China Said to Ask Bank Bond Traders to Check Histories

China’s central bank asked participants in the nation’s $3.7 trillion interbank bond market to examine trading histories as it cracks down on illegal transactions, two people with knowledge of the matter said.

The People’s Bank of China held a meeting last week with participants including the China Foreign Exchange Trade System and the National Association of Financial Market Institutional Investors to discuss possible measures for tighter control over trading, said the people, who asked not to be identified because they weren’t authorized to speak publicly about the matter.

Chinese authorities are seeking to clean up a market that has doubled over five years as they push companies to cut reliance on state-bank lending and increase use of the bond market to finance expansion. Fitch Ratings Ltd. this month cut China’s long-term local-currency debt rating, citing risks from a lack of transparency in local government borrowing.

“The PBOC is probing as part of the government’s broader efforts in clamping down on corruption and controlling escalating credit risk,” said Zhang Zhiwei, the chief China economist at Nomura in Hong Kong. “It may have a negative impact in the short run but setting the rules straight is necessary if China wants to expand the market, and it’s good for the economy in the long run.”

Inspection Teams

Chinese regulators are investigating illegal fixed-income transactions in accounts typically used by senior traders at financial institutions, the Shanghai Securities News reported last week. The government has sent teams to inspect trading records at companies in Shanghai, Beijing and Jiangsu province, the newspaper reported, without citing anyone.

The People’s Bank of China didn’t immediately respond to faxed questions seeking comment.

Some financial institutions, seeking to move bonds off their balance sheets, have asked other institutions to hold those bonds for them over a certain period and for a specific fee, according to an April 22 China National Radio article.

Interest payments and gains from any price appreciation continue to belong to the original owner of the bond, according to the article. Because such transactions are outside of regulated markets, they open the door to abuses like insider trading and the use of client funds for trades generating personal gains, China National Radio said.

Deep Reform

The central bank plans to meet with large lenders today and will listen to their suggestions on improving the market, China Business News reported, citing people it didn’t identify. The topics may include “deep” reform of bond sales and trading, according to the report.

China’s interbank market had 23.1 trillion yuan of outstanding bonds at the end of March, according to Chinabond, the nation’s bond clearinghouse. That compared with 522 billion yuan on stock exchanges, where retail investors are allowed to trade, according to the clearinghouse.

The PBOC regulates the interbank bond market, while the China Securities Regulatory Commission and the National Development and Reform Commission also hold oversight for parts of the domestic debt market.

Ease Risks

The probe into illegal bond market transactions will help ease risks in local government financing vehicle debt, according to a commentary in the China Securities Journal by reporter Wang Hui. China’s bond market should be regulated because then local governments will issue more debt to support the economy, further growing the market, Wang wrote.

People’s Bank of China Governor Zhou Xiaochuan said in November the country will “vigorously” develop the bond market. The central bank allowed note repurchase agreements for the first time and opened the interbank bond market further to foreign institutions such as the World Bank last year.

The China Foreign Exchange Trade System provides systems for foreign exchange and fixed-income trading in the nation. NAFMII, which counts banks, insurers and securities companies among its membership, is an industry group that regulates the interbank market. Both operate under the auspices of the central bank.

A self-regulating body to expand the interbank bond market was also established by Zhou in 2007. That introduced medium-term notes, which became the most popular form of bonds in China. Unlike other regulators, NAFMII doesn’t require companies to get approval to issue debt.

The 20 biggest underwriters of corporate bond sales this year in China are domestic financial institutions, with Morgan Stanley and UBS Securities Co. the only overseas firms in the top 40, the data show.

— With assistance by Steven Yang

Before it's here, it's on the Bloomberg Terminal.