Securities Regulators Probe Sealand Over Disputed Bond Deal

(Beijing) — Chinese securities regulators have started an investigation into a disputed bond deal involving Sealand Securities after the firm defaulted on a bond transaction, causing a crisis of trust in the interbank market.

The Securities Association of China, a self-regulatory organization for the industry, convened a meeting on Tuesday night to address the disputed bond deals. Dozens of financial institutions involved in the deals attended the gathering, which was presided over by Li Chao, deputy chairman of the China Securities Regulatory Commission (CSRC), and lasted for nearly five hours.

Sealand said on Wednesday in a statement published on its website that it recognizes the bond trading agreements concerned, even though the main liability falls on two former employees who signed the deals. It said it will share the responsibility with all the parties involved.

The brokerage said it will pursue legal action against the two individuals who it says counterfeited company seals involved in the transaction. It is unclear whether the two former employees who allegedly used a counterfeit stamp to create the seals were working for Sealand at the time.

The firm was caught in the spotlight on Dec. 14 after rumors surfaced online that it was disavowing the ownership of bonds allegedly worth 10 billion yuan ($1.44 billion) on grounds that the stamp used for the purchases was fake. This left the bank that was temporarily holding the bonds for Sealand with a huge paper loss.

At least 22 commercial banks and securities firms have signed contracts with Sealand using seals that Sealand now claims are fake.

How much loss each party will have to bear is not clear at this time. But people who attended the meeting told Caixin that the regulators asked the securities firms not to sell the bonds they purchased from Sealand in the short term in order to provide Sealand some leeway to arrange compensation and to help the interbank market recover after the disruption that resulted from the scandal.

Proxy holding arrangements, which are similar to repurchase agreements, are not uncommon in the Chinese interbank market as a way to adjust balance sheets. But such deals are ill-regulated and rely heavily on mutual trust among parties, which often do not check the authenticity of company seals.

Initially, Sealand refused to admit fault and honor the transactions, but its counterparties demanded Sealand shoulder responsibility due to its inadequate internal controls.

The dispute has provoked a crisis of trust in the interbank market and has the potential to inflict heavy losses on the domestic bond market.

"It has dealt a blow to the bond market, which is already under pressure from tight liquidity," a bond fund manager said.

Contact reporter Dong Tongjian (tongjiandong@caixin.com)