China Regulators Complete Final "Drill" In Preparation For Petro-Yuan Futures Trading

Amid all the chatter of Venezuela and Russia potentially creating oil-backed cryptocurrencies, the "huge news" of China"s launch of the Petro-Yuan has fallen off the front page... until now.

This week saw the Shanghai Futures Exchange complete its fifth yuan-back oil futures contract trading drill successfully...

As Bloomberg reports, 149 members of Shanghai International Energy Exchange traded 647,930 lots in the drill with total value of 268.2b yuan, according to a statement from the exchange, which added that the system basically met the listing requirements of crude futures after the drill.

While this was a success, it"s not all plain-saling...

As Bloomberg notes, as the world’s largest energy consumer and an increasing source of investment capital for oil-producing nations, China has an interest in using its own currency rather than that of a geopolitical competitor.

One hurdle for setting up a rival to Brent or West Texas Intermediate: Overseas oil producers and traders would need to swallow China’s capital controls and penchant for occasional market interventions.

Similar hurdles have kept foreign investors as bit players in China’s giant mainland stock and bond markets, and the share of payments in Yuan in the Global SWIFT system has fallen...

"This contract has the potential to greatly help China’s push for yuan internationalization," said Yao Wei, chief China economist at Societe Generale SA in Paris.

 

"But its success will hinge critically on the degree of freedom allowed for the capital flows related to the contract," she said.

 

"It is not unreasonable to envision a world in which the overwhelming share of commodity contracts, especially for oil, are no longer denominated just in dollars," said Eswar Prasad, a former China division chief at the IMF.

 

But "the yuan’s role in global finance will ultimately be determined by the degree of commitment of Xi Jinping’s government to economic and financial market reforms."

But, as we detailed previously, the writing is on the wall for dollar hegemony, and we suspect teh decline in global yuan trade volumes is another reason for China to push ahead sooner.

As Russian President Vladimir Putin said almost two months ago during the BRICs summit in Xiamen,

“Russia shares the BRICS countries’ concerns over the unfairness of the global financial and economic architecture, which does not give due regard to the growing weight of the emerging economies. We are ready to work together with our partners to promote international financial regulation reforms and to overcome the excessive domination of the limited number of reserve currencies.”

As Pepe Escobar recently noted, "to overcome the excessive domination of the limited number of reserve currencies" is the politest way of stating what the BRICS have been discussing for years now; how to bypass the US dollar, as well as the petrodollar.

Beijing is ready to step up the game. Soon China will launch a crude oil futures contract priced in yuan. This means that Russia – as well as Iran, the other key node of Eurasia integration – may bypass US sanctions by trading energy in their own currencies, or in yuan. Inbuilt in the move is a true Chinese win-win; the yuan - according to some - will be fully convertible into gold on both the Shanghai and Hong Kong exchanges.

The new triad of oil, yuan and gold is actually a win-win-win. No problem at all if energy providers prefer to be paid in physical gold instead of yuan. The key message is the US dollar being bypassed.

China"s plans for oil futures trading go back more than two decades, with the government introducing a domestic crude contract in 1993 and stopping a year later amid an overhaul of its energy industry. But in 2013, we first hinted at the birth of the petroyuan was looming...

In doing so China is effectively lobbing the first shot across the bow of the Petrodollar system, and more importantly, the key support of the USD in the international arena... setting the scene for the petroyuan.

*  *  *

And now it just became one step closer to reality, as Bloomberg reports, China’s government State Council has officially approved the listing of a crude futures contract in Shanghai, according to people familiar with the matter.

While the date of launch will be determined by China Securities Regulatory Commission and Shanghai Futures Exchange, it would appear we are within weeks of it becoming a reality as China prepares to roll out a yuan-denominated oil contract...

"Approval of the trading rules by the securities regulator marks the clearance of a major hurdle toward launch of the contract," Li Zhoulei, an analyst with Everbright Futures, said by phone.

