July 27, China is expected to launch its first credit default swap (CDS) products this year, said Shi Wenchao, secretary general of the National Association of Financial Market Institutional Investors (NAFMII).
According to a source from the NAFMII, the CDS pilot project will be a type of credit risk mitigation (CRM) contract or obligation, and will also include CRM Letters.
A CDS is a swap contract in which the protection buyer of the CDS makes a series of premium payments to the protection seller and, in exchange, receives a payoff if a credit instrument (typically a bond or loan) goes into default.
China has started a test run of the product under the name Optional CBIC 1, which contains a CRM contract and a CRM letter. Investors only have the option to buy a CRM letter or a full set of Optional CBIC 1. CRM contracts cannot be traded separately.
The product was designed by China Bond Insurance Co. Ltd. (CBIC) and issued to Chongqing Chemical & Pharmaceutical Holding Group Co. on July 13. Industrial Bank Co. Ltd. (601166.SH) underwrote the deal.
The Optional CBIC 1 has a value of RMB 600 million and a maturity of five years. The product consists of RMB 300 million worth of CRM letters, which have a credit rating of AA+, and another RMB 300 million worth of bounded CRM contracts and letters with an AAA rating.
“If CRM contracts could be peeled off for separate trading, the CRM would be very similar to CDS products,” a CBIC source said.
With the development of China's bond market, the People’s Bank of China (PBoC) and other regulatory bodies, including the China Banking Regulatory Commission (CBRC) and NAFMII, have been studying the feasibility of developing a credit derivatives market to hedge and mitigate credit risks, in response to market needs.
In the first half of this year, corporate debenture issues on China's interbank bond market totaled RMB 780 billion, and the debenture bonds under custody hit RMB 3 trillion by the end of June, according to CBRC statistics.
The government had been forced to postpone its CDS pilot project in the past due to disagreements between regulators, some of whom argued that the country’s bond market was too immature and under-developed to introduce complex credit derivatives.
Analysts reckoned the launch of CDS products may imply a significant breakthrough in the development of China's bond market and remarked that commercial banks would be the major participants in the market.
Local media reported that the PBoC and the CBRC have worked out a series of measures to regulate over-the-counter financial derivatives, and will implement a regulatory framework for the launch of Chinese CDS products.
