China slowdown risks fuel investor hedging rush

Global investors have doubled holdings of contracts insuring China's sovereign debt as its companies raise funds abroad and views diverge on the economy.

The net notional amount of credit default swaps protecting against non-payment by the government reached a record US$15.7 billion on November 7, up from US$8.1 billion a year earlier, Depository Trust & Clearing Corp data showed. Chinese companies boosted overseas bond offerings 65 per cent to US$308 billion this year. Alibaba Group Holding raised US$8 billion in Asia's largest dollar debt sale.

Buyers of China's notes are hedging against risks in an economy forecast to expand at the slowest pace in 24 years, with property sales deteriorating, manufacturing slowing and the shadow banking industry in turmoil. Bulls highlight the country's US$3.9 trillion reserves, a benchmark 10-year yield of 3.65 per cent and a growth rate forecast by the International Monetary Fund to be twice the global average this year.

"China is very central to global macro today and many people have many strong views," said Viktor Hjort, the head of Asia fixed-income research and credit strategy at Morgan Stanley. "Views on China are also extremely polarised - very bullish and very bearish. For those who are very bearish or even a little worried, one way that China stands out is in its lack of hedging instruments."

Chinese firms boosted issuance of offshore debt after the 2008 financial crisis as loose monetary policies worldwide flooded markets with cash while domestic interest rates rose. Their dollar debt yields 4.86 per cent on average, compared with 3.17 per cent for their US counterparts, according to Bank of America indices. Alibaba sold its 2.5 per cent five-year notes at a yield of 95 basis points above similar-maturity treasuries and 3.6 per cent 10-year securities at a relative yield of 128 basis points.

The market for Chinese corporate credit default swaps is limited. There are US$1.6 billion of five-year default swaps for Bank of China, which has US$32.3 billion of outstanding offshore debt, the most among the country's firms. Among other companies, only China Development Bank and Export-Import Bank of China have protection that is among Depository Trust & Clearing's 1,000 largest contracts.