China Construction Bank was one of the 10 financial institutions to take part in the credit default swap transactions. Photo: Reuters/Arnd Wiegmann
China Construction Bank was one of the 10 financial institutions to take part in the credit default swap transactions. Photo: Reuters/Arnd Wiegmann

Shield against debt defaults arrives in China

First credit default swaps carried out by 10 members of the interbank market as Beijing steps ups efforts to address the country's growing debt risks

November 2, 2016 12:11 PM (UTC+8)

China has launched its first credit default swaps, as an insurance for investors against bond defaults, marking another step in Beijing’s efforts to address the country’s growing debt risks.

Ten financial institutions conducted 15 credit default swap (CDS) transactions on October 31, the first such transactions in China’s interbank market, a Chinese bond supervisory body said on Tuesday.

The inaugural risk swaps were traded among 10 members of the interbank market — Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, China Construction Bank, Bank of Communications, China Minsheng Bank, Industrial Bank, China Zheshang Bank, Bank of Shanghai, and China Bond Insurance Corporation.

The 15 transactions totaled 300 million yuan (US$44.28 million) in nominal principal, the National Association of Financial Market Institutional Investors (NAFMII) said in a statement on its website. The contracts ranged between one to two years, it added.

A total of 14 financial institutions form the core group of interbank dealers for the new credit risk mitigation tool as approved by the association’s committee on financial derivatives.

“Tools like CDS and IRS (interest rate swaps) are important to development of capital markets in general and fixed income in particular. It is critical to driving bond market liquidity and it is a welcome development,” said Mark Austen, Hong Kong-based CEO of ASIFMA, a securities industry body.

Austen said the lesson to be learned from the experience of international markets is not to have derivatives markets overly complicated with the use of complex products.

China’s debt load has soared since the 2008/09 global financial crisis as companies borrowed heavily to sustain growth. As a result, corporate borrowings are now US$18 trillion or 169 percent of GDP.

The government has cautiously allowed some bond issuers to default since 2014, although doubts remain about how far Beijing is really willing to go when so many companies are state linked and when policymakers are highly sensitive to the risk of financial instability.

This is more likely to be a test of the new CDS scheme rather than concerns over credit risk.

NAFMII stopped short of naming the companies for which CDSs were traded this week, simply pointing out that they were from the petroleum and natural gas, power, water utilities, coal, telecommunications, food, and aviation sectors.

Ying Wang, Fitch’s senior director based in Shanghai, said the trading probably did not reflect worries about underlying creditworthiness of the firms.

“This is more likely to be a test of the new CDS scheme rather than concerns over credit risk. SOEs are usually the first batch of candidates to participate in new regulatory tools,” Wang said.

Widespread pricing distortions in China’s bond market mean risk premiums between higher- and lower-rated corporate bonds are narrow, which in turn makes it difficult to effectively price CDS, analysts said.

Credit differentiation in China’s US$7.5 trillion bond market has diminished as the pace of defaults has slowed. Goldman Sachs estimated there was only one default in the domestic Chinese bond market in the third quarter, compared with at least 10 in the first half of the year.

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