China Intensifies Crackdown on Bond Market

China Intensifies Crackdown on Bond Market

10-22 14:32 Caijing

The long-term solution will be to reduce regulatory arbitrage by ending market segmentation and the current three-rail regulatory system.

By staff reporter Wang Xiaolu

A crackdown on bond market irregularities, triggered by a case involving a high-level Finance Ministry official in 2010, has been intensifying as of late. Heads of fixed income departments in several banks, brokerages, and fund companies have been investigated since March. As part of the latest development, Guosen Securities stated Oct. 11 that Sun Mingxia, head of the company’s fixed income unit, and other two executives at the unit were being investigated by the public security authorities.A month prior to that, Chen Zhijun, head of Hong Yuan Securities’ bond sales arm, and his deputy were arrested. The case implicated two senior executives at the brokerage, who came under investigation Sept. 28.

The fact that Hong Yuan and Guosen cases, just a month apart, targeted more senior executives indicates China is strengthening its crackdown on bond market irregularities.

The crackdown led by the public security authorities mainly targeted malpractices by banking industry insiders, such as buying low in the primary market and selling high in the secondary market, embezzling company funds in search of personal gain, and siphoning profits to corrupt officials, during the second half of 2008 and the first half of 2010, when local government financing vehicle (LGFV) bonds ballooned.

An industry veteran said that during the LGFV bond boom, financial institutions went all out to fight for underwriting contracts. Some institutions relied on their professionalism; others boasted they were able to facilitate the approval process. Still others tried to gain an upper hand by employing a low-price strategy, and some of them even went so far as to pay corporate issuers to get underwriting contracts. In some cases, the main underwriter was simply designated by government agencies in charge of bond issuance approval.

Financial institutions such as Guosen and Hong Yuan managed to quickly expand their market share in the bond market where only central government agencies and state-owned enterprises (SOEs) are allowed to borrow, in particular the LGFV bond market segment, thanks in part to their ability to stay on good terms with regulatory agencies.

The domestic bond market is divided into three submarkets, each of which is supervised by a regulatory agency. The National Development and Reform Commission (NDRC) examines and approves bond issuance by government agencies and SOEs; the National Association of Financial Market Institutional Investors (NAFMII), which is under the leadership of the central bank, reviews issuance of medium-term notes and short-term financing instruments; and the China Securities Regulatory Commission (CSRC) examines corporate bond issuance.

The regulatory agencies had little involvement in the crackdown led by public security authorities, which shows the drawbacks of a segmented bond market with more than one regulator and multiple sets of regulatory standards. The three-rail regulatory system, which has existed for a long time, has led to rampant regulatory arbitrage.

To some extent, the crackdown can deter irregularities in the bond market, but the long-term solutions will be to reduce regulatory arbitrage by ending market segmentation and the current three-rail regulatory system.