The gathering storm

An arrest at CITIC Securities sends shock waves through bond market

When Wang Qishan heard the news of Lehman Brothers’ implosion on September 14, 2008, he was leading a trade delegation to Washington. As the former head of one of China’s big four banks, Wang immediately told his colleagues they should get back to Beijing to get ready for a global credit crisis. The former vice-premier would later head a State Council taskforce set up to tackle the aftermath of the financial meltdown.

Wang was no stranger to debt troubles. Almost a decade before Lehman’s blow up, he was sent to Guangdong to clean up GITIC, a provincial investment vehicle whose default on dollar bonds had caused foreign banks to panic. Wang would fix the situation and later crises, earning him the nickname of the ‘fireman’.

Now China’s new anti-corruption tsar has returned to familiar turf: a purge of the debt market.

Skim through any of China’s financial newspapers in the past fortnight and the commonest headline has been “Bond Market Storm”, with prominent coverage given to the troubles of a series of heavyweight players.

To begin with, Shanghai-based Wanjia Asset Management said last Wednesday that its fixed income head was under police investigation. The announcement came after days of intense speculation, not least because Wanjia is one of the biggest unlisted fund houses.

Later that day CITIC Securities said Yang Hui – the executive director of its own fixed income trading department – had also been “taken away by police for personal reasons”. This was an even bigger shock: CITIC Securities is one of China’s biggest investment bank and its 38 year-old fixed income head had earned plaudits as the ‘king of the bond market’. The Global Times said Rmb4.2 trillion ($680 billion) of bond trading went through CITIC Securities under Yang last year.

According to the Securities Times, a newspaper run by the People’s Daily, at least two other senior bond market executives have been arrested for flouting regulatory rules. One of them worked for Qilu Bank, a regional lender.

The arrests weren’t “isolated cases”, the Century Weekly commented, but part of a crackdown on malpractice that has “angered the highest authority”. The flurry of probes is a result of a “thorough investigation ordered by Wang Qishan”, the magazine said.

The alleged malpractice seems to revolve around a complex technique known as “substitute holding” in which a fund manager transfers a portion of his bond portfolio to a counterparty account. Not only does this help in skirting regulatory limits on leverage, in some cases it can also window-dress trading performance.

But what triggered police activity were revelations about so-called “Class C” accounts (the variety held by an individual rather than an institution) suggesting that executives were diverting trading commissions or gains to themselves and their families.

Scandals over Class C accounts aren’t new. Back in 2010 they also came to public attention, when Zhang Rui, a senior Ministry of Finance official (who had overseen government bond auctions for 12 years) was caught sending text messages to bidders. It was subsequently found that Wang had made Rmb40 million of illegal gains via bond trading in a Class C account.

Local newspapers are now speculating that the subsequent probes have revealed so many abuses of Class C accounts that Wang is determined to stamp out the practice. According to the state media, the crackdown will escalate to “unimaginable breadth and depth” in the coming weeks. China Securities Journal is also forecasting that “a bigger storm is coming and bigger fish will be caught”.

In fact, Wang’s clampdown is being used to explain a series of unusual incidents. Last week, Wang Shiqiang, the 60 year-old chairman of China Jianyin Investment Securities’ supervisory board, plunged to his death from an office building in the heart of Beijing’s financial district. Rumours soon spread. “People suggested Wang committed suicide because of hefty losses in gold trading. I don’t think so. It’s the bond market, rather than the gold market, that is going to implode,” the Hong Kong Economic Times cited an unnamed financial official as saying.

The resignation this week of Bank of Nanjing’s president Xia Ping fuelled similar speculation. The lender said Xia’s new posting is with another regional bank in Jiangsu province. But 21CN Business Herald isn’t convinced, especially as Bank of Nanjing has been one of the most active traders in the interbank bond market. “Will the flurry of debt market scandals spread to Bank of Nanjing?” the newspaper queried.

Parts of China’s bond market have been on a bull run. According to Reuters, outstanding bonds amounted to nearly Rmb24.4 trillion at the end of March, up from Rmb17.7 trillion in 2009.

The fundamental issue, according to Lu Lei, president of the Guangdong University of Finance, is that regulation has failed to keep pace with the growth in size and complexity of the bond market.

That may be changing. The People’s Bank of China held a meeting this week with senior commercial banking executives, the Economic Information Daily has reported, to discuss tighter internal controls on bond trading.

Again, the warning was of tumultuous times ahead. “The entire grey chain of vested interests in the bond market will be sucked into the regulatory storm,” the China Securities Journal predicts.

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