* Sealand Sec defaults on bond deal with bank - local media
* Brokerage says company seal forged by 2 former employees
* Scandal has exposed counterparty risk in debt market
(Adds quotes, more details)
SHANGHAI, Dec 20 China's securities regulator is
investigating the bond-related business of Sealand Securities
, the brokerage at the heart of a scandal that has
hurt sentiment in the country's wobbly debt market and threatens
to trigger further volatility.
Sealand Securities defaulted on a bond transaction with Bank
of Langfang, in China's northern Hebei province, following the
recent tumble in bond prices, local media reported last
Sealand Securities denied it the following day, saying it
had no agreement with the bank and its company seal had been
forged by two former employees. Bank of Langfang, in a statement
on its website, also dismissed the media reports as rumour.
In an exchange filing on Tuesday, Sealand said that the
Guangxi branch of the China Securities Regulatory Commission
(CSRC) sent out a special team to start on-site inspection on
Dec. 15. The brokerage said it would fully cooperate with the
The scandal has exposed the counterparty risk in the debt
market, which has seen bond prices tumbling and yields spiking
since late October, as Beijing steps up efforts to reduce
leverage in the banking system to prevent asset price bubbles.
The Sealand scandal could "trigger panic, and cause a
breakdown of trust" between lenders and non-bank financial
institutions, because the brokerage's response is seen as a
refusal to bear the losses, said Zhou Li, president at
bond-focused asset manager Rationalstone Investment.
If the incident is not settled properly it could result in
more selling, Zhou said. "I'm worried that the bond market has
witnessed just the first wave of sell-offs."
The scandal has thrown into the spotlight a
loosely-regulated type of bond agreement, a financing tool
similar to a repurchase agreement. Such deals are typically
backed by verbal promises rather than a formal agreement.
In a low-yield environment - China's 10-year government bond
yield fell from 3.5 percent in mid-2015 to a low of 2.6 percent
in August and October this year - entrusted agreements were
widely used by securities firms to obtain leverage for bond
transactions in order to meet guaranteed returns to investors.
But as Beijing started to tighten liquidity after China's
economy showed signs of stability during the third quarter, bond
prices began to collapse, finally exposing the counterparty
risks illustrated in the Sealand case, according to OCBC.
"This incident has clearly dampened market sentiment and
broke the trust between banks and smaller non-bank financial
institutions. It may take some time to repair the trust.
Therefore, we should still expect volatility ahead," OCBC
economist Tommy Xie wrote in a note late on Monday.
But the crisis may not worsen further as Chinese authorities
have enough ammunition to maintain relatively stable liquidity,
(Reporting by Samuel Shen and John Ruwitch; Editing by