* Executives from CITIC, two other firms arrested
* Alleged profit skimming via complex trading practices
* Investigation could involve other institutions
* Regulation lags bond market's explosive growth
By Gabriel Wildau
SHANGHAI, April 18 Three Chinese financial
industry executives have been arrested for allegedly using
complex bond trading practices to skim client profits for
personal gain, state media reported this week.
Executives from state-owned CITIC Securities
, China's largest brokerage by assets, unlisted fund
management company Wanjia Asset Management and Qilu Bank, a
small lender 20 percent owned by Commonwealth Bank of Australia
, are under investigation by the Shanghai Public
Security Bureau, the official Securities Times reported on
On Thursday, the official Shanghai Securities News reported
that "related departments" had sent investigators to multiple
brokerages in Beijing, Shanghai, Jiangsu province and other
State media said the alleged skimming centred on a complex
technique known as "substitute holding", in which a fund manager
temporarily transfers a portion of his bond portfolio to a
Market participants say the practice can be used to disguise
profits or losses, increase leverage, or skirt limits on the
types of instruments a fund is allowed to hold.
The executives allegedly used substitute holding - which is
not in itself illegal - to divert to themselves profits that
should have accrued to clients, according to state media.
A Shanghai-based bond fund manager who asked for anonymity
told Reuters that the strong performance of bond markets in
recent months, combined with inadequate regulation, makes it
possible for fund managers to use this practice to enrich
"The market has been pretty good this year, and yields have
mostly been falling. At times like this, you find a third party
for substitute holding and add some leverage - the risk is
pretty small. It's not like when the market is weak and you
could take huge losses," the fund manager said.
FORMAL AND INFORMAL AGREEMENTS
A Beijing-based bond trader said that while large banks
typically formalise substitute holding arrangements with
repurchase agreements or similar contracts, smaller institutions
often use informal agreements with trusted counterparties. That
creates leeway for self-dealing, he said.
A CITIC Securities spokesman confirmed to Reuters that an
employee was under investigation but said that it was for
"personal reasons not involving the company." Media reports said
the person arrested was a senior manager in the company's
China Business News, which broke news of the investigation on
Monday, reported that the arrest occurred more than a month ago.
In a statement, Wanjia Asset Management confirmed that one
of its employees, who media reports described as a high-profile
director and fund manager, was under investigation. Wanjia said
the probe is "unrelated" to the company and that the arrested
person no longer works there.
Qilu Bank did not respond to requests for comment. CBN
reported that an executive in the bank's finance department was
The media relations department of the Shanghai Public
Security Bureau did not answer calls seeking comment.
China's interbank bond market has exploded in recent years,
with outstanding interbank bonds totalling 24.4 trillion yuan
($3.95 trillion) at the end of March, up from 17.7 trillion yuan
at end-2009 and 7.3 trillion yuan at end-2005.
Market participants say regulation has failed to keep pace
with the growing size and complexity of the industry.
China's securities regulator has moved aggressively to
combat insider trading and other corrupt practices in China's
stock market over the past year, but the bond market has
received less scrutiny.
Regulators have encouraged the growth of the bond market as
a means to diversify China's financial system away from reliance
on bank lending.
Corporate bond issuance accounted for 14.4 percent of
China's total social financing in 2012, up from 10.6 percent in
2011 and only 3.8 percent in 2007.
($1 = 6.1723 Chinese yuan)
(Additional reporting by Yong Xu and Samuel Shen; Editing by