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Fitch: China Credit Derivatives Progress, but Hurdles Remain
March 22, 2017 / 1:01 AM / 8 months ago

Fitch: China Credit Derivatives Progress, but Hurdles Remain

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: Spotlight: China Credit Derivatives here SINGAPORE/SYDNEY, March 21 (Fitch) Recent measures introduced to kick-start China's credit derivative market are a step forward, but are likely to only result in a gradual market expansion in line with broader economic reforms, says Fitch Ratings. The country's derivative market remains constrained by regulatory issues that deter the use of credit derivatives, and the lack of a standard set of principles and tested practices, despite the recent measures. It also takes time for investors to incorporate new instruments into their investment strategies, particularly if these represent different risk profiles to those currently available in the market. There are signs that suggest China's financial regulators may be moving toward a more coordinated approach. For example, there are suggestions that a unified system might be under development to oversee asset management products across the financial sector. This is likely to be critical to the expansion of the credit derivatives market, as many of the issues faced in developing the market are cross-sector in nature. Without a single, predictable and clear regulatory position, it is likely that the majority of potential participants will lack confidence in the market. The credit derivative industry's self-regulating body, National Association of Financial Market Institutional Investors (NAFMII), may have deliberately left out some details from its recent September 2016 policy announcement to retain room for manoeuvre with other regulators. For now, these latest regulations attempt to address some of the issues that have stifled the market since its 2010 launch. One significant change is that credit derivatives can now reference an entity or a subcategory of securities - similar to common practice in developed markets - instead of targeting a single debt obligation. The previous rules effectively gave bond issuers the ability to choose whether or not to trigger credit derivatives by selecting the instruments they would default on, as most outstanding bonds do not have cross-default clauses. However, uncertainty still remains over whether credit derivatives will be triggered, even under the new regulations. Another issue is that enforcement of the credit event framework is yet to be tested. The effectiveness of any cross-default clauses at the derivative contract level is uncertain due to the potential problems presented by having a multi-regulator system. The current market arrangements are further complicated by the fact that credit derivatives on non-financial corporates can only reference NAFMII-registered debt obligations. Commercial paper and medium-term notes are registered with NAFMII, but bank loans, enterprise bonds, corporate bonds and offshore bonds are not. This calls into question whether a cross-default clause at the derivative contract level could be effective in case of a default of a non-NAFMII registered debt obligation. Clear, detailed and comprehensive derivative contracts will therefore be essential to avoid potential disputes. The first credit event that triggers a credit derivative is likely to become a model for how the instruments will be handled. However, NAFMII's current guidelines for credit-event determination are based on self-regulation and therefore may not be legally binding. There also still exist procedures for escalating a dispute to an arbitrator or a court, but this process could be prolonged and there is uncertainty over whether the legal process of bankruptcy filing will be free of local government influence, particularly if state-owned enterprises are involved. In addition, long-term development could be held back by the requirement that participants follow NAFMII's master agreement rather than the International Swaps and Derivatives Association (ISDA) master agreement that foreign investors are familiar with. Most current participants are major domestic banks and securities houses, which limits market depth and diversity. For more details, see report "Spotlight: China Credit Derivatives", available at www.fitchratings.com or by clicking the link above. Contact: Wayne Lai, CFA, CMT, FRM Associate Director Corporates +65 6796 7219 Fitch Ratings Singapore Pte Ltd. One Raffles Quay South Tower #22-11 Singapore 048583 Matt Jamieson Senior Director Corporates +61 2 8256 0366 Dan Martin Senior Analyst Fitch Wire +65 6796 7232 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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