Mar 21, 2017 06:42 PM

Henan Considers Credit Default Swaps as Debts Mount

(Beijing) — Facing mounting debts and default risks, Henan province is considering launching credit default swaps, but market observers suggest such a move may simply be a ploy by the government to shelter state-owned enterprises (SOEs).

The government of Henan is planning to set up a financial institution to sell credit default swap (CDS) contracts in a bid to offer credit enhancement services to SOEs, including the largest coal producers and steel makers in the province, including Zhengzhou Coal Industry Group Co. Ltd., and Anyang Iron & Steel Group Co. Ltd., to lower their financing costs, according to a document posted on the official website of the Henan provincial government.

In the annual government work report delivered by Premier Li Keqiang earlier this month, the central government stressed that bond defaults are a major risk facing financial markets.

Henan is the second province to try the tool, following in the footsteps of Shanxi province, China’s top coal producing region, which established a company to sell CDS contracts in September.

CDS contracts are derivatives similar to insurance policies, whereby the buyer pays periodic fees in exchange for protection payments from the seller when negative credit events occur, such as bond defaults. Such contracts became a concern after the global financial crisis of 2007-09 because of their lack of transparency.

As China intensifies efforts to trim industrial overcapacity amid mounting downward economic pressure, companies in Henan’s steel-making and coal-producing sectors are facing difficulties. Some bond rating firms have said debts incurred at these government-backed companies amount to more than 80% of total assets, which means increasing risks of defaults on outstanding bonds and also difficulties for the firms in issuing new financing instruments.

As of the end of March 2016, Henan Energy and Chemical Industry Group Co. Ltd. had taken on liabilities of 184 billion yuan ($26.7 billion), which amount to 83.4% of its total assets of 270 billion yuan, according to data compiled by China Chengxin Credit Rating Group. So far, the chemical company has seven outstanding bonds that have raised 14 billion yuan, and 2 billion yuan worth of bonds will become due this year, data from the rating firm show.

Meanwhile, Anyang Iron & Steel had run up 26.8 billion yuan in debts by the end of March 2016, which accounted for 83.7% of its 32.1 billion yuan worth of assets, according to a report issued by China Lianhe Credit Rating Co. Ltd. Of its total liabilities, 77% is short-term debt, making it hard for the firm to generate sufficient cash flow to meet urgent debt obligations.

CDS contracts are local governments’ last hope to help troubled SOEs. But some financial professionals have voiced concerns that the pricing and marketing of the CDS contracts will prove difficult, and government-run financial companies may turn out to be the only firms willing to sell them to bail out failing companies, as financial institutions that lack government support shy away from industries with overcapacity.

Credit default swaps have become a way for local governments to try to save SOEs by wielding administrative power, resulting in governments increasing their financial leverage instead of cutting it back, a private-fund manager told Caixin. “If the credit enhancement services are all offered by local governments, what is the difference between a CDS and a government bailout?” the fund manager said.

Contact reporter Dong Tongjian (

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