Behind China's Bond Selloff, a Risky Twist on the Repo Trade
This article by Shen for the Wall Street Journal may be of interest to subscribers. Here is a section:
As much as 12 trillion yuan ($1.73 trillion) in bonds—or 19% of the country’s $9 trillion bond market—could be subject to such repurchase agreements, according to an estimate by Shui Ruqing, president of bond clearing-house China Central Depository & Clearing Co., cited last month in China’s influential Caixin Magazine. Traders say the deals are so opaque that even estimates are hard to make.
Banks sometimes use the “dai chi” agreements to move risky assets temporarily off their books during earnings periods or audits, the people said. Brokers like Sealand typically use them to borrow quickly and flexibly—leveraging their investments many times over, they said.
Until last year, Chinese financial regulators had largely ignored the practice, beyond saying they opposed it during a bond-market crackdown in 2013. But the informal nature of dai chi also meant the trades could be difficult to enforce when conditions worsened.
“Because it’s not really an official business, agreements aren’t legally binding,” said the executive who had bought bonds from Sealand.
Sealand’s problems became apparent on Dec. 15, when the southern China-based company announced that two of its traders had forged dai chi agreements worth 16.5 billion yuan ($2.4 billion), a move that market participants interpreted as meaning the broker didn’t intend to honor the deals.
The amount was more than five times what Sealand had declared in its Sept. 30 financials as its financial assets under official repurchase agreements, and more than seven times its disclosed bond-holdings.
