Investor confidence in the world’s third-largest bond market will be boosted by the stricter enforcement of regulations. A unified and stricter enforcement mechanism for Chinese bonds has been announced, while regulators in Hong Kong and China have signed an agreement to cooperate in supervising securities.
“Improved governance is always a good thing. That will attract more international investments into China’s bond market. The stricter enforcement of China’s bond market will cause ratings agencies to improve their governance score for China’s bond market,” said Jack Siu, senior Asia Pacific investment strategist at Credit Suisse.
When international long-term investors make investment decisions, they monitor the market’s governance score, because they have stringent investment criteria, Siu explained. “China’s improved governance score will attract long-term international strategic investors, which is the kind of investors the Chinese government wants. China wants to internationalize its bond market, as demonstrated by the launch of Bond Connect.”
Bond Connect is a cross-border scheme that allows investors from mainland China and overseas to trade in each other's bond markets. Trading between China and Hong Kong commenced on July 3 last year, allowing overseas investors to invest through Hong Kong in China’s interbank bond market. Southbound trading has not yet started.
The China Securities Regulatory Commission (CSRC) and Hong Kong Securities and Futures Commission (SFC) signed a memorandum of understanding on December 3 over the supervision of securities firms that operate between Hong Kong and mainland China. It makes it easier for the CSRC and the SFC to cooperate with each other in reducing systemic risk and maintaining financial stability.
The trading of bonds between mainland China and Hong Kong engenders the risk of cross-border fraud. “Once you mix capital from two regions, fraud can easily be cross-border,” said Andrew Collier, managing director of Hong Kong financial research company Orient Capital Research.
In the first 11 months this year, trading on Bond Connect totalled Rmb812.7 billion ($118.3 billion) with an average daily turnover of Rmb3.58 billion, according to Bond Connect Company, the joint venture between the China Foreign Exchange Trade System and Hong Kong Exchanges and Clearing which manages Bond Connect. There were 467 registered investors in Bond Connect in November.
The People’s Bank of China (PBOC), CSRC, and the National Development Reform Commission (NDRC), the Chinese government bond regulator, issued a joint opinion on strengthening enforcement in the bond market on December 3.
The purpose of this opinion includes improving the ability of the bond market to finance the real economy and improving oversight of the bond market, said the NDRC.
At the end of October, China's bond market had a market value of Rmb83.8 trillion, according to the PBOC. “At the same time, irregularities have surfaced in the bond market, which requires tougher regulations. This opinion is an important measure in improving the management of our nation’s bond market,” it said.
The opinion stipulates a unified enforcement mechanism for China’s bond market under multiple regulators including the CSRC, NDRC, PBOC and the stock exchanges of Shanghai and Shenzhen. If the PBOC and NDRC discover problems, they will send the evidence to the CSRC.
According to the opinion, the CSRC will investigate suspected irregularities in the interbank bond market as well as bond transactions on the exchanges of Shanghai and Shenzhen. The opinion stipulates that the CSRC is authorized to obtain information for its investigations from Chinese stock exchanges and market participants.
Objects of enforcement include corporate bonds, non-financial corporate debt instruments, the interbank bond market, and financial bonds. Irregularities like violation of disclosure rules, insider trading and market manipulation will be punished, said the PBOC.
Year-to-date, the CSRC has investigated six cases of irregularities. In one, the bond issuer distorted its financial results to gain approval to issue bonds. In another, the issuer concealed major guarantees and changes in the use of bond proceeds. A third case involved fake bond transactions. “The effective investigation of irregularities is necessary to spur the healthy development of our country’s bond market,” the regulator said.
The principal problem in China’s bond market is the lack of transparency about investments and the fact that the bond rating agencies do not provide accurate assessments of risk, said Collier. “An additional problem among bonds and other financial products are the guarantees between institutions that are not spelled out in issuing documents.”
One example of bond fraud involved China Guangfa Bank. In December last year, the China Banking Regulatory Commission (CBRC) hit it with a Rmb722 million fine - one of the largest ever in the country’s banking sector. Guangfa Bank was punished for fraud totalling Rmb12 billion, including two bonds worth a combined Rmb1 billion. The bonds had been issued by subsidiaries of Chinese telephone manufacturer Cosun Group, and it was their default in December 2016 that brought this fraud to light.
