China Mainland opens up repo market to more offshore investors

In contrast, under an outright transfer repo, the repo party sells the underlying bonds outright to the reverse repo party for the purchase amount, and the parties agree that the Repo Party will repurchase the underlying bonds from the reverse repo party for the repurchase amount on an agreed future date. This is illustrated in the bilingual diagram below.

The pledged repo is by far the dominant form of repo transaction in the onshore market, accounting for over 95% of all onshore repos.[5] To facilitate the timely enforcement of pledges over the underlying bonds and the speedy recovery of claims, in recent years, onshore market infrastructure organisations such as China Central Depository and Clearing (CCDC) and Shanghai Clearing House (SCH) have published rules that are designed to facilitate and streamline self-help enforcement of pledges over CIBM bonds. 

B)    Onshore repo legal documentation 

Currently, participants in the CIBM repo market are required to use the NAFMII Master Bond Repurchase Agreement (NAFMII Master Repo Agreement) to document their repo transactions. The NAFMII Master Repo Agreement is published by the National Association of Financial Market Institutional Investors (NAFMII), a self-regulatory organisation approved by China Mainland’s State Council for the purpose of developing the CIBM. NAFMII has published a number of industry standard master agreements for documenting repos, other securities financing transactions (SFTs) and derivatives, including the NAFMII Master Agreement (for documenting derivatives), the NAFMII Master Repo Agreement and the NAFMII Master Bond Lending Agreement.

The NAFMII Master Repo Agreement is divided into five main parts. The first part sets out general provisions which are applicable to both pledged repos and outright transfer repos. To cater for the differences between pledged repos and outright transfer repos, the second and third parts of the NAFMII Master Repo Agreement include special provisions that apply to pledged repos and outright transfer repos respectively. The fourth and fifth parts of the NAFMII Master Repo Agreement contain the pledged repo supplement and outright transfer repo supplement to the NAFMII Master Repo Agreement, which are functionally analogous to Annex I (Supplemental Terms or Conditions) to the Global Master Repurchase Agreement (GMRA) published by the International Capital Markets Association (ICMA). The document structure of the NAFMII Master Repo Agreement is illustrated in the diagram below. 

While there are a number of conceptual similarities between the NAFMII Master Repo Agreement and the GMRA, there are also some key differences. For example, the GMRA only caters for outright transfer repos and is governed by English law. In contrast, the NAFMII Master Repo Agreement caters for both pledged repos and outright transfer repos and is governed by PRC law.

2.   Key takeaways from the PBOC and SAFE’s Consultative Document

We set out below, in the form of Q&As, some key takeaways from the Consultative Document. We have also prepared an unofficial English translation of the Consultative Document and accompanying explanatory statement, which is included at the end of this article. 

A)   Which new types of offshore investors will have access to the CIBM repo market?

Currently, only the following types of offshore investors can access the CIBM repo market:

• offshore sovereign entities such as central banks, monetary authorities and sovereign wealth funds;
• multilateral financial institutions; and
• offshore RMB clearing and participating banks.  

According to the Consultative Document, going forward, all offshore institutional investors that engage in cash bond transactions on the CIBM will have access to the CIBM repo market. This means that, in addition to the three existing categories of offshore entities that can access the CIBM repo market, all types of offshore financial institutions (such as commercial banks, insurance companies, securities companies, fund management companies, futures companies, trust companies and other asset management institutions) and medium and long-term institutional investors (such as pension funds, charitable funds and endowment funds) will be granted access as well. Article 10 of the Consultative Document clarifies that investors in Hong Kong, Macau Special Administrative Region and Taiwan are considered offshore investors.

Offshore investors that currently access the CIBM through CIBM Direct and the Qualified Foreign Institutional Investor and RMB Qualified Foreign Institutional Investor ((R)QFII) schemes already have onshore bond accounts at CCDC and/or SCH. Accordingly, the Consultative Document would naturally pave the way for these types of offshore investors to directly trade on the CIBM repo market. However, since offshore investors that access the CIBM through Northbound Trading under Bond Connect[6] do not have any onshore bond accounts or cash accounts, they may not be able to directly trade on the CIBM repo markets in the same manner as CIBM Direct investors and R(Q)FIIs. We explore this issue further in paragraph E below.

B)   Which repo master agreements can offshore investors use?

Article 7 of the Consultative Document provides that offshore institutional investors must sign a master bond repurchase agreement with their counterparties, and the relevant self-regulatory organisation(s) (explained below) must make a record filing of the master agreement with the PBOC. 

