China Starts Credit-Default Swap Trading as Bond Failures Spread

  • Industrial Bank and Bank of China conducted CDS transactions
  • Authorities seeking protection for investors as defaults rise

Faced with mounting bond failures, China has started trading of credit-default swaps on the nation’s interbank market.

Trading began Monday, according to a statement on the website of the National Association of Financial Market Institutional Investors, a unit under the nation’s central bank. Industrial Bank Co. and Bank of China Ltd. were among the institutions to conduct transactions, using China United Network Communications Ltd.’s bonds as underlying debt, said a person familiar with the matter, asking not to be identified because the authorities haven’t disclosed the information.

The swaps, which provide insurance against nonpayment on bonds, can help investors hedge against credit risks after 21 securities defaulted this year, compared with only seven in 2015. There is room for failures to rise after Premier Li Keqiang pledged to weed out zombie companies even after the economy grew at the lowest pace in a quarter century. The start of trading comes after people close to the matter said in September that the People’s Bank of China had approved CDS trading by financial institutions on the interbank market.

“CDS can help investors to hedge risks, but currently the issuers are mainly large institutions and it’s hard to expand, because the market trusts the big ones," said David Qu, Shanghai-based markets economist at Australia & New Zealand Banking Group Ltd. “The market has just kicked off, so both issuers and investors are cautious."

Gradual Approach

Bank of Shanghai Co. and Bank of Communications Co. also completed a deal on Monday, people familiar with the matter said, asking not to be identified because the authorities haven’t disclosed the information. The underlying securities for that deal were bonds issued by China Petroleum and Chemical Corp., or Sinopec, said another person.

Both China Unicom and Sinopec’s bonds are rated AAA onshore.

“It is natural that the assets are rated AAA in the early stage of CDS," said Li Ning, general manager of the fixed-income department in Beijing at Western Securities Co. “And in the future it might be difficult for assets with lower ratings to be traded in CDS markets as suppliers aren’t that willing to do so."

China has taken a careful approach with the derivatives, after they played a role in the global financial crisis. 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 those tools because the instruments are linked to single bonds of issuers.

In the trading Monday, ten institutions including China’s four biggest banks conducted 15 CDS deals with a combined 300 million yuan ($44 million) of notional principal, according to the NAFMII statement.

A public relations official at Industrial Bank said the bank had no immediate comment. Two calls to Bank of China’s press office went unanswered. A public relations official at Bank of Shanghai said the bank had no immediate comment. A press official at Bank of Communications couldn’t immediately comment.

— With assistance by Xize Kang, Shuqin Ding, and Judy Chen

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