Exclusive-China closes local government offshore financing loophole -sources

SHANGHAI (Reuters) -Chinese regulators have closed a regulatory loophole that last year allowed heavily indebted local government financing vehicles (LGFVs) to further increase their borrowing, four sources familiar with the matter told Reuters.

LGFVs, set up by Chinese local governments to fund infrastructure investment, have been told to stop issuing offshore bonds with a 364-day duration, the sources said.

Their combined debt has ballooned to roughly $9 trillion, posing a major risk to China’s slowing economy, and Beijing has rolled out several measures to reduce local government debt risks, with new issuance of LGFV debt now tightly regulated.

The latest guidance comes after a rush by many LGFVs to raise 364-day offshore bonds, seemingly in a bid to circumvent regulation that requires them to seek approval for borrowing outside China with maturities longer than a year.

China’s State Administration of Foreign Exchange (SAFE) said in a statement to Reuters it had not introduced new cross-border financing policies, adding that it will “actively cooperate with relevant departments to reduce LGFV risks, by strictly controlling new borrowings while dissolving outstanding debts”.

LGFVs have found onshore financing challenging, and they also have to seek approval from regulators such as the National Development and Reform Commission (NDRC) to issue offshore debt, unless the tenor of the bond is less than a year.

The NDRC published regulations on medium and long-term foreign debt in January 2023, but said offshore debt financing with maturities of less than one year did not need approval.

That led to 27 offshore LGFV bonds with a duration of 364 days being issued in 2023, most of them after October and with yields above 6%, data from TianFeng Securities showed.

“The issuance of 364-day offshore LGFV bonds has been stopped,” one source at a brokerage familiar with LGFV issuance said. “Such bonds were not regulated and were obviously contrary to the direction of government’s debt resolving efforts.”

Shandong Province issued the most 364-day bonds, with 12 issues that raised more than $1 billion.

“Such offshore bonds certainly came with risks. It’s not realistic that you can easily get double-digit yields on these bonds,” another source at a private fund said.

The NDRC did not immediately reply to requests for comment.

(Reporting by Shanghai Newsroom; Editing by Toby Chopra and Alexander Smith)