China bond executives arrested in probe into alleged skimming; Relaxed quotas could give Asian central banks taste for China bonds

China bond executives arrested in probe into alleged skimming

Thu, Apr 18 2013

* Executives from CITIC, two other firms arrested

* Alleged profit skimming via complex trading practices

* Investigation could involve other institutions

* Regulation lags bond market’s explosive growth

By Gabriel Wildau

SHANGHAI, April 18 (Reuters) – Three Chinese financial industry executives have been arrested for allegedly using complex bond trading practices to skim client profits for personal gain, state media reported this week.

Executives from state-owned CITIC Securities , China’s largest brokerage by assets, unlisted fund management company Wanjia Asset Management and Qilu Bank, a small lender 20 percent owned by Commonwealth Bank of Australia , are under investigation by the Shanghai Public Security Bureau, the official Securities Times reported on Wednesday.On Thursday, the official Shanghai Securities News reported that “related departments” had sent investigators to multiple brokerages in Beijing, Shanghai, Jiangsu province and other locations.

State media said the alleged skimming centred on a complex technique known as “substitute holding”, in which a fund manager temporarily transfers a portion of his bond portfolio to a counterparty’s account.

Market participants say the practice can be used to disguise profits or losses, increase leverage, or skirt limits on the types of instruments a fund is allowed to hold.

The executives allegedly used substitute holding – which is not in itself illegal – to divert to themselves profits that should have accrued to clients, according to state media.

A Shanghai-based bond fund manager who asked for anonymity told Reuters that the strong performance of bond markets in recent months, combined with inadequate regulation, makes it possible for fund managers to use this practice to enrich themselves.

“The market has been pretty good this year, and yields have mostly been falling. At times like this, you find a third party for substitute holding and add some leverage – the risk is pretty small. It’s not like when the market is weak and you could take huge losses,” the fund manager said.


A Beijing-based bond trader said that while large banks typically formalise substitute holding arrangements with repurchase agreements or similar contracts, smaller institutions often use informal agreements with trusted counterparties. That creates leeway for self-dealing, he said.

A CITIC Securities spokesman confirmed to Reuters that an employee was under investigation but said that it was for “personal reasons not involving the company.” Media reports said the person arrested was a senior manager in the company’s fixed-income division.

China Business News, which broke news of the investigation on Monday, reported that the arrest occurred more than a month ago.

In a statement, Wanjia Asset Management confirmed that one of its employees, who media reports described as a high-profile director and fund manager, was under investigation. Wanjia said the probe is “unrelated” to the company and that the arrested person no longer works there.

Qilu Bank did not respond to requests for comment. CBN reported that an executive in the bank’s finance department was arrested.

The media relations department of the Shanghai Public Security Bureau did not answer calls seeking comment.


China’s interbank bond market has exploded in recent years, with outstanding interbank bonds totalling 24.4 trillion yuan ($3.95 trillion) at the end of March, up from 17.7 trillion yuan at end-2009 and 7.3 trillion yuan at end-2005.

Market participants say regulation has failed to keep pace with the growing size and complexity of the industry.

China’s securities regulator has moved aggressively to combat insider trading and other corrupt practices in China’s stock market over the past year, but the bond market has received less scrutiny.

Regulators have encouraged the growth of the bond market as a means to diversify China’s financial system away from reliance on bank lending.

Corporate bond issuance accounted for 14.4 percent of China’s total social financing in 2012, up from 10.6 percent in 2011 and only 3.8 percent in 2007. ($1 = 6.1723 Chinese yuan)

Relaxed quotas could give Asian central banks taste for China bonds


By: Saikat Chatterjee and Gabriel Wildau

Reuters | Friday, 19 Apr 2013 | 2:16 AM ET

HONG KONG/SHANGHAI, April 19 (Reuters) – Asia’s central banks could dip their toes into Chinese bonds in coming months, taking advantage of a relaxation of investment quotas and easier access to the onshore market as Beijing steps up efforts to internationalise the yuan, bankers said. While China has aggressively promoted the use of its currency in international trade, it wants the yuan to be used in cross-border investment flows as well. Only one percent of China’s trade was settled in yuan in early 2010. Now more than 12 percent is settled in yuan, most of which is accounted for by China’s Asia-Pacific trading partners, and they need yuan-denominated assets to invest in. Though there is a long way to go, China could take a significant step along the path if it managed to attract more investment from sovereign wealth funds (SWFs) and reserve managers from those central banks in the region that have currency swap agreements with the People’s Bank of China. “Chinese bonds should be one of the favored candidates for reserve diversification… as investors would be keen to gain exposure to a gradually internationalised currency,” said Frances Cheung, senior strategist, Asia ex-Japan at Credit Agricole in Hong Kong. They have barely more than a token presence in the onshore bond market so far. At the end of February, data from China’s main bond clearinghouse shows that offshore banks – including both foreign central banks and Hong Kong trade settlement banks – had accumulated around 266 million yuan ($43 million) in onshore interbank bonds, based on flows through a PBOC channel that SWFs cannot use. But China’s regulators over the past few months have made it a lot easier for central banks and SWFs to buy onshore bonds in far larger volumes.

STEP THIS WAY In December, regulators ruled that this category of investor, known for their conservative character, should no longer be hobbled by the relatively small quotas allocated to them and they can apply for quotas in excess of the maximum $1 billion limit previously in effect. 1/8ID: nL4N09P058 3/8 And last month, in another incremental step, regulators said Qualified Foreign Institutional Investors (QFII) would be allowed to invest in the onshore interbank bond market for the first time. Previously, QFIIs could only access bonds that trade on China’s stock exchange, even though 95 percent of all Chinese bonds trade on the interbank market. “This change, combined with the clarification in the QFII repatriation rules, and the lock-up period being only three months for sovereign investors as opposed to the general lock-up period of one year, will make it more attractive for them,” Jukka Pihlman, global head, central banks and SWFs, origination & client coverage at Standard Chartered Bank, said.

REASONS TO BE CAREFUL A Hong Kong based QFII fund manager, who requested anonymity, reckoned the three-month lock up period was unlikely to deter sovereign investors, who typically buy to hold rather than trade. The fund manager expected central banks and SWFs to enter the onshore bond market cautiously, particularly as it is not uniformly liquid, with most volume concentrated in the short-end. He also said investors have to do more homework to assess the quality of issuers due to a lack of credit-rating coverage. “Unlike the offshore markets, credit differentiation is more difficult, so early investors will have to be careful. Moreover, given that the reforms were announced just last month, most of these large investors will take their time to make portfolio allocations to the onshore bond market,” the fund manager said. “We may not see the first investments for some weeks or even months. Given the conservative nature of their portfolios, we may see them start investing in extremely short-dated government debt before gradually buying more longer-dated bonds.” A source that understood the thinking of sovereign wealth funds said another concern was that the current regulatory oversight is fragmented among three different regulators leading to overlapping and gaps in a regulatory environment. While the offshore yuan bond markets and onshore equities are accessible, they are far smaller markets and more volatile than onshore debt. Still 70 percent of funds invested through the QFII channels were invested in equities at the end of 2012, while the remainder was largely held in cash. Due to a lack of investment choices hitherto, central banks have trod carefully. Few exercised their entitlement to the now obsolete maximum $1 billion quota, and had instead requested smaller quotas. Thailand’s central bank only requested a quota of $300 million earlier, as did Bank of Korea, for example. Whereas, the Hong Kong Monetary Authority, which oversees a far deeper offshore yuan market than any other centre, opted for the maximum 1 billion dollar quota. But, that was before the changes, and all Asia-Pacific central banks could have more reason to top up their quotas now.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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