China will have its first credit default swap (CDS) products before the end of 2010, as regulators carefully review the credit derivative product.

"We are now prudently facilitating the development of credit derivatives in China on the condition risk management is strengthened," Shi Wenchao, secretary general of the National Association of Financial Market Institutional Investors (NAFMII), told Xinhua.

"In designing our own credit derivatives, we will start with the simple products. Then we will look at more complex ones," Shi said, adding that the institutional and supervisory frameworks are in place for CDS's introduction.

CDS are a type of insurance policy against bond default. But they have been blamed for exacerbating the global financial crisis.

Compared with the lightly regulated and speculative international markets, one of China's problems remains the lack of credit derivative products, said Gao Zhanjun, a senior trader at Beijing-based Citic Securities.

"The absence of credit derivatives has restricted the development of China's financial markets," Gao said Monday.

According to a NAFMII report released July 23, the CDS pilot project will be a type of credit risk mitigation (CRM) contract or obligation.

The NAFMII report said Chinese credit derivatives must follow the principles of simplicity and transparency and cater to the real economy. Leverage ratios, moreover, must be strictly controlled, the report added.

"Currently, we don't have any instrument to allow market participants to hedge their credit portfolios, which are worth hundreds of millions of yuan," Shi said, adding that such a situation adds to risk.

More than 780 billion yuan (US$115 billion) of unsecured bonds were issued in China's interbank market in the first half of 2010 and the value of such bonds already issued tops 3 trillion yuan (US$442 billion).

"It's time for us to set up a risk-sharing mechanism and to let that credit risk become liquid for risk mitigation purposes," Shi said.

Still, the credit derivatives market will be restricted and leverage levels will be capped as market participants will have to adhere to strict capital adequacy requirements, he added.

(Xinhua News Agency July 27, 2010)