China has launched its first credit default swaps in spite of opposition from some senior regulatory officials who have urged caution because of the role such products played in the global financial crisis.
On Friday – the first day of the new pilot project – nine financial institutions, including Deutsche Bank, Industrial and Commercial Bank of China and China Construction Bank, conducted 20 trades involving a total of Rmb1.84bn ($276.3m) of derivatives.
Beijing has picked 17 institutions, including all of China’s largest banks as well as HSBC, Citigroup, BNP Paribas and Barclays to write contracts and trade in the new market, which is expected to grow slowly, at least in its early stages.
The decision to launch the new products follows a prolonged power struggle in which proponents of greater financial innovation, led by the central bank, faced off against more cautious officials, led by the banking regulator.
The National Association of Financial Market Institutional Investors (Nafmii), which was set up under the central bank to help regulate the interbank market, has been lobbying hard for more than a year, arguing that credit derivatives are important for the development of a mature debt market.
China’s banking regulator, already facing mounting risks in the financial sector following an unprecedented credit boom, is worried about allowing banks to dabble in the complex products that many observers blame for exacerbating the financial crisis in the west.
Credit default swaps, a kind of insurance policy against a bond defaulting, are barely regulated in most markets and critics say that speculators use them to profit from the problems of companies and governments.
In China, the new products have been given the benign-sounding name of “credit risk mitigation tools” rather than the more risky “credit default swaps” and Nafmii has designed the market so it can maintain strict control.
Only large, approved financial institutions will be allowed to conduct trades and only when they own the underlying bonds or loans, a rule aimed at curbing the speculation that has been criticised in other markets.
Nafmii has argued that China’s rapidly growing bond market, which is already valued at about Rmb3,300bn, is in urgent need of hedging instruments that will allow for faster growth in nascent corporate debt issuance.
"Developed markets like Europe and the US showed that the main problem [with credit derivatives] is blind innovation and a lack of regulation,” Shi Wenzhao, the secretary-general of Nafmii said in comments released this week. “[In China] market participants have found it very hard to effectively hedge credit risk. They have been swimming naked in a huge bond market and we can imagine their desire for a well-fitting lifejacket.”
The new products cannot be used to insure high-risk securities and will only be sold through the Shanghai interbank clearing system, which is regulated by Nafmii.
The value of the swaps cannot exceed five times the value of the underlying bond or loan.
