(Bloomberg) -- China has taken another step to limit domestic investors’ exposure to offshore debt issued by local government financing vehicles, according to people familiar with the matter.

The National Association of Financial Market Institutional Investors, the country’s interbank market watchdog better known as NAFMII, has halted registration of new credit-linked notes, a derivatives product, that use offshore LGFV debt as underlying assets, said the people who requested anonymity for discussing private information.

While the NAFMII earlier this month told some brokerages who are major issuers of CLNs that the suspension is temporary, it didn’t indicate when it may be lifted, the people added.

A media representative from NAFMII didn’t immediately respond to Bloomberg’s emailed request seeking comment. 

The decision marks Beijing’s latest effort to rein in risks from a sector long considered a financial time bomb, with local government finances now under greater strain amid an unprecedented property slump. 

It follows similar measures in recent months, including regulatory scrutiny of offshore holdings of LGFV debt at Hong Kong-based Chinese financial institutions and an instruction for some lenders to limit their use of a repayment-support mechanism backing LGFVs’ offshore debt sales.

Launched in 2016, CLNs were originally designed as a derivative instrument to help bond holders or loan issuers mitigate risks. However, the product has since morphed into a tool that offers indirect exposure to the underlying assets for other investors. 

In the case of CLNs backed by LGFVs’ offshore bonds, they have become popular among local investors who use them as a way to bypass China’s cross-border capital controls to seek higher returns as onshore yields fell to record lows.

In 2023, six financial institutions, including banks and securities firms, launched 26 CLNs with combined nominal principal of 2.3 billion yuan ($317 million) via private placements, according to a February NAFMII report.

--With assistance from Shuiyu Jing.

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