 

"The latest rules raised entry threshold for investors from the draft rules, which shows the government wants to avoid volatility when it first starts trading."

Which, according to Adam Levinson, of hedge fund manager Graticule Asset Management Asia, will be a “wake up call” for investors who haven’t paid attention to the plans.

China Regulator Instructs Companies To Delay Bad Results Until After Congress

In the U.S., equity markets have officially reached the phase in the bubble where fundamentals are almost entirely irrelevant and stocks trade up irrespective of whether company earnings are positive or negative...in technical terms you could say we"re in the later stages of the BTFD phase of the economic cycle. 

That said, as Bloomberg points out today, regulators in China still have to be a bit more "creative" to quell market volatility during important national events.  As such, the China Securities Regulatory Commission has sent out a notice to public companies kindly requesting that they delay their earnings report during China"s Communist Party Congress...but only if they"re going to be bad.

China’s securities watchdog has asked some loss-making companies to avoid publishing quarterly results this week as authorities seek to ensure stock-market stability during the Communist Party Congress, according to people familiar with the matter.

 

The China Securities Regulatory Commission made its requests via the country’s stock exchanges, the people said, asking not to be named as they’re not authorized to talk to the media. At least 17 Shenzhen-listed companies announced delays to their earnings reports from Oct. 20 to Oct. 24, up from three during the same period last year, exchange filings show. The CSRC declined to comment, while China’s bourses didn’t respond to faxed questions.

 

Chinese regulators have stepped up efforts to quell market volatility during the twice-a-decade congress, a highly-choreographed reshuffling of the country’s top leadership that’s expected to shape President Xi Jinping’s influence into the next decade. While the smallest equity swings in 25 years suggest government interference has worked, critics argue that China’s leaders have backpedaled on a pledge to give market forces a more central role in the world’s second-largest economy.

And, to our great shock, the strategy seems to be effective:

Of course, you can"t be too blatant in your attempts to control markets so a lot of companies have suddenly decided they need to "finish checking earnings reports" while others simply said they "have a lot on our plate to deal with" and can"t be bothered by silly regulatory filings at this point in time.

Shandong Minhe Animal Husbandry Co., which farms chickens, and Shenzhen Hifuture Electric Co., an electrical equipment maker, were among the Shenzhen-listed companies asked to withhold their results this week, the people said.

 

Shandong Minhe, which estimated a loss for the Jan.-Sept. period in an Oct. 13 filing, said on Sunday that it hasn’t finished checking the content of its earnings report and will postpone its release, previously scheduled for Tuesday, to Oct. 30. Shenzhen Hifuture, which also projected a Jan.-Sept. loss on Oct. 13, gave this explanation for a similar delay in a Sunday filing: “We have a lot on our plate to deal with.”

 

Shandong Minhe declined to comment further when contacted by Bloomberg News. The stock dropped 1.1 percent on Tuesday and is down 35 percent this year. Shenzhen Hifuture, whose shares have been suspended since January, didn’t immediately reply to an email.

 

Most of the 17 Shenzhen-traded companies that announced delays to their results had previously predicted losses or steep earnings declines, filings reviewed by Bloomberg show. Ten of the companies declined on Tuesday, while one was little changed and one rose. Trading in five of the stocks was suspended.

Of course, now that the cat"s out of the bag, we"re going to go out on a limb and suggest it might be a safe bet to go ahead and unload any company that delays earnings reports over the next week or so...just a hunch.

China Orders No Market Turbulence Ahead Of Party Congress

The most important event in China in five years is about to take place, and Beijing isn"t taking any chances.

Ahead of the Communist Party’s twice-a-decade congress - an event so massive that according to Bloomberg "nothing escapes its pull" - which is slated to start on October 18 in Beijing, regulators have made it clear to the nation’s top brokers, bankers and financiers that they don’t want to see any major turbulence in markets.

