Pledge-style Repo Transactions Hit Record High of 5.3 Trillion Yuan Heightening Leveraged Arbitrage Concerns

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Financial institutions are taking advantage of the flood of liquidity unleashed by China in the wake of the COVID-19 outbreak to engage in leveraged arbitrage on the bond market, driving transactions of renminbi pledge-style repos on the interbank market to unprecedented heights.

Figures from financial data provider Wind indicate that since the start of April the daily average transaction volume for interbank pledge-style repos has reached 4.8 trillion yuan, for a rise of 700 billion yuan compared to the previous month.

On 7 April the daily transaction level rose to 5.3 trillion yuan for a record high.

Renminbi bond pledge-style repos are short-term financing transactions involving the use of bonds as pledges, whose trading amount is calculated based on a discount rate for the pledged bonds.

Members of industry impute the surge on pledge-style repo transactions on the interbank market to the wave of liquidity unleashed by China to deal with the economic fallout of the COVID-19 pandemic, which has created key arbitrage opportunities.

“At present funds are loose, yields on bonds are low, and adding leverage for arbitrage purposes is the strategy of many institutions,” said one trader as a major brokerage in Beijing.

The surge in transaction levels is believed to reflect a rise in leveraged arbitrage on the bond market.

Leveraged arbitrage by financial institutions in China involves borrowing low-cost overnight funds to invest in longer-term bonds, primarily via interbank pledge-style repo transactions.

Since the second half of 2018 looser funds drove a slight rise in bond market leverage, with interbank market pledge-style repos remaining stable at around 3 – 3.5 trillion yuan in daily transactions.

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