Things seem to be moving rather quickly in China. First, there was the move to increase flexibility. Now, there’s this:
China plans to introduce credit derivatives soon to control risks in the nation’s growing domestic bond market, according to the National Association of Financial Market Institutional Investors.
“We will make this a true risk-hedging instrument for the growth of the financial market,” unlike how the derivatives were used during the financial crisis, Shi Wenchao, secretary- general of the government-backed body, said at a briefing in Beijing today.
It seems all at once that China has been moving from a regime that is rather tight-fisted to one that isn’t. From zero-to-gun-slinging capitalist in no time flat.
But is that what really is going on? Let’s consider another piece from Bloomberg:
China’s central bank set its daily reference rate for yuan trading 0.18 percent weaker, the biggest drop since 2008, a sign the currency is being guided to reflect the global risk environment following the end of a two-year peg.
So they’re not quite ready to step away from the mechanisms they’ve used, stating they will prevent “excessive” exchange-rate moves. And then there’s this from the same piece:
“There’s a new normal now for the yuan as it increasingly reflects what’s happening in the broader market,” said Brian Jackson, a Hong Kong-based strategist at Royal Bank of Canada. “Yesterday, there was talk that state banks were buying dollars on behalf of the PBOC. This indicates that they want to introduce more two-way moves to reflect what’s going on in the rest of the world. It won’t just be a one-way bet.”
I wonder if their reserve requirement management regime will give us any indicator as to how active they will be in the currency market. See, where most central banks try to use overnight lending rates to sway credit appetites one way or the other, the Chinese use minimum reserve requirements. Raise requirements, credit tightens. Lower reserve requirements, credit loosens and flows more freely. They have had a tradition of being rather interventionist and hands-on in that regard, so I wonder just how much intervening they plan on doing in currency markets. I assume they will be pretty active.
It also makes me wonder about secretary-general Wenchao’s statement on the use of credit derivatives. How are they going to do this? Will they outlaw outright credit protection purchases and only allow purchases for hedging purposes? Are there any other wrinkles they plan on introducing to the market? It’s not all that clear. The one thing that strikes me is that the National Association of Financial Market Institutional Investors is government-backed. Not very typical.
But let’s take a look at the would-be reference entities that CDS will be bought and sold on. From the first Bloomberg piece:
Treasury bonds, central bank bills and policy bank bonds made up 78 percent of bond issuance in China last year, according to the website of Chinabond, the nation’s largest debt clearing house.
In the first quarter, 346 billion yuan of corporate bonds, medium-term notes, and financing bills were issued, compared with 317 billion yuan in the same quarter last year, according to China Lianhe Credit Rating Co.
So obviously there’s a bunch of government debt involved here. A big majority of it, in fact.
But here’s the bottom line: the Chinese appear to be moving to a more market-based framework, which should be applauded. Just how market-based it is, is a whole other matter completely. Because make no mistake: they hope the market will do some things for them so they have political cover with the G-20. As I said yesterday:
If the enhanced flexibility means the Yuan goes lower, the Chinese would’ve pulled off a brilliant coup: a depreciating currency with little to no interference from the government.
“Little to no” may have been pushing it on my part. Significantly less seems more reasonable on second thought.
The most curious thing to me about this whole situation? Just how liquid the market for China CDS will become. There are well-documented issues with CDS liquidity in its current state, but that being said, I’ll be curious to see how much volume gets done in both the sovereign and the corporate names.
This could get interesting…