Securities Finance Industry News | ICMA Releases Guide to China’s Domestic Repo Market

The International Capital Markets Association (ICMA) has published a guide to the Chinese repo market, which represents the fifth in its series of market practice guides to domestic repo markets in Asia.

This volume provides a detailed introduction to repo market activities in mainland China, including an analysis of market developments, trading products and activities, market infrastructure, the interbank market, and traded repo in the stock market, as well as a review of the regulatory and legal framework and its continued development.

Written by Richard Comotto, senior consultant to ICMA’s European Repo and Collateral Council and long-time repo market expert, this contribution follows national repo market guides for Japan, Indonesia, Vietnam and the Philippines that were released earlier this year.

The volume notes that China has a 30-year history of repo trading, with activity ranging from informal transactions conducted on various local stock exchanges in the early 1990s to a market that now generates nearly $220 trillion. dollars of turnover per year, which is the equivalent of an average daily turnover. of 850 billion US dollars or 5.6 trillion yuan.

Given the size of the repo market in China, Comotto advises comparing it to other large repo markets globally, rather than its smaller Asian regional counterparts. The repo market is now the largest fixed income and money market in China, with 2021 repo turnover of 1,395.4 trillion yuan, compared to 214.5 trillion yuan for repo transactions. cash on bonds and 118.8 trillion yuan for unsecured interbank loans.

The guide concludes that although the repo market is the most efficient and liquid financial market in China, the underlying cash market for securities deployed as collateral is relatively illiquid, due to its very low turnover, and the illiquidity of collateral therefore constitutes a systemic risk in this market. .

While the one-day term of most repo transactions mitigates this liquidity risk for investors, it presents significant funding risk for borrowers. The heavy use of short-term wholesale funding to generate leverage and manage maturity transformation puts the repo market at risk of sudden deleveraging.

Another source of systemic risk in repo markets stems from the fact that the vast majority of repo transactions in China are collateral repos, which are actually collateralized loans rather than a real repo.

In the event of counterparty default, Comotto notes that such repos would fall within the scope of the statutory insolvency regime and that China’s undertested bankruptcy law may delay or block access to collateral. .

More generally, repos do little to encourage liquidity in the market for the underlying securities, as cash lenders are unable to reuse pledged collateral, for example to cover short positions. The use of collateral also limits the use of close-out netting.

The repo market in China is divided into the interbank market and trades on two stock exchanges, the Shanghai Stock Exchange and the Shenzhen Stock Exchange. The guide provides a useful overview of how each market segment works and the products and business activities they support.

In theory, Comotto notes, the interbank market trades on the China Foreign Exchange Trading System (CFETS), which supports trading and data services for repos, cash bonds, currencies and OTC derivatives.

In reality, repo market participants typically trade bilaterally outside of CFETS, using voice or chat, with CFETS being used to report the transaction in accordance with the regulatory requirement for OTC transactions.

The author highlights the important role that the interbank market has played since its inception in 1997 in supporting the central bank’s move towards an interest rate-based monetary policy framework. This facilitated the People’s Bank of China’s move from quantitative credit targets and direct interest rate guidance to a monetary framework guided by daily free market intervention, average reserves, standing facilities and strategic policy signals.

Comotto notes that an efficient repo market provides a safe means for open market operations, while repo rates provide an accurate indicator of the cost of wholesale funding, providing an efficient benchmark for pricing risk and financial assets at short term.

Comments are closed.