Shanghai: China is adjusting rules concerning the use of borrowed money to buy certain bonds, prompting speculation authorities are signalling that they won’t tolerate overheating.

The new regulations from the China Securities Depository and Clearing Corp apply to exchange market investors who use existing noteholdings as collateral to borrow funds for new debt purchases, it said in a statement on its website Wednesday. CSDC may adjust the amount of borrowing that’s allowed in proportion to the face value of the debentures used as collateral, based on the number of holders of the pledged notes, their trading volume and the issuer credit profile, it said without giving more details.

“The rules mean CSDC will at first lower some bonds’ conversion ratios, especially those of lower-rated notes,” said Chen Kang, a debt analyst at SWS Research Co. While regulators, who have made stability their top priority, won’t allow the change to have a big market impact, it’s still “a message to investors: don’t be so crazy,” Chen said.

Chinese bonds had surged after investors shifted cash into debt following a plunge in equities from a June high. The falling yields encouraged fund managers who wanted to lock in higher rates to wade into notes with lower creditworthiness, even after at least six defaults in the onshore bond market this year. Issuance of onshore corporate debentures rated AA or below has surged, reaching an 18-month high of 132.5 billion yuan ($20.7 billion) in October, according to data from China Investment Securities Co.

Lower-rated notes

“We expect lower-rated bonds to be more affected by the new rules,” because authorities are likely to reduce the amount of borrowing backed by such securities, said Ji Weijie, credit analyst at China Securities Co. “Combined with more defaults, that could have wider implications on China’s bond market.”

While the exchange-traded note market that the rules apply to is dwarfed by the interbank bourse, it is growing more rapidly. Companies issued a record 866.7 billion yuan of exchange-traded securities this year, already more than three times all issuance in 2014, according to data compiled by Bloomberg. That compares with a 58 per cent increase in sales in the interbank market this year to 10.4 trillion yuan.

“It’s a government measure to prevent financial risk,” analysts led by Hua Chuang Securities Co.’s Qu Qing wrote in a report dated Thursday. “Defaults on lower-rated bonds’ principal, plus high leverage, would cause relatively high financial risks.”