CHINA’S central bank has told commercial lenders to be more vigilant of risks linked to bonds issued in Shanghai’s free trade zone, people with knowledge of the matter said on Thursday (Jul 6), a fresh sign Beijing is tightening rules on local government borrowing.

The informal, or window, guidance sent to lenders by the People’s Bank of China (PBOC) in recent weeks covers a form of corporate debt that has been gaining popularity among China’s local government financing vehicles (LGFVs), two sources with direct knowledge of the matter said.

The sources said the guidance has asked banks to be more aware of purchasing the free trade zone (FTZ) bonds known as “pearl bonds” which are issued as foreign debt in the area.

China’s cash-strapped local governments have rushed to the unusual corner of the debt market in Shanghai since late last year where ambiguous rules offered ways to skirt restrictions on onshore borrowing.

Sales of the pearl bonds soared to a record 72 billion yuan (S$13.5 billion) in the first five months of the year, official data shows – nearly double last year’s total.

LGFVs accounted for about two-thirds of the issuers and 60 per cent of the debt sold nation-wide, according to Reuters’ calculations.

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However, there have been no FTZ bonds sold after Jun 16, according to official data.

“China’s FTZ bond market should ‘live up to its name’ and adhere to its offshore positioning,” the PBOC told Reuters.

“The FTZ bond market should develop in an orderly manner based on such supervision, and relevant entities should not engage in regulatory arbitrage or other violations,” it said.

A third source said LGFVs are now also required to get approvals to issue such pearl bonds, whereas no such requirements were needed in the past.

Authorities have also recently moved to shut a private funding route for LGFVs, according to planned new rules and people familiar with their aims.

Bloomberg News, citing unnamed sources, reported that Chinese banks have stopped buying bonds issued in the Shanghai free trade zone after regulators increased scrutiny. REUTERS