To market participants and financial institutions in China’s bond markets, November 5 was a big day. It marked the first day of trading for new contracts that function in a very similar way to credit default swaps (CDS). As many may recall, CDS were blamed by some European and US officials as one of the key factors that worsened the global financial crisis. But this time, China seems to have a better plan.
The National Association of Financial Market Institutional Investors (NAFMII) emphasises that China’s CDS have two unique differences compared with Western ones. According to Secretary General of NAFMII, Shi Wenchao, the first is that if you are not a holder of the risk asset, you cannot hold the CDS as a diversification instrument. Chinese regulators also will place restrictions on the gearing ratio for the underlying risk assets.
The launch of CDS is definitely a significant breakthrough in the development of China’s bond market. However, a big challenge facing Chinese commercial banks, which are the major participants in the programme, is whether they can secure the right professionals for this new adventure.
NAFMII was formed in 2007 by the People’s Bank of China to develop the country’s OTC markets, including foreign exchange, bonds and commercial paper. During the past three years, NAFMII not only learned about CDS from its Western counterparts, but it also invested a substantial amount of time and effort cultivating domestic talent and attracting bankers from Hong Kong and Western countries to ensure the success of the new programme.
For example, NAFMII officials travelled to New York to meet firms including Citigroup and JP Morgan. After all the discussions, China realised that there were some problems with the Western CDS structure. That is also why China launched its own distinctive CDS programme.
Market chatter indicated that the CDS pilot project was forced to be delayed until now because some argued that China’s bond market is too immature to introduce CDS. Some traders in China also worried about the market liquidity for CDS, how to price them correctly, and which interest rate to choose from – LIBOR, SHIBOR etc.
Growing pains aside, China’s expanding economy will increasingly demand more complex derivatives to maintain and improve efficiency. As China’s bond market continues to mature, there will continue to be increasing opportunities for talented and experienced individuals in all areas of debt financing and risk management.