In a repeat of the fiasco that followed the bursting of China"s equity bubble in the summer of 2015 when Beijing effectively nationalized the stock market, and went so far as to throw prominent hedge fund managers and assorted "speculators" in prison, the China Securities Regulatory Commission has ordered local brokerages to "mitigate risks" and ensure stable markets before and during the Communist Party’s leadership congress next month, according to Bloomberg. Additionally, to leave virtually nothing to chance - and to have ready scapegoats in case someone does in fact sell - the CSRC also banned brokerage bosses from taking holidays or leaving the country from Oct. 11 until the congress ends.

Brokerage bosses were told to avoid travel of any kind from Oct. 11 until the congress ends, including business trips.

Luckily for them, China’s national day holidays are coming up in the first week of October. Local markets will be shut for an entire week, providing plenty of time to recharge for the congress.

Since the congress, which is expected to replace about half of China’s top leadership, is of paramount importance to President Xi Jinping who will use it as a foundation to cement his influence into the next decade, nothing is allowed to spoil the optics of supreme control at this critical moment.

And while China routinely takes steps to reduce market swings during key political gatherings, the travel ban on brokerage chiefs illustrates how seriously regulators are taking next month’s meeting, according to Bloomberg.

Still, the news will hardly come as a surprise to most market participants, and explains why Chinese markets have already rallied significantly this year amid expectations of government support, while equity volatility has tumbled to the lowest level in over 2 decades. The Shanghai Composite Index touched a 20-month high on Tuesday, while the yuan has strengthened 6.4% against the dollar this year.

In addition to the travel ban, China"s regulator told brokerages and futures companies to check for risks in their liquidity, operations and financial health, effectively warning that it does not want to see any selling. The regulator also ordered firms to assess their information system security and credit risks and report their findings before October, Bloomberg"s sources added.

Of course, with so much focus on how effective China will be at keeping its equity markets growing at a steady, controlled pace and avoiding turbulence ahead of the critical summit, anyone hoping to make a political statement against the Xi regime - whether domestically or offshore - could do so simply by causing even a modest market correction sometime in mid-October, especially since even the smallest spike in volatility could lead to a panicked selloff in light of such an unexpected move.

Investors Rage After 3 Billion Yuan Vanish From China's Largest Private Bank

Theoretical warnings about risks inherent in China"s shadow banking system became all too for 150 customers of China"s largest private bank, when Minsheng Banking Corp found itself involved in a 3 billion yuan (US$436 million) fraud case, after it emerged that a branch chief of the lender in Beijing allegedly issued false bank acceptance bills and later secured funds from individual investors to cover up the misdeed.

According to SCMP, an accidental inquiry from an investor exposed the fact that the WMPs sold by a Minsheng branch didn’t even exist. When shocked investors rushed to the bank, they found the head of the branch had been taken into police custody and the supposed due payment date had passed.

A little background: bank acceptance bills, one of the shadier funding pathways of China"s shadow banking system, and a form of bank-backed IOU, are commonly used as a form of payment between Chinese companies. The holder of such bills is entitled to cash the bill at a bank under any circumstances... unless of course fraud is involved. It is different from commercial acceptance bills, which are issued by companies and do not guarantee repayment despite companies’ trustworthiness.

Well, in this case fraud was involved.

The branch head at the Beijing branch of Minsheng, Zhang Ying, allegedly helped a corporate client disguise commercial acceptance bills as bank acceptance bills by using a false seal of the bank. The bills were issued by the client to a number of companies, which later discovered the bills were fake, Caixin said.

Then, in order to cover up the fact that the fake bills were not able to be cashed by the bank, Zhang later sold 3 billion yuan of unauthorized wealth-management products to the bank’s private customers to get funds for the client to repay the bills. Caixin said a huge amount of funds may be transferred between the client and Zhang.

Zhang Ying, the branch head, has been detained by Beijing police, while Xiao Ye, vice head of the branch, is still missing, Caixin magazine reported on its website. Minsheng said it is assisting the police with an investigation into Zhang, according to its public announcement yesterday, and will “investigate thoroughly the incident and try to recover investors’ funds to the utmost.”

