New law has more holes than Tiger Leaping Gorge

The interbank bond market, bond varieties and crimes tied to bonds have been overlooked

by Chris Gill
New Securities law has more holes
Li Chao, deputy head of the China Securities Regulatory Commission, attends the listing ceremony of the first batch of companies on the SSE Star Market in Shanghai in July 2019. Photo: AFP

(ATF) – With the dramatic imposition of the new Securities Law on March 1  governing financial markets in China, the debate on who will regulate the country's 96 trillion yuan (US$13 trillion) bond market goes on. And the new law has some legislative gaps to fill, as those involved are pointing out.

Article 2 stipulates that this law shall apply to the issuance and trading of stocks, corporate bonds, depositary receipts and other securities recognized by the State Council in accordance with the law within the People's Republic of China. If not stipulated, the national Company Law shall apply, along with other laws and administrative regulations. This law applies to the listing and trading of government bonds and securities investment fund shares. If there are other laws and administrative regulations those provisions shall apply.

A professor of Chinese law, who asked not to be identified, pointed out this article is the most important provision of the entire law. This article involves the precise definition and scope of application of "securities", so it was very controversial when the law was revised, but some valuable amendments were made in the end. However, a major regret is that the Securities Law lacks further explanation on the substance of "corporate bonds".

Given the Securities Law relates to new content, such as how to promote a registration system for public offerings of securities and how to protect the legitimate rights and interests of investors, the State Council's general office issued a notice on February 29 about work relevant to the implementation of the amended law – to make arrangements for that to be done.

“Public issuance of corporate bonds should be registered with the China Securities Regulatory Commission (CSRC) or the National Development and Reform Commission."

The second article stipulates that requirements for a registration system for public offerings of corporate bonds must be implemented. Under the revised law, public issuance of corporate bonds should be registered with the China Securities Regulatory Commission (CSRC) or the National Development and Reform Commission.

Under the law, the CSRC is responsible for making registration decisions on public issuance of corporate bond applications, and the stock exchange designated by the CSRC is responsible for accepting and reviewing applications. The National Development and Reform Commission is also responsible for making registration decisions on public issuance of corporate bond applications, and institutions designated by the NDRC are responsible for accepting and reviewing those applications.

It is noteworthy that the "notice” classes “corporate securities” in the Securities Law as “corporate bonds” regulated by the securities regulatory authority and “corporate bonds” regulated by the NDRC.

Second, the "notice" defines the "National Development and Reform Commission" as the "authorized department of the State Council" referred to in Articles 9 and 16 of the new law.

Interbank bond market and bond varieties overlooked

Obviously, this important development of the Securities Law missed the very important "corporate bond" market – that is, the "interbank bond market" managed by the central bank and the China Interbank Market Dealers Association.

It also missed important bond varieties – "financial bonds" managed by the central bank and "debt financing instruments" managed by the China Interbank Market Dealers Association.

The new law and the notice require "publicly issued" corporate bonds to implement a registration system. However, both financial bonds and debt financing instruments may constitute "public offerings" under Article 9 of the Securities Law.

Financial bonds are still under an "approval system", so it is not clear whether to change to the new "registration system". And it is not clear what the relationship between the registration system of the dealers association and the registration system in the securities law is.

Major flaw in bonds regulatory structure

There should not be these sorts of omissions in major legislation, and it is also a major flaw in China’s regulatory governance structure on bonds.

In the past 10 years, China's bond market has achieved leapfrog development – the market size has rapidly expanded and it has become the second largest bond market in the world. As of the end of 2019, the balance of China's bond market exceeded 96 trillion yuan (US$13 trillion).

Why does the Securities Law ignore "corporate bonds" in the interbank market? The competent supervisory agency for corporate bonds is divided into three and it is difficult to coordinate. Otherwise, the main differences between interbank bonds and corporate bonds regulated by the CSRC are:

  • Issuance targets are different. Inter-bank bonds are issued only to qualified institutional investors, and CSRC corporate bonds are also issued to natural citizens;
  • There are different trading venues. Inter-bank bonds are traded on the over-the-counter market, and corporate bonds of the CSRC are listed and traded on the Shanghai and Shenzhen stock exchanges;
  • Issuance methods are different. Inter-bank bonds have been registered since 2009. They have been registered for issuance with the Association of Trade Self-Regulatory Organizations and Traders Associations, and corporate bonds of the CSRC were approved by the CSRC before the new Securities Law was implemented and registered by the CSRC after implementation;
  • There are different set-ups. The infrastructure of the interbank market mainly includes the interbank lending center, the interbank market clearing house, and China Securities Depository. The corporate bond infrastructure of the Securities and Futures Commission is mainly the Shanghai Stock Exchange, the China Securities Exchange and the company.

Proposed administrative regulations to make up for shortcomings

In light of this, at present, the Securities Law and the State Council Notice do not fully respect the existing practices of the Chinese bond market and the lack of arrangements for the interbank bond market, which has deepened ambiguity on how the law will apply to the bond market.

The size of China's bond market exceeds 96 trillion yuan in value, and corporate bonds make up about 10 trillion yuan, while the size of financial bonds and debt financing instruments in the interbank bond market exceeds 30 trillion yuan.

The financial chain is fragile and debt burden more serious

The State Council's notice only makes arrangements for the public issuance of corporate bonds, but there are no clear arrangements in regard to larger interbank bonds, which could easily lead to financial market chaos. In the critical period of supply-side structural reform and increasing downward pressure on the economy, the financial chain is more fragile, the debt burden is more serious, and there are more debt defaults. If this causes chaos in the bond market, systemic financial risks are likely to occur.

The State Council's Notice focuses on making arrangements for registration, but ignores the long-term registration system of the interbank bond market and different regulatory bodies. The purpose of the Notice is to regulate reform of a corporate bond registration system, but it ignores a registration system that has existed in the interbank bond market for a long time. This may cause confusion or stop the existing registration system from being effectively consolidated.

To make up for shortcomings in the Securities Law, it has been proposed that the State Council promulgate administrative regulations applicable to the entire Chinese bond market. But the actual scope of China's bond market is much larger than that prescribed by the securities law, and market development is gradually expanding the scope of the law.

However, due to the lack of effective regulations for a large number of bond varieties such as government bonds, local government bonds, financial bonds, and debt financing instruments, the securities law has weakened the legal foundation of the Chinese bond market and confused the legal system, adding to market uncertainty about legal aspects.

The bond market is very different to the stock market

It is recommended that the State Council issue administrative regulations applicable to the entire Chinese bond market to fill the deficiencies of the securities law:

It would be a good move to integrate corporate credit bonds into the regulatory framework of this administrative regulation, to clarify the applicability of financial bonds, and unify the applicable standards of basic laws;

It is also necessary to strengthen the scientific nature of the bond information disclosure system. The essential differences in the investment attributes of "shares" and "debts" mean that investors' attention to information is different. Differences in the investor structure of the stock market and bond market also affect the effectiveness and nature of the information disclosure system. Unified bond administrative regulations should establish an information disclosure system that fits the attributes of bonds and the structure of the bond market, rather than simply applying stock rules;

Standards need to be spelt out and liability for illegal activities in the bond market also need to be clarified. False statements, insider trading, and market manipulation are the three major securities concerns.

Due to differences in issuance methods, pricing mechanisms, and trading systems, illegal behavior in the bond market is very different from the stock market in terms of expression, damage consequences, and liability determination. It is also very difficult to identify.

A more scientific identification standard and a method of sharing responsibilities should be established for bond violations to ensure healthy development of the bond market.