How China Is Reviving Tools for Hedging Credit Risk

As regulators have cracked down on excessive borrowing by China’s property developers, the fallout from a resulting liquidity squeeze has weighed on an economy already struggling due to pandemic lockdowns and other disruptions. So regulators have returned to a tool they used to try to restore domestic investor confidence the last time the onshore credit market ran into trouble: derivatives that hedge risks against default. The response has been limited, however, with bond issuance by private-sector builders as of June off to its slowest annual start since 2015 -- illustrating the extent of the challenge to reassure markets this time.

Construction and property sales have been the biggest engines of economic growth since President Xi Jinping came to office almost a decade ago. Home prices have skyrocketed as an emerging middle class flocked to property. The boom led to speculative buying as new homes were pre-sold by property developers who turned more and more to foreign investors for funds. In 2020 China tightened financing rules for developers to crack down on reckless borrowing, fearful that a collapse could undermine the financial system. But many developers didn’t have enough available cash to cover their liabilities. A sales slump that began during the pandemic was deepened by aggressive measures to contain Covid-19, aggravating the liquidity crisis. A default last year at one of the biggest, China Evergrande Group, shocked the market (China only started letting companies default on bonds in 2014). The ripple effects have hit other private developers, including Sunac China Holdings Ltd. in May. As of June 1, every Chinese firm defaulting in 2022 has been a developer except for E-House China Enterprise Holdings Ltd., which provides real estate services.