China has made great strides in its efforts to modernize its financial markets over the past few months. Beginning with the creation of National Association of Financial Market Institutional Investors (NAFMII) in 2007, introducing the concept of bond insurance, the adoption of a standardized master agreement (a copy is available here) for trading derivatives (the earlier NAFMII Financial Derivatives Master Agreement, as well as a new Certificate Version – the Certificate Master – allowing for the multilateral trading of credit risk mitigation tools) and the establishment of an inter-bank loan transfer market in Shanghai have all helped move China to the forefront of financial market innovation in Asia.
It has been a few months since China first introduced their own equivalent of a credit default swaps – the credit risk mitigation tool – and as far as first indications go, the market has been moving along alright. The country hosted a Credit Risk Mitigation (CRM) Instrument Symposium last month to discuss and share the feedback from its pilot program and first round of CRM trades and HSBC’s China subsidiary recently announced that it was the first foreign bank to issue a CRM when it sold a CNY10 million notional 1-year CRM warrant* on a 5-year PetroChina bond. HSBC’s announcement comes just before another foreign bank’s (Societe Generale) recent announcement that it too was planning to offer another kind of derivative – commodity derivatives – in the country.
Now China appears to be tackling the challenge of increasing liquidity in illiquid products by creating financial asset exchanges across the country. The country now has four financial asset exchanges in its 4 direct-controlled municipalities to deal with non-standardized financial instrument transactions:
- The Beijing Financial Assets Exchange (BFAE) setup by the China Beijing Equity Exchange (CBEX), Cinda Investment and China Everbright Investment in the capital city last May.
- A Shanghai branch of BFAE
- The Tianjin Financial Assets Exchange (TJFAE) setup by China Great Wall Asset Management Corp (CGWAMC) and Tianjin municipal government.
- And most recently the Chongqing Financial Assets Exchange (also being called the Chongqing Gold Exchange) in western China setup by Chongqing Financial Office (a quasi-official body that promotes the city’s financial services industry), the Chongqing bureau of the People’s Bank of China and the China Banking Regulatory Commission (CBRC).
Most of these exchanges will facilitate and participate in various financial activities, particularly credit-related ones, such as disposing of non-performing assets, fund raising, private equity fund and trust sales and transfers and exchanges of stakes in financial institutions, and credit assets and trust products according to the credit asset trading regulations and guidelines issued last year. Or as described by BFAE,
At present, China is home to large amounts of financial assets, including not only bonds, equities and securities funds which feature high liquidity and are traded in a standardized way, but also large amounts of financial assets that are tradable but lack support from an open trading platform. Transactions of these products need to be regulated, so as to enhance liquidity. As of the end of 2009, stocks of financial assets had totalled approximately RMB 130 trillion, including approximately RMB 42 trillion credit assets. Such high financial assets stock creates a strong demand for trading. The establishment of the Beijing Financial Assets Exchange is expected to effectively help solve issues such as the lack of a smooth transaction channel in China’s financial assets market.
Based on their given descriptions, it appears like the new credit risk mitigation tools could be another product that could ultimately be allowed to trade on the financial asset exchanges although it does not appear that any of the early CRM trades have taken place over them. Given the market is in its infancy and the current CRM trades are still quite new, it make take some time before traders of the first CRM’s find the need to have to close-out or novate their trades but the development of these multiple exchanges shows that China is covering all bases when it comes to managing the growth and development of this market.
*As Risk.net recently summarized nicely, the “only two types of [CRM] products [allowed in China are]: credit risk mitigation (CRM) contracts, which are effectively over-the-counter single-name reference obligation-only credit default swaps (CDSs); and CRM warrants, which are transferrable instruments giving holders the right to put reference obligations to the issuer.