Unexpected! Investment in "Nanshangtong" city investment trust debt has been halted. The rapid surge in investment in city trust debt this year has approached nearly 700 billion.

As we are paying off debts, we are also adding new high-interest debts, apparently this cannot be tolerated by regulators. Recently, there have been rumors in the market that investments in local government bonds through cross-border income swaps (TRS) have been suspended by relevant authorities. Several insiders have confirmed this to the financial media, stating that under the southbound channel, investment institutions are only allowed to reduce their holdings of local government bonds and are not allowed to purchase new ones. "The prices of local government bonds are getting higher and higher, with the overall yield reaching more than 10%, mostly around 15%. This indicates that the financing costs of local governments are very high." The scale of local government bonds has soared this year. According to the financial media's analysis, the overall issuance of local government bonds has reached nearly 700 billion yuan this year, an increase of 174.35% compared to the same period last year. Insiders believe that local government bonds account for a significant portion of this increase (about 40%), but the specific amount is unknown. With the promotion of a new round of debt reduction policies, the potential risks of high-interest financing through local government bonds are emerging. Under regulatory guidance, the issuance pace of local government bonds may face a certain degree of cooling down, and the future of cross-border investments in foreign bonds will face further regulation. High-interest financing through local government bonds has been criticized, and the "southbound channel" has been suspended Regulators have been paying close attention to the investment of cross-border funds in local government bonds in recent years. According to previous reports by the financial media, regulatory authorities have begun to review the situation of Chinese financial institutions holding local government financing tools in US dollars this year, focusing on bonds with maturities of one year or less, which may also involve issues related to anti-money laundering and equity financing, and may pose risks associated with misdirection of funds due to the fact that funds do not actually leave the country. According to information from private equity fund channels, investment in local government bonds through the securities channel has required transparency at the underlying level, with no involvement of legal entities, and only private equity fund products are permitted to be purchased. Many institutions have been seeking funds to package products to meet the requirements of the channel, and the threshold for product sizes is getting higher and higher, with some private equity professionals revealing, "In order for institutions to get involved, at least 50 million must be involved in overseas income swaps." However, following recent regulatory requirements, under the "southbound channel," investment institutions are only allowed to reduce their holdings of local government bonds and are not allowed to purchase new ones. This has once again put the cross-border income swaps business in the spotlight. Several insiders have told the financial media that the suspension of cross-border funds was inevitable after the investigation work, it just came sooner than expected. Given the situation since the beginning of the year, several securities firms that have cross-border TRS qualifications were instructed to limit their investment balance to the end of January and prohibit new cross-border TRS investments, although this was aimed at US dollar bonds. As US dollar bond issuances have declined, local government bonds have expanded rapidly. At present, TRS investments in US dollar bonds have gradually slowed down, and regulatory focus is gradually shifting towards local government bonds. According to data from Wind as of November 18, the overall issuance scale of local government bonds has reached 686.85 billion yuan this year, an increase of 174.35% compared to the same period last year when the issuance scale was 250.26 billion yuan. About 40% of these issuances are related to local government bonds, while according to iFinD data, US dollar local government bond issuances during the same period this year were only 23.011 billion US dollars. A research analyst at a securities firm stated that this year the issuance costs of local government bonds have increased, while the costs of US dollar bonds have decreased. The average issuance coupon rates of the two have gradually converged. In terms of use of funds raised, local government bonds are more flexible, mainly for project construction and supplementing operational funds, while US dollar bonds are mostly used to repay old debts with new ones. In the analyst's view, the rapid expansion of local government bonds, combined with high issuance costs and more flexible use of funds, suggests that potential risks are gradually brewing. A proprietary trader at a securities firm stated to the financial media that the suspension of financing under the southbound channel is a way to plug the leak