Critics of the Chinese bond market have long complained that it should be more like Wall Street. Western investors, global regulators and even the IMF and World Bank assume that debt markets everywhere need to provide easy liquidity and the kinds of short-term “repo” borrowing and derivatives that Americans use to finance and hedge their investments.
But this gospel of structural reform overstates the suitability of the US model for China and the rest of the world. According to a book edited by IMF staff, the Chinese bond market, the third largest in the world, unfairly shackles foreigners. They cannot do many things western investors take for granted, including borrowing against them via repo markets and betting that prices will fall. Nor can they count on local banks to make markets or serve as counterparties on bond futures.
Instead, the Chinese market’s structures work in favour of local institutions, which largely use bonds as collateral to finance interbank lending via their own version of the repo market. Trading in that market is 20 times higher than in the bond market. Instead of trading bonds, China “collateralises” them to fuel short-term borrowing.