July 20, 2018 / 12:36 PM / 5 months ago

China, sensing risks, moves to limit short-term bond funds

SHANGHAI (Reuters) - China’s securities watchdog is urging mutual fund managers to reduce the size of a type of short-term bond funds that have thrived on investors’ flight to safety, amid growing concerns of the quality of underlying assets.

FILE PHOTO: A China yuan note is seen in this illustration photo May 31, 2017. REUTERS/Thomas White/Illustration/File Photo

So-called cash-management bond funds nearly doubled in size in the first half of the year to roughly 700 billion yuan ($103.41 billion), after almost tripling in 2017, according to fund consultancy Z-Ben Advisors. A volatile stock market and Beijing’s crackdown on shadow banking were the catalysts.

Worried about a potential fund run in the event of investment losses, the China Securities Regulatory Commission (CSRC) this month urged fund houses to reduce the size of their cash-management bond funds by 20 percent every six months, according to a notice seen by Reuters.

In the notice, the CSRC also asked fund managers to take precautionary measures against liquidity risks, and adopt concrete steps to prevent investor “panic”.

At issue is the credit quality of the funds’ underlying assets.

Despite having the word “bond” in the product name, such funds - similar to money market funds (MMFs) - mainly invest in short-term debt instruments such as short-term bills and negotiable certificates of deposit (NCDs).

But in recent weeks several small lenders have had their credit ratings downgraded, raising red flags for mutual funds holding NCDs that may have been issued by such banks or other institutions that are potentially weak.

China has also seen a spike in corporate defaults this year, stirring worries about rising credit risks in money markets.

J.P. Morgan Asset Management, which runs MMFs in China via a local joint venture, cautioned that funds holding debts issued by weaker banks for higher yields would be exposed to liquidity challenges ahead.

In the past, “investors in China have been very complacent and very relaxed, assuming that the government will bail them out, and assuming that these funds are safe,” said Aidan Shevlin, J.P. Morgan’s Head of Portfolio Management for Global Liquidity.

But with the Chinese government now apparently trying to build a link between risk and returns, “for more sophisticated investors, when they become aware what a fund is holding...when issues by a particular bank is quite weak or have negative headlines, they may not want to own that fund anymore.”

Z-Ben Advisors agreed that mutual funds’ growing reliance on bank NCDs - the industry currently holds 2.5 trillion yuan of such debts - is potentially a major cause for concern.

Rising non-performing loans at smaller banks in China could see significant institutional redemptions at some funds, it said.

In an apparent effort to reduce credit risks, the CSRC in the notice urged cash-management bond funds to adjust their portfolios, and make sure that at least 80 percent of their assets were invested in bonds, which are typically debts with maturity of one year or longer.

Fund managers must submit their plans for corrective measures to the CSRC by the end of this month, and have a grace period until the end of 2020 to comply fully with the new requirements.

($1 = 6.7693 Chinese yuan renminbi)

Reporting by Samuel Shen and John Ruwitch; Editing by Shri Navaratnam

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