SHANGHAI: China released new rules tightening bond trading regulations on Thursday, with a focus on restricting leverage and banning under-the-table deals.

The regulations, jointly issued by the People’s Bank of China and China’s banking, securities and insurance regulators, come as Beijing launches a series of co-ordinated initiatives across government agencies designed to reduce leverage in the financial system.

Under the new rules, published on the central bank’s website, institutions must sign written deals when conducting bond repurchase or bond forward transactions. Any deals designed to dodge regulatory requirements are to be banned.

The rules order financial institutions to report financial data to regulators if their outstanding repurchase agreements, known as repos, and reverse repo volumes exceed a certain limit.

A version of the rules seen by Reuters earlier on Thursday and confirmed to be authentic by three sources was dated Dec 29. The document posted on the PBOC’s website did not include a specific date but carried the year 2017.

China is escalating a campaign to reduce excessive leverage in the banking system that threatens financial stability.

In November, Beijing formally set up its State Council Financial Stability and Development Committee to strengthen financial supervision. In the same month, the central bank drafted sweeping rules to tighten supervision of the country’s $9 trillion asset management industry to curb shadow banking.

“All these measures are aimed at deleveraging, and preventing systemic risks in the financial industry, after years of aggressive expansion by financial institutions,” said Zhang Zibing, chief investment officer at Shanghai-based asset manager Bona Capital.

“Banks must change their mentality, both in their growth models, and in how they allocate their assets,” Zhang said, adding he expects bond yields to remain elevated this year.

Yields of China’s benchmark 10-year government bonds climbed steadily in 2017, and on Thursday hovered around the highest level in three years, at 3.937 per cent.

By publishing the rules, regulators are seeking to avoid a repeat of the $2.4 billion bond scandal involving Chinese brokerage Sealand Securities in late 2016, which triggered panic across the country’s financial markets.

Although Sealand Securities blamed “forged” bond agreements, analysts largely pointed to a popular practice called “daichi”, which is Chinese for “pledged financing” and works in a similar manner to repo agreements, although such transactions are made through informal, oral agreements.

The new rules would effectively terminate the practice, which traders have used to keep increased leverage off the regulatory radar.

They would also restrict leverage by setting a cap on repo or reserve transactions, tools which help some institutions channel short-term borrowings into longer-term assets for profit.

Published in Dawn, January 5th, 2018