Investors are taking a new look at the government debt market amid signs that regulators are moving to close off funding avenues for opaque local government financing vehicles and promote a more transparent municipal bond market.

The China Securities Depository and Clearing Corporation, the nation’s clearing agency for exchanges, said on Dec 8 it will not allow bonds rated below AAA to be sold by issuers graded lower than AA, or to be used as collateral for short-term loans obtained through repurchase agreements.

The ruling sparked a retreat from lower-rated bonds and contributed to shares in Shanghai tumbling as note holders reassessed the appeal of owning such debt.

The CSDC is the clearing house for bonds that are traded on China’s exchanges, which account for less than 10 percent of all outstanding notes in the country.

There were 1.03 trillion yuan ($166 billion) of outstanding corporate bonds regulated by the National Development and Reform Commission and traded on exchanges as of Oct 31.

The move means about 470 billion yuan of outstanding debt can no longer be pledged for repos, according to Haitong Securities Co.

Although the affected number is relatively small, and the new rule is only being applied to the secondary market, CSDC’s move still affected the main market with yields of several bonds issued by the local government financing vehicles, or LGFVs, rallying more than 100 basis points on Tuesday and Wednesday.

“What the government is trying to do is repress the liquidity of riskier bonds, raise borrowing cost for lower-quality issuers and widen the yield differentiation among bonds,” said Xu Gao, chief economist with Everbright Securities.

In the short-term it is hoped that LGFV borrowing could be curbed but in the long run, Xu said, that would only happen if the government significantly boosted its on-budget spending, thus reducing incentives for local government to incur off-budget spending through LGFV financing.

Sun Binbin, a bond analyst with China Merchant Securities, said that the new AAA-or-nothing rule is not targeted at debt products issued by the local government financing vehicles, widely known as chengtou notes.

General corporate bonds that are usually given a lower rating were more affected, marginally improving the popularity of chengtou notes.

“But I would still suggest the price of chengtou notes is overvalued by investors as they blindly assume all of the notes were granted implicit guarantees from local governments,” Sun said. “This has nothing to do with the latest CDSC move as we held that view even before this move.”

In theory, the National Development and Reform Commission has banned local government guarantees, but what matters is how the market views the latest developments.

But investors still think chengtou note is a risk-free investment option, betting that local governments would never let them default, analysts said.

The government is trying to reverse that thinking by clarifying the boundaries between government credit and corporate credit. In a landmark document on October 2, the State Council clarified for the first time that LGFVs could not issue new government debt, and the central government would not bail them out.