REGULATORS have published rules on credit default swaps (CDS), marking the launch of a much-needed hedging tool in the country’s corporate bond market, which has witnessed increasing defaults.

    The new rules published Friday were met with scepticism about how effective the hedging tool would be in addressing the country’s growing debt risks.

    The market provides insurance against debt defaults and is the latest indication of China moving to find tools to help manage what the International Monetary Fund has described as an “unsustainable” rise in credit.

    Investors said that CDS could help bond investors better manage risks. But they questioned how effective or popular they would be when defaults are still rare, legal frameworks are largely untested and other Asian markets already struggle for liquidity.

    Widespread pricing distortions in China’s bond market mean risk premiums between higher- and lower-rated corporate bonds are narrow, which in turn makes it difficult to effectively price CDS, these investors said.

    “This is a really big market, there will always be some people who are interested in protection,” said a Singapore-based portfolio manager who invests in Chinese onshore debt, but who declined to be identified.

    “But foreign investors will want to know what the legal framework is, who the market makers are, etc.”

    Thomas Drissner, investment manager at Aberdeen Asset Management in Singapore, said the Asian dollar bond market lacked the liquidity to hedge credit risk efficiently.

    “Hence, I have my reservations what liquidity in a yuan instrument will look like. Hedging only makes sense if you can trade in and out whenever you want,” Drissner said. “You have to have a very strong view to make this work from an economic point of view.”

    Integration with other CDS markets will be difficult because of different documentation and laws, cutting off another avenue of potential liquidity, said Keith Noyes, Asia director at International Swaps and Derivatives Association, a global derivatives trade body that sets industry standards for the biggest CDS markets.

    “That makes standardization and product fungibility difficult,” he said. “Its prospects would be enhanced by integration and access to offshore liquidity. That is constrained by differences in documentation and choice of law.”

    China has cautiously allowed some bond issuers to default since 2014, although doubts remain about how far the government is willing to go. But China’s debt load has ballooned since the global financial crisis to sit around 250 percent of GDP. (SD-Agencies)