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China Attempts to Limit use of Corporate Bonds by Struggling Businesses

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China is attempting to limit use of corporate bonds by struggling businesses. The securities clearing house in China said for corporate bonds to qualify as collateral specific to repurchase agreements or repos, which are short-term loans that have maturity ranging from overnight to 182 days, the threshold is being raised.

In an official statement released by China Securities Depository and Clearing Corporation, which surprised investors, newly issued corporate bonds being used for repo purposes will be stopped temporarily. The only exception is if the bonds are a credit rating of AAA. These rules will disqualify higher risk bonds from being used as collateral for the repurchase of bonds.

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As part of the statement officials also said that the country’s new rule will apply to bonds issued by financing vehicles of the local government, which are not obviously covered in budgets of local authorities.

In response to the announcement on China’s new rule, there was a significant selloff within the bond market. As a result, yields climbed sharply. For the seven-year government bond benchmark, this increased from 3.78% on Monday to 4.0% in the most recent trading activity.

Based on the release of this information, corporate debt yields in China have turned volatile. Excluded is low quality debt from repo business, which analysts believe will exclude approximately $81 billion US of corporate bonds.

Currently, China’s clearing house has more than one trillion yuan worth of bonds in deposit and to reduce corporate bonds from being used as collateral for repo trading, if related risks increase, further measures will be taken.

Following a fresh statement from the clearing house, price made a full recovery. An unnamed official played down the impact, noting that net related corporate bond collateral specifically used for the repurchase trade from last week jumped by just five billion yuan. This same individual said that no reaction in the stock market was expected.

The official also said because the bond and stock markets are somewhat separated, there should be no major impact in the stock market. However, no matter the reassurances this officials and others provide, surging yields were cited by the China Development Bank while cancellation of a scheduled four billion yuan offer of onshore bonds was announced.

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David Goldstein

David is cool! :)

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