Meanwhile, the investors in the WMPs sold by Minsheng, realizing their money is now gone, are understandably furious.

“If we can’t even trust a big national bank, what other financial institutions can we trust?” Liu Min, who bought 12 million yuan worth of WMPs from Minsheng, said as he waited in the lobby of the Hangtianqiao branch of Minsheng Bank to hear news. Two million yuan of the WMP he invested in is was “due” April 17 but he can’t get the money back. Liu, 52, was one of 150 private banking customers of Minsheng who had bought the WMPs. In most cases, their ties with the lender go back 10 years when the Hangtianqiao branch joined them up in a “golf club”. Under the programme, they frequently invested in the products offered by the branch and in return, the bank paid for them to go on golfing trips domestically and overseas.

“We have bought the banks products for many years and none of the previous one had trouble,” said an investor surnamed Li. “Many other institutions peddle various products to me but I didn’t buy them because we trusted the [Minsheng] bank. We are not yield hunters.”

* * *

While there have been numerous allegations and warnings that China"s entire shadow banking facade, dominated by WMPs and other "investment products", is nothing but a giant ponzi scheme in which  recoveries - should there be a bank run (a topic recently discussed on Bloomberg) - would be non-existant if there is ever a bank run, defaults of WMPs issued by big banks – and this case an unapproved WMP – are rare. For now.

The Minsheng case involved an “innovative” WMP in which yields were amplified by purchasing a secondhand WMP. For a rough analogy, think CDO-squared products sold to retail investors.

According to investor contracts seen by the South China Morning Post, Minsheng’s private banking customers purchased transferred WMPs from the original investors. Bank employees told the buyers that the original investors urgently needed cash and were willing to cash out of the WMPs, which at the time were not yet due, and forego the supposed yields. As a result, the original WMPs that guaranteed principle and at least 4.2 per cent annual return “turned into” a product with more than 8 per cent annual return. Bank employees said the products were exclusively for longstanding private banking customers who owned at least 10 million yuan in financial assets.

How the fraud was uncovered: last week an investor happened to ask a friend who works at a bigger branch of Minsheng about the WMP at Hangtianqiao, but was told it didn’t exist. Officials at the Beijing branch of Minsheng subsequently reported Zhang Ying to the police, who then arrested her. By Thursday night all investors had become aware of the situation.

The 150 members of the so-called “golf club”gathered at the Hangtianqiao branch the next day demanding an explanation. They also visited the China Banking Regulatory Commission and its Beijing subsidiary, as well as the headquarters of Minsheng Bank, and the China Securities Regulatory Commission. However, no clear answers have been given to them to date.

Unfortunately for the 150 members of the "golf club", their money is long gone, and without any backstop or guarantee, their hope of recovering their funds is zero.

* * *

Ironically. the Minsheng case comes at a time when the Chinese banking regulator, the CBRC, has launched a crackdown on banks’ transgressions, including bank employees’ colluding with clients to forge unapproved lending programmes and sell them to investors. Last Monday, the China Banking Regulatory Commission issued risk management guidelines for lenders that included a section on WMPs. The regulator said the products should be simple and transparent, avoid excessive leverage and invest in distinct assets - rather than pooling funds with other WMPs.

And yet this is precisely what happened. As a result, what the CBRC will find as part of its inquiry, is sure to shock it. Meanwhile, as Bloomberg recently wrote in "China Is Playing a $9 Trillion Game of Chicken With Savers" the biggest risk for China"s financial system at this moment may be a wholesale run by investors on the "shadow banking" system, demanding their money back, as they would promptly find this money no longer exists. Indicatively, there is now over 30 trillion in total WMP assets in China, or over $4 trillion USD, nearly half of China"s GDP.

A few more cases of big bank fraud such as this one at Mingsheng, and said bank run may be inevitable.

