Last year China embraced one of the more controversial innovations in modern finance – the credit default swap. “Love them or loathe them,” WiC wrote at the time, “the CDS is coming to China.”
But eight months into the experiment, and reportedly just 31 ‘credit risk mitigation’ contracts have been created, covering a little over Rmb2 billion in debt. That’s a tiny sum, considering China’s bank assets are put at Rmb100 trillion.
“The gap between the expectations and the reality [of the CDS market’s growth] reflects a difference of opinion about the need [for CDS],” contends the 21CN Business Herald. “Neither the market, the investors, nor the regulators are really ready to embrace this novelty.”
Most significant: the banks (who are expected to create most of the liquidity) haven’t seen much upside in the trade. Since ‘naked’ speculation isn’t allowed, purchasers of CDS also have to own the underlying bonds, eating up precious capital. “It’s not very profitable for banks to invest in bonds with low credit ratings,” affirms Tian Jimin, a risk manager for the Agricultural Bank of China. 21CN also blames a lack of credible bond ratings and an underdeveloped bond market for scaring off investors. “It’s uncertain that the market can properly assess the risk of a bond and price the derivative accurately,” a high level source told the newspaper. But Bloomberg yesterday reported that regulators have plans to give CDS a renewed push, by allowing swaps contracts to be written on companies, in addition to their bonds.
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