The Consultative Document does not provide details regarding which master repo agreements offshore investors can use to participate in the CIBM repo market. While there is little doubt that the NAFMII Master Repo Agreement will be permitted (since it is currently required to be used in the CIBM repo market), a key question on the minds of many offshore investors is whether they will be allowed to use the GMRA instead of the NAFMII Master Repo Agreement. The GMRA is widely used in the international market to document repos and is familiar to offshore investors. Allowing offshore investors to use the GMRA to document repos in the onshore market would also be consistent with the policy objective stated in the explanatory statement, which is to support the CIBM repo market’s convergence with international practices. 

In terms of the PBOC record filing requirement, we anticipate the term “relevant self-regulatory organisation” in Article 7 of the Consultative Document is intended to capture at least NAFMII. However, if offshore investors were allowed to use the GMRA to document their onshore repos, it remains to be seen whether NAFMII is the most appropriate entity to make a record filing or an offshore industry association should be recognised to make a record filing, since the GMRA is not published by NAFMII. The Consultative Document is also silent on whether the relevant self-regulatory organisation should file a template of a standard form master repo agreement or the actual master repo agreement (including any supplements or annexes) executed by the parties. The PBOC currently requires onshore CIBM repo market participants to make a record filing of the executed NAFMII Master Repo Agreement and any supplements with NAFMII. 

Offshore investors that would like to use the GMRA to document their onshore repos may wish to seek guidance from the PBOC and SAFE on these issues.  

C)   What does the Consultative Document say about pledged repos and outright transfer repos?

Article 2 of the Consultative Document defines “repo” as a transaction where the repo party “sells” the underlying bonds to the reverse repo party and both parties agree that the repo party will “buy back” the underlying bonds from the reverse repo party for an agreed price on a certain future date, and “includes pledged repos and outright transfer repos”. 

The Consultative Document’s definition of repo appears to describe an outright transfer repo that involves the actual sale and subsequent buy back of the underlying bonds, as opposed to a pledged repo which merely involves the creation of a security interest over the underlying bonds without transferring title. Accordingly, while the Consultative Document’s definition is consistent with the definitions of outright transfer repos previously published by the PBOC and NAFMII, it is different from the previously published definitions of pledged repos.[7] Curiously, however, the Consultative Document’s definition of repo ends with the phrase “includes pledged repos and outright transfer repos”, which suggests that the definition is purporting to describe both pledged repos and outright transfer repos. 

The explanation provided in the explanatory statement is that, in order to support the convergence of the CIBM repo market with international practices, the Consultative Document requires that when offshore institutional investors engage in repos on the CIBM, “whether in the form of pledged repos or outright transfer repos, they must effect the transfer of the underlying bonds to facilitate the disposal of the bonds by the reverse repo party (emphasis added)”. This statement appears to suggest that both pledged repos and outright transfer repos must involve a transfer arising from the sale and purchase (in Chinese: 买卖过户) of the underlying bonds. Besides a desire to align with international market practices (where outright transfer repos are prevalent), the PBOC and SAFE’s emphasis on actually transferring the underlying bonds could be designed to improve liquidity in the CIBM in order to facilitate the transmission of monetary policy through the financial markets.  

However, the current description of “repo repurchase business” in the Consultative Document  is different to how pledged repos currently work in the CIBM and how they are documented under the NAFMII Master Repo Agreement. It is also unclear how a pledge can be effectively created over the underlying bonds in favour of the pledgee if the bonds are transferred by the pledgor to the pledgee (to facilitate the usage of the bonds by the pledgee during the repo tenor), and how such pledge can be recognised as a valid security interest under the PRC Civil Code. 

While the overall policy objective of converging the CIBM repo market with international practices (including the prevalence of title transfer repos internationally) is a welcome move, how exactly a pledged repo involving a transfer of the underlying bonds can be effected and documented under PRC law remains to be seen, and further guidance and clarification from regulators on this issue may be helpful. 

D)   Is close-out netting in respect of outright transfer repos enforceable under PRC law?

The Consultative Document does not expressly address the issue of close-out netting in respect of outright transfer repos.[8] The PRC Futures and Derivatives Law (FDL) expressly recognises and confirms, at a national legislative level, the legal enforceability of close-out netting in respect of derivatives transactions.[9] However, repos and other SFTs fall outside the definition of derivatives under the FDL. Therefore, market participants will need to look elsewhere for the legal basis supporting the enforceability of close-out netting in respect of repos. 

