Credit derivatives in Asia need liquidity boost

Jonathan Davies, head of global credit derivatives practice at PwC, said banks in the region have yet to adopt appropriate business models and risk management frameworks for the active use of credit derivatives. He also highlighted the importance of education on the benefits and risks associated with credit derivatives in aiding the development of the market.

He added that the definitions of credit events as provided by Isda (International Swaps and Derivatives Association) documentation continue to be an obstacle. For example, bankruptcy - the primary credit event - is of particular interest in Asia, where countries such as Indonesia have no bankruptcy laws.

“In the past there have been credit derivatives written on companies in Indonesia which say that if an Indonesian company goes bankrupt, we will pay out. Having said that, Indonesia does not have any bankruptcy law and therefore even if an Indonesian company - in theory - went bankrupt, as there is no actual law in place, the credit derivatives couldn’t be invoked and the result for the bank which took out the position would be that the bank did not get paid,” said Davies.

However, Duncan Fitzgerald, partner, financial services division for PwC, also speaking at the conference, said that Asian countries, such as Hong Kong, are advantaged by their late arrival into the market, as they are able to learn from the mistakes made by their counterparts in Europe and the US.

“The old adage 'first to market is not always best', is true. So, the fact that Hong Kong is waiting for its global allies in Europe and the US - from the market perspective - to sort the systems issues out first… [means] Hong Kong will be able to learn from those issues and actually have better systems. I’m not particularly worried that Hong Kong is less developed than its global counterparts, and indeed it may be an advantage,” he said.

PricewaterhouseCoopers believes that as more participants enter the market, including banks, dealers, insurance companies, investment companies, investment funds and hedge funds, the global volume of credit derivatives is expected to reach US$1.6 trillion of notional value by 2002.