China Said to Allow Default Swap Trade in 1st as Bad Debts Rise

(Bloomberg) -- China’s central bank has approved trading of credit-default swaps by financial institutions in the nation’s interbank market, as it seeks to help investors tackle rising non-payment risks among the country’s borrowers, according to people familiar with the matter.

The National Association of Financial Market Institutional Investors, a unit under the People’s Bank of China, will likely make an announcement soon, the people said, asking not to be identified because the information isn’t public. This would be the first time the government is allowing CDS to be traded in China, said Xia Le, chief Asia economist in Hong Kong at Banco Bilbao Vizcaya Argentaria SA.

Chinese investors have called for tools to hedge credit risks after at least 18 local bonds missed payments this year, compared with seven for the whole of 2015. NAFMII had been considering starting trading of new versions of CDS products and held a meeting in Beijing in May at which some market participants voted to pass proposed rules, people familiar with the matter said around that time.

“To have CDS is a very good thing because so far there are no meaningful hedging tools in the domestic market yet,” said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shenzhen. “The market has high demand for such instruments. After the government allows this tool to trade, I believe it will be under less pressure to bail out many of the troubled companies.”

‘Positive Development’

There was no immediate response from NAFMII and the PBOC to faxed requests for comments.

Authorities issued rules on bond default hedging instruments called credit risk mitigation warrants in 2010, with NAFMII saying at the time that products must focus on specific underlying debt. Shi Lei, head of fixed-income research at Ping An Securities Co., said in June there was almost no trading of credit risk mitigation tools because the instruments are linked to single bonds of issuers.

“It is a positive development for China’s credit market to have a risk hedging tool," said Xia at Banco Bilbao Vizcaya Argentaria. "The problem is China doesn’t have a good variety of market participants yet. Now banks are the main players in the credit market so it’s likely the risks will still be within the banking system. But the good thing is the government can now allow more corporate failures.”

Reuters reported earlier that China is said to start CDS trade soon.