Reg­u­la­tor opts for cau­tion as credit de­fault swap trad­ing starts

China Daily (USA) - - BUSINESS - By LI XIANG lix­i­ang@chi­nadaily.com.cn

China started trad­ing in credit de­fault swaps this week, with an­a­lysts say­ing that it re­mains to be seen whether the new hedg­ing tool would help in­vestors deal with the ris­ing risk of cor­po­rate de­faults as the econ­omy slows down.

A to­tal of 15 CDS trans­ac­tions were con­ducted in the in­ter­bank mar­ket with to­tal 300 mil­lion yuan ($44.4 mil­lion) of no­tional prin­ci­pal on Mon­day, ac­cord­ing to a state­ment on the web­site of the Na­tional As­so­ci­a­tion of Fi­nan­cial Mar­ket In­sti­tu­tional In­vestors, a unit un­der the Peo­ple’s Bank of China.

Ten Chi­nese fi­nan­cial in­sti­tu­tions, in­clud­ing the coun­try’s four big­gest banks, par­tic­i­pated in the trad­ing of the first batch of CDS.

The trans­ac­tions cov­ered sec­tors in­clud­ing oil, elec­tric­ity, wa­ter, coal, telecom­mu­ni­ca­tions, food and avi­a­tion. The un­der­ly­ing as­sets for these CDS were bonds is­sued by com­pa­nies with an AAA rating.

In­dus­try an­a­lysts said that start­ing the CDS trad­ing with AAA-rated com­pa­nies shows the reg­u­la­tor has adopted a cau­tious ap­proach to test the mar­ket, in­tend­ing to en­sure a smooth in­tro­duc­tion of the riskhed ging tool.

“The CDS price of AAA-rated com­pa­nies will be sta­ble, which can help en­sure a sta­ble mar­ket,” said Liu Dongliang, a se­nior an­a­lyst at China Mer­chants Bank Co Ltd.

The Chi­nese reg­u­la­tor in Septem­ber ap­proved the trad­ing of CDS, a fi­nan­cial swap agree­ment that al­lows buy­ers of CDS to be com­pen­sated by the swap sell­ers in the event of a loan de­fault.

The move is seen as con­sis­tent with the gov­ern­ment’s in­ten­tion to in­crease the use of mar­ket forces to ad­dress China’s debt prob­lem, in­stead of re­sort­ing to a gov­ern­ment bailout when credit de­faults take place.

There has been a ris­ing demand by Chi­nese in­vestors to hedge the ris­ing risk of cor­po­rate fail­ure to re­pay debts, amid the eco­nomic slow­down.

No­mura Se­cu­ri­ties es­ti­mates that China’s non-fi­nan­cial sec­tor debt stood at 158.5 tril­lion yuan, or 231 per­cent of GDP by end of last year. A large share of the debt was owed by the cor­po­rate sec­tor, in par­tic­u­lar the State-owned en­ter­prises, while gov­ern­ment debt is rel­a­tively low.

“The in­tro­duc­tion of the CDS helps im­prove China’s fi­nan­cial mar­ket with greater abil­ity to price risk. We will in­evitably see more debt de­faults. So there is an ur­gent need in the mar­ket for such a tool,” said Zhao Yang, chief China econ­o­mist at No­mura Se­cu­ri­ties.

Or­derly de­faults, shift­ing the SOE debt to the gov­ern­ment and con­tin­u­ous fi­nan­cial re­forms will help ad­dress China’s debt prob­lem, Zhao said, adding that pol­icy has to head to­ward lower in­ter­est rates and a weaker cur­rency at the macroe­co­nomic level.

The in­tro­duc­tion of CDS helps im­prove China’s fi­nan­cial mar­ket with greater abil­ity to price risk.” Zhao Yang, chief China econ­o­mist at No­mura Se­cu­ri­ties

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