Change in loan policy spurs rate swaps to new highs

China's interest-rate swaps climbed to a three-month high and bonds dropped after a policy change narrowed the pool of corporate debt that can be used as collateral for short-term loans.

China Securities Depository and Clearing Corp stopped accepting new applications for repurchase agreements that involve notes rated below AAA or sold by issuers graded lower than AA, according to a statement posted on the agency's website on Monday.

The move means that about 470 billion yuan ($76 billion) of outstanding corporate bonds that are regulated by the National Development and Reform Commission, the top economic planner, can no longer be pledged for repos, according to Haitong Securities Co.

"The regulation will damp investor demand for lower-rated corporate bonds," said Yang Feng, an analyst at CITIC Securities Co, the nation's biggest brokerage. "That may result in higher borrowing costs for local government financing vehicles."

One-year interest-rate swaps, the fixed payment to receive the floating seven-day repurchase rate, rose 2 basis points to 3.355 percent in Shanghai, according to data compiled by Bloomberg. The interest rate swaps jumped as much as 29 basis points earlier to 3.67 percent, the highest since August.

The yield on Kashi Urban Construction Investment Group Co's 800 million yuan of debt due November 2019 climbed 75 bps to 7.17 percent, the biggest jump since July, exchange data show. The issuer is an local government financing vehicle.

"As low-rated bonds cannot be used for repurchases on the exchange, this will force many financial institutions to deleverage," said Zhou Hao, a Shanghai-based economist at Australia & New Zealand Banking Corp. "When there's a liquidity issue, all bonds are sold off."

The yield on government debt due October 2019 surged 14 bps, the most for a five-year note since November 2013, to 3.88 percent, according to prices from the National Interbank Funding Center.

The seven-day repo rate, a gauge of interbank funding availability, fell 9 bps to 3.39 percent, a weighted average compiled by the National Interbank Funding Center showed.

The People's Bank of China did not conduct repurchase or reverse repurchase auctions on Tuesday, according to traders at primary dealers required to bid at the auctions.