Credit default swaps booming in China

Trading in mainland sovereign credit default swaps has more than doubled in the past year as fears over slowing growth and rising corporate defaults in the world's second-largest economy have helped transform the contract into the go-to Asia hedge for macro investors.

The net notional outstanding in China CDS now stands at US$14.1 billion according to DTCC, a leap of 109 per cent compared to a year ago. The country is now the third largest single-name CDS contract in the world by net notional, despite having only a handful of small outstanding bond issues.

The mainland's lack of external debt has led some investors to dismiss the CDS as a purely speculative instrument, highlighting that it is unlikely to provide any default protection.

But this has not prevented the contract from building a critical mass of liquidity, as global managers such as bond behemoth Pimco have become more active in the contract amid rising fears over an economic slowdown, property bubble and the shadow banking system.

"As China became the main cause of concern for global growth at the start of the year, we have seen a lot more macro accounts get involved in China CDS as a cheap and efficient way to hedge their cross-asset exposure," said Salih Unsal, a Hong Kong-based credit trader at Citigroup.

"The China (CDS) sovereign curve is arguably now one of the most liquid credit products in the region. Whether it's hedging or speculative activity, it's the easiest way to take a view on Asia."