Chinese CDS, margining and UBS

CDS market faces headwinds in China

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UBS saves Sfr295m in capital via swaps margin change

COMMENTARY: The dangers of fragmentation

China's financial regulators are making a second attempt to kickstart a credit derivatives market. The failure of the existing credit risk mitigation (CRM) products to take off has led them to try something closer to the credit default swaps used elsewhere in the world. But the main reason for the failure may not have been the CRM structure, but the country's fragmented regulatory system, with different industry watchdogs even proposing different versions of the master agreement.

It's bad enough that, with Chinese corporate credit risk (and default rates) rising, the country still lacks a liquid and functional credit derivatives market. So much Chinese corporate credit is issued by companies that are state-owned or state-backed that it is probably not going to function like anything recognisable to the rest of the world any time soon. But the number of different regulators involved, and the apparent lack of crosstalk between them, is a sign of a much more worrying problem.

One of the more remarkable aspects of the 2008 financial crisis was the amount of regulatory arbitrage it revealed – not only between countries, but even within them, with the US Office of Thrift Supervision failing to spot the flaws that led to the downfall of many of the huge institutions it was supposed to be overseeing, including AIG, IndyMac, Countrywide and Washington Mutual. While there seems to be less potential for this sort of venue-shopping under the Chinese system, which is fairly rigorously divided by industry, the lack of effective co-operation between regulators over the credit market issue is concerning.

The Chinese central government, in most areas of policy, seems to take a fairly mission-command approach, giving subordinates general objectives and leaving them alone to get on with it – often in competition with each other – and rewarding or punishing them later depending on results. Whatever the benefits of this strategy elsewhere, it risks disorder and disaster if applied indiscriminately in financial regulation. If the false steps over credit derivatives are a sign of a broader disconnect between China's many financial watchdogs, it could be an extremely worrying sign.

STAT OF THE WEEK

Total assets under management (AUM) in commodities fell from $451 billion in 2012 to $161 billion in 2015, although that number has rebounded to $220 billion as of April, according to Barclays.

QUOTE OF THE WEEK

"We think it's good practice to hold ourselves accountable to the same high standards we impose on the institutions we supervise" – Linda Cunningham, chief risk officer at the US Office of the Comptroller of the Currency

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