Bond traders lash out in China
HONG KONG, Aug 9 (IFR) - Mr Song was so angry that a trader at China Pacific Insurance had walked away - "defaulted", in his words - after agreeing a price for a bond trade that he turned to the internet to vent his frustration.
Within hours of Song's July 25 post on Weibo, the Chinese micro-blog, the portfolio manager at Shanghai Pudong Development Bank had seen his message reposted 50 times and received 22 mainly sympathetic comments from his peers.
He is far from alone. Fixed-income traders are reporting a growing number of failed trades attributable to brokers or investors not honouring the prices they agreed.
"[Complaining on Weibo] is the only thing we can do at the moment. There are no other punishments for such unacceptable cancellations," said a senior trader with a major commercial bank. "The worst thing is that the whole market is somehow getting used to this."
The reasons given for reneging on trades include failing to win approval from a supervisor, or no longer having access to the bonds in question. As brokers typically do not own the bonds they are trading, multiple parties sometimes attempt to trade the same paper, while bank traders often claim to be unaware that their treasury colleagues had locked up the paper as collateral for a repo trade.
Traders dismiss many of those explanations as excuses.
"You come to the market: what you offer and agree should be on behalf of your company," said a bank trader, who recently had a medium-sized fund manager cancel his purchase of Rmb30m (US$4.9m) of bonds, apparently because another broker had placed the paper.
"I don't understand why some people don't take it seriously. This is a bad and dangerous trend for the market."
Whatever the reasons, the practice in effect allows traders to walk away from deals if the market moves against them. That could have a big impact on market liquidity in volatile conditions, while it also threatens to undermine efforts to introduce market-based prices for new issues.
While broken promises are not unique to the renminbi market, traders say spurious cancellations have become more common in recent months.
Coming after a number of trading scandals earlier this year, the practice hints at the scale of reform needed in China's domestic market, where analysts say growth has outpaced regulatory oversight.
GROWING TOO FAST?
The amount of bonds outstanding in China has already grown threefold in the past 10 years to Rmb24.8trn (US$4.06trn), according to Chinabond, the country's biggest bond clearing house. The total volume is on track to surpass that of France later this year, making domestic China the world's third-largest bond market.
Excluding financial issues, China's corporate bond market will probably surpass that of the US in the next two years, S&P said in May.
Last year, the equivalent of US$35trn traded onshore, about three times the amount traded as recently as 2007, according to Wind Data. As a comparison, US$5.56trn of US dollar-denominated emerging-market bonds changed hands in the secondary market in 2012, says the Emerging Markets Trade Association.
The authorities in China are in the midst of a thorough reform of the country's bond markets, and have already clamped down on various "irregular trading" practices in an effort to improve transparency and boost confidence.
Accurate and representative secondary prices are a key part of the move from regulator-set benchmarks to market-determined pricings of new issues. In addition, as the practice becomes more rampant, some market participants are starting to call for regulation to stop people from stepping away from trades unharmed.
"To go back on your word is not something that offshore traders normally have in mind," said Meng Xiaoning, senior portfolio manager with Bank of China, Hong Kong. "Clear punishments, such as warnings or even trading bans from the regulators and compensation, are needed," said Meng.
"Here in Hong Kong, you can sue your counterparty."
Almost all the bond trading in China is done in the interbank market, where brokers, banks and even individual investors exchange securities over the counter.
OTC trading is a feature of most of the world's bond markets. However, in the US, the world's biggest bond market, the Financial Industry Regulatory Authority has clear guidelines for trading that are enforced through an arbitration forum.
While Finra is a self-regulated organisation, it is overseen by the US Securities and Exchange Commission. Europe has similar organisations.
In China, credit traders can take their complaints to the National Association of Financial Markets Institutional Investors, an industry body that answers to the central bank. But such complaints are virtually unprecedented, as traders believe such a course of action would destroy too many valuable relationships.
Reforming the bond markets is crucial to Chinese policy, coming as Beijing promotes the capital markets as an alternative to bank financing. Although volumes have ballooned in recent years, the domestic renminbi market lacks many features that are common in overseas markets, and credit risk remains untested with a record of zero defaults.
As well as insisting that brokers stick to their word, traders are calling for a market-maker mechanism to be introduced to aggregate small orders and to simplify prices, similar to international practices.
"Certain market-makers need to digest some of the offers in the first place," said the broker. "Retail investors are bidding and offering together with the wholesale market. That makes it hard to find the real prices behind the trades and easier to agree a deal you then regret."
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