The House of Cards?

When the Standing Committee of the Chinese People’s Political Consultative Conference (CPPCC) gathered for a meeting in Beijing this week, the 300 attendees were surprised to see Wang Qishan invited onstage as a special guest.

It was the first time for the Party’s chief graftbuster to turn up at the conference and his first public appearance for more than a month. That’s not without significance since whenever Wang disappears from public view for a spell, it normally signals his anti-corruption commission may be about to announce another major catch.

Such was the case ahead of the downfall of retired Politburo Standing Committee member Zhou Yongkang (see WiC248), as well as Xu Caihou, former number two at the Chinese military. So there would have been a collective intake of breath as Wang climbed to the conference stage.

According to Hong Kong’s Ming Pao newspaper, a delegate then asked Wang if his team was on the verge of another major scalp.

Wang just smiled in response.

“Should I interpret that as a ‘You understand what I mean’ answer then?” the delegate queried, referring to the non-committal response from a Party spokesman in March when he was asked about Zhou Yongkang’s case.

“You will understand what I mean… slowly,” Wang replied, to laughter in the audience. ­­­

So, no new scandal for the moment. But what is confirmed is that Wang is trying to clean up China’s bond markets, which is familiar turf after his experience of the GITIC credit crisis in 1997.

What is the latest bond market scandal about?

Last Sunday a Chinese court announced that Zhang Dongsheng was “suspected of taking bribes” and is now under formal investigation. Before his retirement this year Zhang had served as head of the employment and income distribution division at the National Development and Reform Commission (NDRC). That meant that he wasn’t the sort of official that most foreign investors will have heard of. Nevertheless he was an influential man, spending more than 30 years of his career at the powerful economic planning body.

As the former director-general of the NDRC’s financial department, Zhang had also overseen approvals for the issuance of so-called ‘enterprise bonds’ between 2003 to 2006.

This was a significant role, but to understand why some background is required.

Regulatory authority for debt issues in China is divided among three institutions. The National Association of Financial Market Institutional Investors (NAFMII) is in charge of vetting the short-term bills and medium-term notes that trade in the interbank market. The China Securities Regulatory Commission oversees the issuance of corporate bonds, a category that generally requires borrowers to have a stock market listing. Then there are the enterprise bonds, a loosely defined category that allows any Chinese firm with proper legal identity to raise debt. In practice, this financing channel has become a lifeline for cash-strapped companies, including local government financing vehicles. According to market intelligence firm iFinD, up to 433 enterprise bonds have been issued this year with total borrowing of Rmb588 billion ($96 billion), up 70% from the same period in 2013.

Zhang’s arrest is the result of a wider investigation. Chinese media reported last week that Sun Mingxia, former president of Guosen Securities fixed income division – and the leading banker in the enterprise bond market – has been detained by police since last October. Century Weekly said Sun has also confessed her wrongdoing, naming more than 100 people that have dealt with her under the table. The list is alleged to include ex-NDRC man Zhang, as well as executives at domestic brokerages such as Haitong and Galaxy, the magazine reported. Market observers expect the investigation to net other big fish. “What we see now is a higher level crackdown on malpractices in the bond market. It is the beginning of another storm,” China Business Journal suggested.

What’s the dirt being uncovered?

WiC reported last April that a “bond market storm” was gripping the financial markets. An investigation ordered by Wang Qishan on allegations of rogue activity then resulted in a slew of arrests (see issue 190). The clampdown revolved around dubious trading in the secondary bond market. In a complex technique known as “substitute holding”, fund managers would transfer a portion of their bond portfolio to counterparty accounts (commonly known as “Class C” accounts, denoting the variety held by an individual rather than an institution) in order to skirt regulatory limits on leverage while pocketing some of the margin.

This time round investigators are targeting collusion between regulators and underwriters in the primary market for enterprise bonds.

According to China Business Journal, Sun joined Guosen’s bond division in 2012 and swiftly contributed around Rmb520 million in underwriting income that year. The year prior, she had helped to arrange 16 enterprise bonds, amounting to 28% of the market in 2011. But the newspaper reckons Sun’s success as a rainmaker was purely down to her guanxi with the NDRC’s finance department, of which Zhang was head.

