Deep losses, scandal face bond dealer

Firm says it is willing to take responsibility and its total credit risk position is under control

China's top securities watchdog said on Friday that it will step up scrutiny of the internal controls and risk management of the country's investment banks, after a Shenzhen-listed securities firm said it is facing heavy losses in a bond financing scandal.

The regulator's comment came after the Shenzhen-listed Sealand Securities Co was involved in leveraged bond financing deals totaling 16.5 billion yuan ($2.4 billion) that have exposed the company to a huge potential loss.

"We will urge Sealand Securities and other relevant parties to carry out solutions to address the risk and will supervise the investment banks to strengthen their internal controls in order to ensure that their practices are integrated and legal," said Zhang Xiaojun, spokesman of the China Securities Regulatory Commission at a news conference.

More than 20 financial institutions, which are trading counterparties in the bond financing deals with Sealand Securities, have demanded that the company honor trading contracts drafted by former employees who allegedly forged the company's official seal.

The scandal highlighted the rising risk of rampant leveraged trading in China's bond market. Bond prices have fallen sharply after the US Federal Reserve raised the interest rates last week and indicated a faster-than-expected pace of monetary tightening.

Sealand Securities had been trading bonds through a leveraged transaction structure, known as a proxy holding arrangement.

Similar to a repurchase agreement, the trading structure allowed Sealand Securities to borrow money from various lenders to trade bonds and the lenders have been holding the securities on behalf of the bank in return for a fee. The recent sharp correction of the bond market prompted these lenders to demand their money back, triggering a squeeze on the securities firm.

Sealand Securities claimed that the bond financing contracts were fake documents forged by two former employees who are currently under investigation.

But, the firm said that it is willing to take the responsibility and its overall credit risk is under control as 80 percent of securities involved in the deals are highly liquid treasury bonds.

On Friday, the benchmark Shanghai Composite Index declined 0.94 percent to 3110.15 at the close.