All is far from well in the Chinese bond market. And the implications for blockchain technology are deep.
December was not a good month for bond traders. As if the deep slump in bond prices after the US Fed raised rates wasn’t enough, the market was also shaken by two major incidents of fraud.
In one case, the forgery involved papers in which a bank guaranteed a bond that subsequently defaulted. The bank said “not my problem” and refused to honor that guarantee.
In another case, it emerged that two rogue employees of a trading house called Sealand Securities had used a forged company seal to purchase, on behalf of other financial institutions, over 16 billion RMB (almost $2.4bn) worth of bonds. You read that right, “billion”. The bond prices fell, and someone had to make up the loss. Sealand said “not my problem”, the blame lay with the perpetrators, and why not, also with the correspondent financial institutions who “should have checked”.
In the end, Sealand agreed to honour the bond contracts, but the fright did not help market jitters. At least 29 bonds defaulted in 2016, up from 7 the year before. Over 117 billion RMB of sales were canceled or postponed in December, almost four times the amount in November. A government bond index fell 1.7% in December, the steepest monthly decline since October 2013. And with interest rates heading higher and economic difficulties ahead as leverage is reigned in and global trade becomes more, um, complicated, it looks like defaults will continue to increase in 2017.
Tighter regulation and controls could help to calm fears that fraud is making the system more vulnerable. Local media has reported that the government is contemplating the creation of a regulatory body just to focus on systemic risks.
Or, financial institutions could step up their investigations of blockchain technology applications.
On the blockchain, transactions cannot be tampered with, and fraudulent use of signing keys is instantly visible to network participants. An unalterable ledger of events would make accountability more transparent, authorizations can be more tightly controlled, and the falsification of ownership documents ceases to be an issue.
In other words, with financial settlement supported by blockchain technology, fraud would be much more complicated. The incentive would not just be for corporations. With enhanced transparency, government officials would be under greater pressure to clamp down on irregularities, especially given President Xi Jinping’s anti-corruption drive.
China’s financial institutions, tech enterprises, universities and startup community are active in blockchain innovation. The central bank recently announced that it was testing a blockchain-backed digital currency, with a view to using the platform for bank bill transactions.
The government, perhaps aware of the need for speed, is encouraging blockchain research and adoption. In October, the Ministry of Industry and Information released a white paper that explored blockchain applications, particularly in finance, and encouraged businesses to be more active in global experimentation. The same month, the government hosted a forum aimed at fostering cooperation in blockchain development.
Given the obvious need for a lasting solution, we can expect these efforts to intensify over the next few months. But will it be fast enough?
While blockchain-based solutions could restore confidence in the integrity of the bond market and open up channels of financing to a broader range of businesses, it is unlikely that any would be ready for the market in the short term.
The situation is verging on urgent, though, as a rapid build-up of leverage has made firms increasingly vulnerable to an economic downturn or even to a change in market sentiment. A looming trade war with the US, or even military conflict in the South China Seas, could be enough to trigger a string of defaults, which are likely to uncover even more fraud and misappropriated leverage.
The damage could be harsh, in an environment that would already be suffering from economic and geopolitical factors.