Financial tool set to shield bondholders from default risk

PUBLISHED : Friday, 26 August, 2016, 6:54pm
UPDATED : Friday, 26 August, 2016, 6:54pm

As bond defaults soar in China, investors and regulators are moving to introduce financial tools that have been widely used in global markets to provide protection for creditors in cases where companies can’t pay their debts.

The National Association of Financial Market Institutional Investors (NAFMII), a Chinese industry body under the People’s Bank of China (PBOC), has consulted major banks and brokerage firms in recent weeks about a plan to introduce credit default swaps, according to recent media reports in the mainland and Hong Kong.

A credit default swap (CDS) is a financial product allowing bond investors to buy and sell insurance that pays out if a company fails to repay their debts. The product has been widely used in global markets to hedge the risk of debt default.

It’s been reported that NAFMII has drafted guidelines and standardised contracts for the product and the PBOC is likely to approve the scheme in the next few months.

The Post has contacted the NAFMII to confirm the report, but hadn’t received a reply as of publication.

This is not the first time that the country has considered introducing the scheme. Back in 2010, the NAFMII made an attempt to introduce the product. However, since bond defaults were virtually unheard of in China before 2014, the CDS market failed to take off due to weak demand.

But this time round, as the Chinese government attempts to build a mature bond market to attract domestic and overseas investors, an effective tool to hedge against risks has become a necessity.

Some local governments are moving ahead quickly with the idea. The provincial government of Shanxi province, China’s major coal mining region, said earlier this month it was looking into CDSs as a way of helping its coal companies, which have faced challenging times. The Shanxi authorities propose setting up a financial services company aimed at improving the financing of the province’s companies.

But analysts say it may take time for the CDS market to take off and to develop a pricing mechanism for such a complex product.

“Many Chinese bondholders still expect government support in the event of more bond defaults, which, to some extent, will dampen the demand for the products,” said Ying Jian, an economist at the Bank of China (Hong Kong).