, and the structure worked well with low interest rates, ample liquidity and plenty of trust among financial institutions. However when such conditions evaporate, the risk of the deals unravelling increases.