In November 2021, the then China Banking and Insurance Regulatory Commission (CBIRC), which has since been replaced by the National Administration of Financial Regulation, published an important notice and accompanying Q&As (collectively, CBIRC Notice) regarding the enforceability of close-out netting under PRC law in respect of PRC financial institution counterparties. Although the CBIRC Notice does not have the same legal status as national legislation such as the FDL, the legal significance of the CBIRC Notice is that it reinforces and confirms the uniform position across the PRC government (including the PRC financial regulators, legislature and judiciary) regarding the enforceability of close-out netting under PRC law, both before and during bankruptcy proceedings. Specifically, the CBIRC Notice states that “both legislative and judicial bodies have expressed support for close-out netting.”

Significantly, the CBIRC Notice broadly defines “close-out netting” as a process for closing out “financial transactions” (in Chinese: 金融交易), a term which would cover derivatives transactions as well as other financial transactions such as repos, which are expressly mentioned in the CBIRC Notice. Therefore, the CBIRC Notice should provide market participants with substantial comfort regarding the legal enforceability of close-out netting, especially for repo transactions documented under an ISDA Master Agreement (using the ISDA SFT definitions and related SFT provisions), which is expressly recognised in the CBRIC Notice as a lawful and effective master netting agreement. Notably, the GMRA is not expressly mentioned in the CBIRC Notice. We understand that some industry bodies have asked the PRC government to expressly recognise the effectiveness of close-out netting under the GMRA at a PRC legislative or regulatory level. 

Title transfer arrangements used in outright transfer repos are legally effective and enforceable under PRC law and PRC courts are unlikely to recharacterise such arrangements as creating security interests. 

E)   What does the Consultative Document say about ‘Repo Connect’?

As mentioned above, since offshore investors accessing the CIBM through Northbound Trading under Bond Connect do not have onshore bond accounts, it is unclear how they will participate directly in the CIBM repo market. Building on the success of Bond Connect,[10] relevant onshore and offshore financial market infrastructure organisations are likely to establish an innovative market infrastructure linkage (which we shall unofficially call ‘Repo Connect’) to allow Bond Connect investors to directly access the CIBM bond market.

The Consultative Document lays down the groundwork for Repo Connect. The potential for Northbound Trading under Bond Connect to cover not only cash bond transactions but also repo transactions in the CIBM was contemplated as early as 2017, when Bond Connect was first launched. In a June 2017 Q&A on Bond Connect,[11] a PBOC spokesperson stated that Northbound Trading under Bond Connect will be gradually extended to cover bond repos, bond lending and other types of transactions. 

While the Consultative Document does not provide details on how Repo Connect will work, we  note Article 5 of the Consultative Document provides that offshore financial market infrastructure organisations and self-regulatory organisations which serve offshore investors in the CIBM repo market will be subject to the PBOC’s regulation – does this imply that Repo Connect may seek to leverage the existing offshore and onshore infrastructure linkages established under Bond Connect? Article 4 of the Consultative Document requires onshore market infrastructure organisations to formulate or revise their business and operating rules, and report to the PBOC. The very existence of these provisions in the Consultative Document suggests that both offshore and onshore market infrastructure organisations will play an important role in facilitating offshore investor access to the CIBM repo market, similar to the important role played by these organisations under Bond Connect. 

3.    Where can I find out more about the onshore repo market and related legal and documentation issues?

We at KWM are here to help you. KWM advised the China Foreign Exchange Trade System (CFETS) in connection with the establishment of Bond Connect and Swap Connect.

Our fully bilingual team of partners and lawyers regularly assist international and PRC-based financial institutions and corporates with GMRA, NAMFII and ISDA documentation negotiations, as well as with designing and documenting innovative and complex cross-border repo, securities lending and derivatives products. We also regularly advise international and PRC-based clients on regulatory requirements that apply to repos, securities lending and derivatives transactions.

In addition, KWM has been actively participating in legal developments relating to the enforceability of close-out netting, central clearing, as well as security and title transfer arrangements in the PRC. We are familiar with the unique issues faced by PRC-based financial institutions (including market infrastructure organisations) and their counterparties and would be pleased to share our insights with you. Please feel free to contact our core team members below.

*For purposes of this article, “Hong Kong” means “Hong Kong Special Administrative Region of the  People's Republic of China”, and “China”, “onshore” or “PRC” shall mean the People’s Republic of China excluding Hong Kong, Macau Special Administrative Region and Taiwan.