in local government's overseas financing under the debt reduction policy, "They will not allow paying off debts while adding new high-interest debts." This high-interest financing is essentially operational debt and is not included in this round of "hidden debt-to-debt" list, requiring local governments to address this issue themselves. They are forced to turn to overseas high-interest financing as a last resort, and the prices of local government bonds are rising, with overall yields over 10%, mostly reaching around 15%, making them no different from non-standard debts. Under the debt reduction policy, the issuance scale of high-interest local government bonds may be affected The temporary halt in the incremental scale of cross-border income swaps (TRS) will once again deprive domestic mainstream high-yield bond investment institutions of an important product category. Although the current suspension of TRS is mainly directed at the TRS model of overseas local government bonds (while the QDII model is unaffected), investments in US stocks and other targets will continue smoothly, but it may still affect the business planning and arrangements of investment institutions. According to information from bond traders, aside from TRS, the credit-linked notes (CLN) business using the southbound channel quota has also been temporarily suspended. "CLN is directly tied to credit default risks, and under regulatory requirements, the issuance of local government bonds may be affected, and the credit risk of the issuers may need to be reassessed." It is understood that since CITIC SEC first received approval from the China Securities Regulatory Commission to conduct pilot cross-border business in 2014, a total of 10 securities firms, including CITIC, Haitong, CICC, Guotai Junan, Huatai, GF, Ping An, and Galaxy, have received no objections from the CSRC regarding the pilot cross-border business. At the same time, the regulations stipulate that the scale of cross-border business must not exceed 20% of the net capital of securities firms, and the business scale should be calculated based on the investment scale of similar domestic businesses specified in the "Regulations on Risk Control Indicators for Securities Companies," and risk capital reserves should be calculated strictly in accordance with regulatory requirements. A portfolio manager at a securities firm stated that currently, the counterparties in cross-border income swaps business for domestic institutions are mainly the proprietary teams of a few top brokerage firms, "They have a large volume, and their available quotas may also be abundant." Under the TRS model, domestic securities firms generally conduct their offshore bond asset allocations through their Hong Kong subsidiaries, while foreign banks' domestic branches do the same through their Hong Kong branches. "If the TRS channel is temporarily suspended, these securities firms may have to resort to financing abroad for debt allocations and may no longer be able to engage in cross-border activities," the portfolio manager added. According to industry insiders, the temporary halt of TRS is due to the high issuance of overseas local government US dollar bonds, which has caused the risk for domestic local government entities to increase. Therefore, the credit risk of the issuing entities may need to be re-evaluated. In addition to the pressure of capital, it may also be related to the recent increase in exchange rate volatility and the narrowing of the arbitrage space for offshore bonds. "Due to the depreciation of the RMB, the growth of the QDII quota, another compliant offshore capital outflow channel, has been slow this year. TRS is the only exchange rate risk for securities firms, which is also increasing," industry insiders pointed out. As the cost of issuing offshore bonds for local government financing vehicles continues to rise, the average coupon rate for urban investment bonds this year has reached 5.8%, which is about 300 basis points higher than the average coupon cost of national urban investment bonds. Some small and medium-sized private equity funds are engaging in risk-free cross-border arbitrage, which has also increased the difficulty of issuing corporate bonds overall.According to reports, the recent 10 trillion yuan debt swap launched by the Ministry of Finance includes increasing the limit on local government debt by 6 trillion yuan, with a three-year plan to replace existing hidden debts, and arranging 800 billion yuan annually from new local government special bonds for five consecutive years to replace 4 trillion yuan of hidden debts. In the view of industry insiders, with the US dollar starting to lower interest rates, there is a possibility that cross-border TRS under debt conversion policies may resume after a temporary suspension, but the likelihood of a full recovery is not high, especially for private equity funds investing in bonds. It is still under high pressure. In addition, there may be a significant increase in the threshold for institutional access and product access in the future, with small institutions and products, especially small private equity funds, potentially being rejected. This article is reprinted from "CaiLian News", GMTEight Editor: Liu Jiayin.