As Mystery Of China's Multi-Billionaire Default Deepens, A New "Bond Scare" Emerges

Last week, in a largely "under the radar" event, one of China"s wealthiest billionaires (if only on paper), Wu Ruilin, chairman of the Guangdong based telecom company Cosun Group, and whose personal fortune of 98.2 billion yuan ($14 billion) makes him wealthier than Baidu founder Robin Li who is ranked 8th on the Hurun Rich List 2016, shocked Chinese bond market watchers when he defaulted on a paltry 100 million yuan ($14 million) in bonds sold to retail investors through an Alibaba-backed online wealth management platform, citing "tight cash flow."

Needless to say, many were stunned that a billionaire for whom $14 million is pocket change, blamed "tight cash flow" for defaulting on mom and pop investors. In any case, as South China Morning Post reported, despite the founder"s personal fortune, according to a notice put up by the Guangdong Equity Exchange on Tuesday, two subsidiaries of Cosun Group are each defaulting on seven batches of privately raised bonds they issued in 2014. According to the notice, “the issuer had sent over a notice on December 15, claiming not to be able to make the payments on the bonds on time, due to short-term capital crunch."

To be sure, yet another default in a Chinese landscape suddenly littered with bankrupting debt dominoes would have been the end of it, however this morning Reuters added to the mystery when it said that the fate of the defaulted $45 million Chinese corporate bond sold through an Alibaba-backed online wealth management platform was thrown into doubt on Monday, after a bank said letters of guarantee for the bonds were counterfeit.

Quoted by Reuters, China Guangfa Bank Co Ltd (CGB) said guarantee documents, official seals and personal seals presented by the insurer of the bonds "are all fake" and that it has reported the matter to the police.

The dispute highlights challenges in China"s loosely regulated online finance industry, where retail investors often buy high-yielding bonds and other assets, expecting them to be "risk-free" due to guarantees provided by various parties.

As first reported last Wednesday, at the center of the latest dispute are up to 312 million yuan ($45 million) worth of high-yielding bonds issued by southern Chinese phone maker Cosun Group that defaulted this month. The bonds were sold through Zhao Cai Bao, an online platform run by Ant Financial Services Group, the payment affiliate of e-commerce firm Alibaba Group Holding Ltd.

Ant Financial has asked Zheshang Property and Casualty Insurance Co Ltd, which wrote insurance on the bonds, to repay investors. On Sunday, Zheshang Insurance published two documents on its website that it said were from CGB carrying the bank"s official seals, and that guaranteed Zheshang Insurance policies for the Consun bonds. The letters were issued at CGB"s Huizhou branch in December 2014, when the Cosun bonds were sold, Zheshang Insurance said.

And yet, suggesting there is a massive landmine hiding just below the surface of China"s bond market, far worse than merely the consequences rising interest rates, on Monday, CGB said the documents were fake and that it had reported the incident to police as "suspected financial fraud."

While material misrepresentation of facts in Chinese finance is hardly new, the recent alleged violations usher in a whole new breed of fraud, one which is far less nuanced and far more simpllistic and includes outright forgeries of documents that backstop tens if not hundreds of billions in debt. The Cosun dispute follows similar instances of financial fraud this year including forged bond agreements that led to brokerage Sealand Securities sharing potential losses of up to $2.4 billion. In May, the government advised banks to be vigilant after several cases of bill fraud.

Ant Financial on Tuesday said Zheshang Insurance "hasn"t any reason to refuse repayment" which it was obliged to do "within three days" of default.

Making matters worse, the fraud has taken place in the context of a bond default that, according to an Ant Financial spokeswoman cited by Reuters, was a "a one in billions incident" on the platform.

Incidentally, Cosun"s bond issuance totals 1 billion yuan, according to Zheshang Insurance. The insurer"s total registered capital is 1.5 billion yuan.

