George Washington’s Blog
Thursday, Oct 16, 2008

Conventional wisdom is that China is shielded from the derivatives hurricane battering the rest of the world. For example, an article in the Financial Times says (partly tongue-in-cheek):

Asia . . . shunned the easy profits promised by the peddlers of toxic derivative products and fancy collateralised debt obligations. Its banks eked out a respectable living through the sensible business of lending money, its manufacturers through the old-fashioned practice of making things.

Is this true?

Well, China has in fact allowed currency derivatives, gold futures, and other types of plain vanilla derivatives trades.

  • A d v e r t i s e m e n t

And China apparently has had problems with a unique type of derivative called an “accumulator”, betting against an inverted Euro curve. Indeed, when the Euro curve inverted, people demanded that the Chinese banks pay out on the derivatives, and they have simply refused to do so. See this and this.

Chinese banks have also purchased credit default swaps in Lehman and other American companies. As China Stakes reported on September 20th:

“China’s banking authorities have been rocked by Wall Street’s financial crisis and are worried about the risks facing Chinese banks and financial institutions. Analysts repeat that the crisis has perhaps only begun and may worsen.

According to Caijing Magazine, Chinese-funded banks hold assets worth dozens of billions of dollars related to Lehman . . . . These assets include direct-held bonds, loans to Lehman, and bond-related derivatives with Lehman . . . .”

So China is clearly not totally insulated from foreign derivatives.

However, China did largely avoid the repackaged mortgage derivatives known as CDOs.

Moreover, China passed derivatives regulations in 2004 which aim to “specify qualifications, standardize trading behaviour, contain trading risk and ensure financial safety”. It is not clear whether or not such regulations were effective (or even enforced). But given that the U.S. has not regulated derivatives at all, this is better than nothing.

So the bottom line is that China does have some derivatives exposure, but probably less than Western countries. As one blogger puts it “state owned Chinese Banks . . . have far less exposure to derivatives” than Western banks.


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