Member Article

Definition

“Bond lending” refers to bond financing whereby the bond borrower borrows the underlying bonds from the bond lender by providing a certain amount of performance assurance assets and both parties agree that on a future date the underlying bonds shall be returned and the bond lender shall return the performance assurance assets.

“Outright transfer bond repo” refers to a transaction wherein the bond holder (repo party) sells bonds to the bond buyer (reverse repo party) and both parties agree that, on a future date, the repo party shall buy back bonds of the same type and quantity from the reverse repo party at an agreed price.

“Pledged bond repo” refers to the financing transaction where the funds receiver (repo party) receives the funds by pledging bonds to the funds provider (reverse repo party), and both parties agree that, on a future date, the repo party shall return the funds to the reverse repo party at the amount calculated at a stipulated interest rate and the reverse repo party shall release the pledge on the pledged bonds.

Transaction mechanism

Transactions are concluded at the China Foreign Exchange Trade System (“CFETS”) through bilateral negotiation or centralized lending mechanism.

The 2022 Measures newly introduce a centralized bond lending mechanism. Centralized lending refers to the matching and concluding of bond lending transactions by bond settlement service institutions (i.e., China Central Depository & Clearing Co., Ltd. (“CCDC”), Shanghai Clearing House (“SHCH”) and custodian banks), pursuant to their prior agreements with the market participants that have insufficient bonds for delivery on any bond settlement date and on their behalf, with other market participants at CFETS.

Centralized lending service may effectively avoid the risk of settlement failure. The specific centralized bond lending mechanism is still subject to the implementation rules to be stipulated by CCDC, SHCH, CFETS and other financial infrastructures.

Transactions are concluded at the CFETS through bilateral negotiation.

Collateral

The 2022 Measures change references to collateral from “pledged property” to “performance assurance asset”, which indicates that the form of security will no longer be limited to pledge. The 2022 Measures also provide room for the introduction of all types of performance assurance (such as “transfer by way of security”) as permitted under the PRC Civil Code and relevant security-related regulations, and even the performance assurance in the form of outright transfer which commonly used under derivatives master agreements.

That said, in practice, implementing new forms of performance assurance is still subject to the bond lending master agreement and other relevant documents, as well as further observation of the market.

Applicable law does not impose restrictions on the form of performance assurance, so parties can at their discretion determine the form of performance assurance based on their commercial needs.

According to the form of the NAFMII Bond Repurchase Master Agreement (2013 version), under outright transfer bond repo transactions, parties may adjust the net risk exposure via cash margin or collateral securities; under pledged bond repo transactions, parties may adjust the net risk exposure by creating or releasing the pledge on the underlying bonds. In addition, the parties may also agree on other forms of performance assurance.

Function

n Lending bonds to earn a yield.

n Exchanging bonds to reduce funding costs; for example, a borrower can reduce its funding costs if it borrows funds through a pledged repo transaction by pledging interest bonds which are borrowed in by collateralizing credit bonds under a bond lending transaction, and the interest rate in the bond lending transaction is lower than the differences of funding rates between the pledged bond transaction with credit bonds being pledged collateral and those with interests bonds being pledged collateral.

n Financing - repo party borrows funds by using bonds in its possession.

n Short selling bonds - borrowing bonds and selling them when the bond price is expected to go down, and buying the bonds of same issue and return them when the price goes down, so as to earn a spread gain.

n Borrowing bonds for delivery purposes in other businesses (such as cash bond transactions, pledged bond repo transactions, and physical delivery to settle treasury futures short positions).

N/A

Market participants

n Various types of onshore financial institutions that satisfy bond market access requirements and non-legal person products they issue.

n Offshore institutional investors may engage in bond lending transactions for hedging purposes.

n Various types of onshore financial institutions that satisfy bond market access requirements and non-legal person products they issue.

n Offshore central banking institutions, offshore RMB clearing banks, and offshore participating banks that satisfy bond market access requirements; other types of offshore commercial institutions cannot currently engage in bond repo transactions.

Underlying bonds/repo bonds

Bonds traded in the inter-bank market.

The 2022 Measures delete the requirement in the 2006 Provisions that underlying bonds must be self-owned by the bond lender. This can solve the practical problem where the manager is acting as the nominee holder for non-legal person products while the product is the transacting counterparty. In addition, diversified bond lending needs can be satisfied; for example, institutions holding underlying bonds may be entrusted as agents to conclude bond lending transactions.

Bonds traded in the inter-bank market.

Transaction period

The maximum period shall be no more than 365 days.

Settlement institutions

Bond registration and settlement institutions and custodian banks recognized by PBoC, i.e., CCDC, SHCH and recognized custodian banks.

Compared with the 2006 Provisions, the 2022 Measures add SHCH and custodian banks as the settlement institutions of bond lending business.

CCDC and SHCH.

Agreement form

There is currently no applicable standard agreement form, and each participant formulates its own bond lending (master) agreement.

The 2022 Measures newly provide that market participants shall sign a master agreement recognized by PBoC, which is formulated by the self-disciplinary organization in the inter-bank market (i.e., the National Association of Financial Market Institutional Investors (“NAFMII”)) and filed with PBoC for record.

NAFMII Bond Repurchase Master Agreement (2013 version) issued by NAFMII in January 2013.

Important Announcement

This Legal Commentary has been prepared for clients and professional associates of Han Kun Law Offices. Whilst every effort has been made to ensure accuracy, no responsibility can be accepted for errors and omissions, however caused. The information contained in this publication should not be relied on as legal advice and should not be regarded as a substitute for detailed advice in individual cases.

If you have any questions regarding this publication, please contact:

TieCheng YANG

Tel: +86 10 8516 4286

Email: [email protected]