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Why Hedging Credit Risk Is Getting Easier in China

Views of Shanghai's Financial District as Confusion Heightens Amid Push to Increase Private Credit
Photographer: Qilai Shen/Bloomberg

A record pace of bond defaults and increasing corporate-funding strains have spurred China’s regulators to re-energize efforts to provide investors with ways of hedging risk in the world’s third-largest debt market. While credit-default swaps, which allow traders to place bets on a company’s -- or a collection of companies’ -- creditworthiness have been around for decades in developed nations, such securities are rare in China. Regulators are now actively supporting financial contracts that let investors make bets on risk. The thinking: that might make them as a group more comfortable buying bonds.

Up until recent years, it didn’t. The country first started letting companies default on bonds in 2014. Regulators have come round to the idea that only by allowing insolvent borrowers go under can they achieve the objective of pricing credit on the basis of risk, rather than relationships -- which ultimately will limit the build-up of bad debt. What started as a trickle has become more of a steady stream: There has been some 75.6 billion yuan ($11 billion) in defaults this year. But now that defaults are becoming a regular feature of the landscape, investor appetite for bonds could be dented, and all the more so with the economy slowing. An active market for debt insurance could help sustain demand for the underlying bonds.