China and CDOs

Expect more issuance of collateralized debt obligations from China this year says rating agency.
Fitch Ratings expects more issuance of collateralized debt obligations ("CDOs") from China this year after the country's first CDO was launched at the end of 2005.

"The transaction represents the first official step towards the development of a CDO market in China and paves the way for more CDO issuance in the country this year and in the near future," says Charles Chang, Fitch's Director of Structured Credit for Asia Pacific.

There are also policy reasons to encourage more CDO launches. "Chief among these is the need to reduce the concentration of the country's credit risk in the banking system, which has become substantially pronounced in recent years as China increasingly relied on bank credit to fund its economic growth," Chang notes.

The most likely deal type in the near future is cash balance sheet CLOs (CDOs backed by pools of bank loans), since the need is compelling and since other deal types are severely challenged by regulatory and market issues. Fitch believes synthetic structures are less likely over the short-term, but there could be applications of synthetic technology in CLOs.

Although the early introduction of CDOs will ensure the place of CDO products in China's emerging bond market, many challenges remain. Fitch adds that regulatory controls currently restrict the supply and demand of CDOs in China.

These include multi-ministry approvals required for each transaction and the absence of investment guidelines for CDO products. "The CDO market in China will develop slowly until the government streamlines approval processes and transitions to a rules-based approach," Chang comments.

Fitch points out that a shortage of developed credit skills, the absence of reliable domestic credit benchmarks and structural impediments to learning will also challenge Chinese market participants' ability to develop CDO-related know-how.

However, the ratings agency also concludes that China has a consistent history of experimentation followed by broader implementation in economic reforms. "Opportunities will arise as market, regulatory and institutional challenges are overcome and as the market liberalises over time," says Chang.
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