* Daily trading volumes down 90 pct from April high
* Collapse occurred before recent cash crunch
* Crackdown on corrupt trading practices reveals fake trades
* Difficulty exiting investments may give foreigners pause
By Gabriel Wildau
SHANGHAI, July 3 Daily turnover in China's once
high-flying bond market has collapsed since April amid a
crackdown on corrupt trading that has revealed how sham trades
have inflated reported liquidity in recent years.
Authorities have arrested at least four bond traders and
fund managers since April as part of an investigation into
The probe has been accompanied by new rules clamping down on
practices commonly used to skim profits and increase leverage.
Investigations have focused on abuse of 'proxy holding'
trades, whereby one investor buys bonds on behalf of another,
often using funds borrowed from a third party.
The trades can be considered bogus when the buyer and seller
effectively belong to the same portfolio. Sometimes both
accounts are controlled by the same individual.
"This regulatory windstorm starved many proxy holding trades
to death," said an asset manager at a major Chinese brokerage.
The collapse in trading volumes could scare off foreign
investors who were granted more access to the market in March,
while the fall in bond prices has also forced domestic firms to
postpone plans to issue bonds to raise debt.
"It's mainly due to new rules implemented in the bond
market," said a bond trader at a European bank in Shanghai, when
asked why volumes had collapsed.
While proxy holding is not illegal, the practice is open to
In some cases, a trader may transfer bonds to another
account that he controls, then pocket the profit when the bonds
are resold at a higher price.
Another recent rule targeted the high-risk shadow banking
sector. It forbade trading bonds between different accounts
controlled by the same institution.
Some banks had done this in order to raise cash to make
payouts on maturing short-term wealth management products, even
when the longer-term assets underlying these products had not
Some investment firms are also suspected of using sham
trades to boost their standings in industry league tables for
A cash squeeze that propelled interbank lending rates to
record highs last month exacerbated a collapse of bond trading
volumes, but the steep fall in business was underway well before
that squeeze began.
Daily trading volume in China's interbank bond market
averaged 282 billion yuan in the first five
months of 2013 and hit an all-time high of 433 billion yuan on
April 17, data from China's biggest bond clearing-house shows.
But turnover plummeted to 36 billion yuan on June 13, the
lowest since the clearing-house began providing data to Thomson
Reuters in May 2011. Volumes have recovered only slightly, to 47
billion, by Tuesday.
Market participants said volumes would recover slowly but
are unlikely to approach recent highs anytime soon.
The People's Bank of China (PBOC), which oversees the
interbank bond market, said in March that foreign firms approved
under the Qualified Foreign Institutional Investor (QFII)
program could apply for access.
Previously, QFIIs were limited to investing in stocks and
the small number of bonds also listed on China's exchanges.
But poor liquidity, which limits ability to exit an
investment, could make foreign investors think twice about
entering the market.
China's top leaders recently called for a detailed plan to
eliminate capital controls and open up the economy more fully to
Analysts say a deep and liquid bond market is essential to
an economy's ability to absorb increased cross-border flows.
Otherwise the large waves of capital flowing in and out could
cause interest rates to fluctuate wildly.
Corporate bond issuance volumes rose 51 percent year-on-year
in the first five months of 2013, and top policymakers have long
said they want bonds to comprise a larger portion of overall
But momentum appeared to stall in June. Since June 20, more
than a dozen companies have postponed previously planned bond
issuances due to market volatility.
Most said they would raise money during the second half of
this year, or the first quarter of next year.
(Reporting by Gabriel Wildau; Editing by Simon Cameron-Moore)