“The origin of corruption lies with the NDRC’s approval mechanism,” an unnamed insider told China Business Journal. “The NDRC’s finance department not only has the power to approve an enterprise bond sale, it also decides the timing and scale of the issuance. It even has a say in the pricing and allocation of the bonds.”

A trader who didn’t want to be named made the further point to Century Weekly that bond investors could only buy into a new issuance via Class C accounts controlled by corrupt officials and bankers.

“Normally we have no access to bonds at a fair price and can only buy from them. They resell the enterprise bonds with higher prices. Sometimes they even don’t need to pay a penny and simply ask you to deposit the cash in their counterparty accounts,” the trader alleged.

Is the crackdown a prelude to wider bond market reforms?

Since the clampdown on rogue trading last year, the central bank has already tightened market entry and interbank trading rules, especially those that relate to Class C accounts.

Similarly, the NDRC is now under pressure to improve its vetting procedures. Two of the three key officials in the planning agency’s finance department have been transferred to other bureaus. Tellingly, their positions remain vacant, a source close to the NDRC told Century Weekly.

Guangzhou Daily has also reported that the NDRC is planning to tighten thresholds on enterprise bond issuers. Companies with debt-to-equity ratios exceeding 80%, or receivables from government bodies of more than 40% of net assets, won’t be approved.

Others say the fundamental problem is that the NDRC has been too powerful. “The two most valuable assets in China’s financial market are the right to award a business licence to a financial institution (such as a brokerage); and the other being the vetting power of a regulator. No one is willing to give up the power they already have. Perhaps the rent seeking blackhole revealed by Sun Mingxia’s case will prompt central authorities to rethink the NDRC’s vetting power on enterprise debt issuance,” another unnamed regulator predicted to CBN.

Ye Tan, a financial columnist, even called for an end to the NDRC’s powers in vetting enterprise debt, proposing a shift to the CSRC, the securities regulator instead.

“It is time to clean up China’s bond market, put different regulatory bodies under one roof, and build up a transparent approval mechanism according to market-oriented principles,” Ye wrote in the National Business Daily.

And probes continue at the NDRC

Regular WiC readers will be familiar with the NDRC’s status as “the Ministry of State Capitalism”. Formed in 2003 by the merger of the State Planning Commission with other powerful planning agencies under the State Council, it has grown into a super ministry with 28 functional departments covering almost every aspect of the economy (arguably only military and foreign affairs fall outside its scope).

But cynics complain that the NDRC itself has become one of the biggest stumbling blocks for structural reforms. (The China Times once described the NDRC’s roles as “heavy on approvals, light on planning; heavy on development, light on reform”.) Since taking office last year, Premier Li Keqiang has been pushing to simplify administrative procedures and decentralise some of the levers of government power. The speculation is that NDRC bosses have been some of Li’s most determined opponents and that they are fighting desperately to maintain their influence. That could even be why they have launched a recent spate of price-fixing probes against international carmakers (see WiC249).

The latest reports from the Chinese press show no sign of the furore abating. Century Weekly said on Thursday that Cao Changqing, who was in charge of the NDRC’s pricing department before retiring this year, was detained at Beijing’s international airport this week. If true, that would mean that nine senior NDRC officials have either been arrested or put under investigation since President Xi Jinping launched his anti-graft offensive in late 2012. One of them was Liu Tienan, a deputy director responsible for approving major infrastructure projects in the energy field. Liu’s case was viewed as a prelude to the wider challenge to the NDRC’s authority (see WiC195). Since then there has been a broader push too to open up the energy sector to private sector investment.

It also seems that other government entities are combining to cut the NDRC down to size. The Financial Times has observed that the crackdown on the bond market requires the cooperation of different government bodies including the central bank, the Public Security ministry and the National Audit Office. “For this many government bodies to work together, someone needs to be playing a coordinating role,” the FT speculated. “That someone is Wang Qishan.”

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