Should more such "one in billions incidents" emerge, Chinese bond investors - already freaked out by the recent record plunge in Chinese govt bond futures, soaring overnight funding rates, and fears over Fed rate hikes - will rush for the exits just as China"s housing bubble is also popping as reported yesterday, leading to a rerun of the US 2006/2007 dual bursting of the housing/credit bubbles, only this time instead of an $8 trillion financial system, the world will have to backstop China... whose banking system at last check had over $30 trillion in liabilities.

Incidentally, we wonder if now that China"s bond insurers are also under the spotlight, if that means China"s very own MBIA/Ambac moments is imminent, as billions in bond insurance contracts are deemed "fake" by the insurers who would rather not pay up on what is set to be an avalanche of defaults.

* * *

Finally, for those interested in what Bloomberg last week dubbed the "latest China Finance Scare", namely outright forgeries in various debt products, mostly focusing on Entrusted Bonds, here is a useful primer courtesy of BBG:

There’s another Chinese financial practice that’s prompting high-decibel warnings. So-called entrusted bond holdings are a way for financial institutions to skirt rules on using borrowed money to invest in bonds. How? By getting a third party to buy the bonds and agreeing to purchase them at a later date. What could possibly go wrong? How about the worst rout in China’s bond market in a decade. That’s left regulators concerned about the prospect of investors failing to make good on such arrangements, estimated to involve at least $144 billion of bonds.

1. Why entrust us with this news only now?

Concerns about entrusted bond holdings have worsened the tumble in the debt market. Last week, Caixin cited market rumors when it reported a brokerage called Sealand Securities Co. had refused to take over bonds held by a counterparty. That got investors worried. Oversea-Chinese Banking Corp. then said in a note, citing media reports it didn’t identify, that the entrusted holding agreement may have been tied to alleged fraud by ex-staff. Sealand cleared the air when it said it would in fact fulfill the bond contracts that had been stamped with a forged seal. The whole incident was enough to frighten an already jittery market.

2. So why do investors use entrusted holding agreements?

Brokerages and other institutional investors ask counterparties to buy bonds from them when they need to circumvent internal rules on note holdings and leverage, according to Xu Hanfei, a bond analyst at Guotai Junan Securities Co. Or they can simply have third parties buy the notes directly from the market. The practice boosts leverage by effectively giving the financial institutions loans: As brokerages and institutional investors don’t carry the bonds on their books, they can use the funds freed up on paper to purchase more bonds, which can then be rolled into more such agreements. “Non-bank financial institutions, which emphasize returns, have more motivation to amplify leverage through entrusted holdings,” said Li Liuyang, a market analyst at Bank of Tokyo-Mitsubishi UFJ in Shanghai.

3. How widespread is the practice?

Outstanding entrusted holdings are "in the trillions of yuan," according to Guotai Junan’s Xu. That estimate is based on the bond holdings of the brokerages and smaller banks that are major participants in such transactions. That means the amount of money tied up in such deals is at least 5 percent of the 21 trillion yuan ($3 trillion) of outstanding corporate notes in China, according to data compiled by Bloomberg.

4. What broader risks does it pose to China’s financial markets?

A default in an entrusted holding could turn what otherwise might have been a problem with one company’s liquidity into a broader credit event, given that multiple parties may be involved, according to Li at Bank of Tokyo-Mitsubishi UFJ. Li says “everyone is worried about similar situations in their transactions with non-bank financial institutions.” OCBC said that things had got so bad that banks were reluctant to lend to non-bank institutions amid a breakdown in trust between investors.

5. What are regulators doing about it?

Authorities including the central bank and the China Securities Regulatory Commission are investigating some financial institutions’ entrusted bond holdings after the Sealand incident, people familiar with the matter said Tuesday. The holdings run contrary to the central bank’s push to trim investments made on borrowed money, according to China Merchants Bank Co. “It’s just a question of when Chinese regulators will clean up entrusted bond holdings,” said Liu Dongliang, a senior analyst at the bank. Tommy Xie, an economist in Singapore at OCBC, says China’s market rout may prompt regulators to strengthen rules on entrusted holdings. He describes them as "a common practice in the grey area of the bond market.”