NAFMII Bond Lending Master Agreement: the latest addition to Chinese interbank market
On 10 June 2022, the National Association of Financial Market Institutional Investors (“NAFMII”) published the China Interbank Market Bond Lending Master Agreement (2022) (the “Master Agreement”), which will be the market standard document for bond lending transactions concluded by market participants on the China Interbank Bond Market (“CIBM”).
- Introduction
Onshore banks have been using the CIBM trading platform operated by the China Foreign Exchange Trade System (“CFETS”) to conduct their bond lending transactions on the CIBM since 2006. Currently, offshore institutional investors can access the CIBM via different routes such as QFI, CIBM Direct and through the Bond Connect scheme. QFIs and CIBM Direct participants are permitted to carry out bond lending transactions on the CIBM. The publication of the Master Agreement by NAFMII will help to establish a uniform set of trading terms for market participants when conducting bond lending transactions on the CIBM. Offshore institutional investors will find that the Master Agreement contain contractual arrangements which are slightly different to those provided in the industry standard documents (such as the Global Master Securities Lending Agreement (GMSLA)) used in the international markets. We highlight below some of these differences.
Like the master agreement published by NAFMII for bond repurchase transactions, the Master Agreement is an “open agreement” which adopts a multilateral approach for execution by market participants. A market participant is required to file with NAFMII an executed copy of the Master Agreement post-execution and the Master Agreement will take effect between it and each other party who has executed the Master Agreement and completed the filing procedure with NAFMII in the same manner. Any supplemental agreement to the Master Agreement will have to be signed bilaterally between a pair of contractual parties although such supplement agreement is still required to be filed with NAFMII. - Features of the Master Agreement
The Master Agreement provides for “collateralised” bond lending in the CIBM. On the initial settlement date of a bond lending transaction, the bonds to be lent (the “Target Bonds”) are transferred from the lender’s bond account to the borrower’s bond account. The borrower is required to provide collateral in the form of cash or bonds by way of security interest or title transfer. On the final settlement date, the borrower shall return the Target Bonds and pay the lending fee to the lender, and the lender should return the collateral to the borrower or release the collateral from the security interest (as the case may be). The Master Agreement provides for a set of Special Terms for Pledged Lending where collateral is provided by way of security interest over bonds.
Market participants should note that the Master Agreement provides for a contractual arrangement whereby collateralisation of the bond lending transactions is done on a trade-by-trade basis (i.e. both the market exposure and the collateral value are calculated on a trade-by-trade basis). This is a significant difference from the practice adopted in the international securities lending market (as provided in industry documentation such as the GMSLA) where collateralisation is typically done on an aggregated basis unless the parties elect for trade-by-trade collateralisation. Despite being a “master agreement”, the Master Agreement does not contain a “single agreement” clause with respect to all the bond lending transactions entered into under the Master Agreement. There is also no “netting” of the exposures across the outstanding bond lending transactions. This approach seems to be a deliberate one taken in light of the recently-passed PRC Futures and Derivatives Law, which affords statutory protection to the single agreement and netting provisions in derivatives master agreements (but not for securities lending transactions).
Events of default provided in the Master Agreement include failure to pay, repudiation of agreement, misrepresentation and bankruptcy, which are of similar nature to the ones found in the GMSLA. In addition, the Master Agreement also includes certain types of events of default which are more akin to the ones included in the ISDA master agreement (such as merger without assumption, cross default and default under specified transactions). Interestingly, the Master Agreement provides for multiple remedies following an event of default: the non-defaulting party can choose to early terminate the transactions or to continue the transactions in which case the defaulting party shall pay default interest on a daily non-compounded basis at 0.02%.
If the event of default is a failure to pay, the Master Agreement provides that the non-defaulting party can elect to terminate the single defaulted transaction; for other types of events of default, the non-defaulting party can terminate all outstanding transactions. Settlement post-termination is done on a trade-by-trade basis, i.e., the return obligation with respect to the Target Bonds and the payment obligation with respect to the lending fee payment are accelerated, and the collateral shall be returned (or released from security). The Master Agreement provides that the non-defaulting party can also claim for compensation calculated on commercially reasonable standard in good faith.
A non-defaulting lender can also protect itself by enforcing the pledge over the collateral. With respect to collateral in the form of CIBM bonds, China Central Depository and Clearing Co., Ltd. (“CCDC”) and Shanghai Clearing House (“SCH”) are the two depository institutions. Since 2019, both CCDC and SCH have streamlined their processes to allow the secured creditor to unilaterally initiate enforcement (as a self-help remedy), and to achieve timely disposal of the collateral securities by way of public auction or private sale.
The publication by NAFMII of the Master Agreement is very much to be welcomed by the market as it will provide a standardised approach to how market participants conduct bond lending transactions in the CIBM.
