Derivatives Rules create interest in the emerging market Swaps

The rules governing the credit default swaps in China are too narrow, hampering their growth at a time when the corporate bond market is growing 45 percent, according to bankers.

About 23 agreements covering a notional 1.99 billion yuan ($ 298 million) have been sold since China established a credit derivatives market last month, according to the central bank. That compares with outstanding contracts at $ 30 trillion global debt at the end of June, according to data compiled by the Bank for International Settlements in Basel, Switzerland.

As central bankers, regulators and government officials met on the island of Hainan, last week at the first conference since the contracts began yuan to discuss the future of the market, which expanded on the rules for determining what would in a settlement of swaps under a so-called credit event.

"At this time a credit event is a very narrow definition," said Gao Feng, co-director of China's Global Markets for Deutsche Bank AG, at the conference. Rules for payments should be simplified and standardized to help market liquidity, he said. The rules "should include more" he said.

Five-year CDS cost an average 81.5 basis points over AAA debt in China, according to the prices of 12 financial institutions. That compares with 34 basis points for similar debt-rated in North America and 65 basis points in Europe from December 16, according to Moody's Analytics.

"It is not clear"

Swaps credit-default usually rise as confidence deteriorates and fall investors because it improves. They pay the buyer face value if a borrower defaults on its obligations, less the value of the defaulted debt. A basis point equals $ 1,000 annually on a contract protecting $ 10 million of debt.

"If the company defaults on the link below, no problem, but if you have a bankruptcy or other event, then it is unclear what will happen," said Qiao Hongjun, a senior manager in the global capital department markets at the Bank of Communications Shanghai, at the conference.

Elsewhere in credit markets of China, 10 yuan denominated - year notes met last week, the repo rate more than seven days were up more than three years and United Co. Rusal of Russia plans to sell bonds in China . The yuan broke two weeks of gains.

Bonds, repurchase rates

The government bond yield 3.29 percent in 2020 due in September fell six basis points last week to 3.86 percent, according to the price of the National Interbank Funding Center. Swaps credit-default linked to China's sovereign debt for five years fell four basis points to 68, according to CMA prices.

China seven days repurchase rate, a measure of interbank funding costs, rose 123 basis points to 3.72 percent, the highest since October 2008, according to fixations journal published by the National Center funding interbank market in Shanghai. The increase was the highest since October 2007. A basis point is 0.01 percentage point.

Rusal plans to hire banks later this year to sell yuan-denominated bonds and carry out the sale and in the first quarter of 2011. A "reasonable" for the bonds would be about one billion yuan, Rusal Chief of Capital Markets, said Oleg Mukhamedshin December 17 in Moscow. Rates may be 2 percent to 5 percent, he said.

The yuan depreciated to 6.6640 per dollar from 6.6553 in Shanghai on 10 December. The government fixed the reference rate at 6.6623 against the dollar today, weaker than Friday's 6.6593. The currency has strengthened about 2.4 percent against the dollar since a plug of two years ending 19 June. Delivery time in twelve months reflect a commitment to advance 2 percent in the coming year.

Target Loan

Banks want to credit risks disperse after the annual target of 7.5 trillion yuan in new loans was breached last month near China tries to control the following claims unprecedented 9.59 trillion yuan loan in 2009. During the development of credit markets is the key to the government's goal of transforming China into a global economic powerhouse, regulators want to avoid speculation and leverage.

corporate bond market in China grew 45 percent in the 12 months to November to 3.39 trillion yuan, according to Chinabond, the largest clearinghouse in the nation. The figure includes corporate bonds, medium term notes and commercial paper, and excludes corporate bonds approved by the Securities Regulatory Commission China, according to the website of Chinabond.

"It'sa good step to have a derivatives market in place," said Zhang Zhiming, head of China research at HSBC Holdings Plc in Hong Kong. "But the market is small, since, for all corporate matters in China, so far there has been no breach."

"The best test"

China's banking regulator said it has not determined whether banks can use derivatives to reduce its risk assets and improve their capital, and it takes more time to test its effectiveness.

"From a long term, the biggest risk China's commercial banks face a credit risk, focused on the business of lending and investment in bonds," said Huang Zhi, director of innovation in China Banking Regulatory Commission in a speech at the conference last week.

There have been no defaults on debt traded in China since the central bank began to regulate the market in 1997, Moody's senior analyst Ivan Chung said last month.

"The problem is that nobody has tested the liquidation of these instruments," said Lian Li Khoo, executive director in the legal department and compliance with UBS AG, in a telephone interview from Hong Kong.

Different rules

China products differ from the global standard to ensure that only specific binding or underlying loan.

The lack of clarity surrounding the company's bankruptcy proceedings is also of concern, Hui Ou-Yang, managing director of UBS, said in an interview at the conference. "The bankruptcy laws that have been tested for state-owned enterprises in China may raise concerns about what constitutes a credit event."

Bankruptcy Act 2006 which came into force June 1, 2007, is one of the most significant pieces of legislation for the movement of China toward a market economy, according to a guide to the bankruptcy law published by Herbert Smith LLP last year. How Chinese courts apply the law in practice has not yet been seen, he said.

The central bank is likely to set a target of at least 7 billion yuan in new loans in 2011 after leaders met to decide key policy objectives for next year, said two people briefed on the matter on 13 December.

Loan Ceiling

The ceiling of 7.5 trillion yuan in new loans for 2010 was almost raped in the first 11 months of the year, forcing banks to set aside more deposits as reserves. Policy makers are concerned that the pace of borrowing can contribute to asset bubbles and derail the recovery.

The People's Bank of China on December 10 ordered lenders to park more money with the central bank for the third time in five weeks to counter the threat of inflation. China's economic growth last quarter was the fastest among the BRIC countries and their 2.65 trillion U.S. dollars of foreign exchange reserves are almost a third of the world total reserves.

While new contracts yuan simple definition of a credit event, which can be insured against is restricted.

"This limits the possible extent of the amount of risk that can cover and will have an impact on demand," said Ji Jiangfan, a bond analyst at China International Capital Corp., the nation's first bank Sino-foreign investment in an e-mail. However, this should result in lower premiums for insurance, said Ji.