Respectable Leaders and Experts,

Good morning! Welcome to attend today’s Credit Risk Mitigation Symposium! We are very much honored to have leaders from the General Office, the Legal Affairs Office, the Development Research Center and the Policy Research Office of the State Council, the People’s Bank of China, China Securities Regulatory Commission, China Insurance Regulatory Commission, the State-owned Assets Supervision and Administration Commission and other competent authorities, as well as experts from market institutions to jointly discuss problems related to the innovation and development of credit risk mitigation instrument. To begin with, I will give an introduction on following dimensions:

I. What is credit risk mitigation?

Credit risk mitigation (CRM) refers to the credit risk mitigation agreement (CRMA), the credit risk mitigation warranty (CRMW) and other simple underlying credit derivatives used for credit risk management. Overall, CRM is CDS plus China’s actual condition. It is a “2+N” innovative product system. CRMA and CRMW are the core products of this system which also includes simple underlying credit derivatives that can be developed by market participants through innovation in the future. CRM includes different forms of product, but its core function is to mitigate credit risk and provide market participants with an effective resort to manage credit risk.

CRMA is a typical traditional OTC financial derivative, under which credit protection seller provides credit risk protection on the agreed underlying debt to the buyer, and the buyer will pay a fee according to the standard as agreed with the seller. CRMA applies to the operational framework of the existing interbank financial derivative market, and is similar to credit swaps and other OTC financial derivatives in trading and clearing.

CRMW is a more standardized credit derivative, which is created by a third party other than the underlying entity to provide credit risk protection for the warranty holder, and is tradable in the secondary market. CRMW implements “concentrated registration, concentrated custody, concentrated clearing” to help enhance market transparency, control leverage ratio and prevent market risk. It is an independent innovation product with Chinese characteristics that many market participants developed by summing up the profound lessons from the international financial crisis, adapting to the actual conditions of the Chinese market and “bringing together the market wisdom”. It is an important contribution China has made to the world’s credit derivative market.

II. Why is CRM launched?

NAFMII has organized market members to promote CRM innovation. This is the objective need to promote financial market development in depth and carry out strategic adjustment of economic structure.

Firstly, it satisfies the need of market participants to effectively manage credit risk. Credit derivative is only a neutral instrument in nature. The key is how investors use this instrument. At present, the aggregate loans that are held by China’s banking sector exceed RMB40 trillion. If a quarter of these loans are unsecured, the total volume will be over RMB10 trillion. In recent years, China’s bonds market has developed quickly. Now, it is the second largest in Asia and the sixth largest in the world in terms of market size. In particular, the size of the debenture market has ranked the first in Asia. By the end of November 2010, up to RMB1.5 trillion worth of interbank debentures had been issued, and by the end of the third quarter, the value of the debentures under custody had exceeded RMB3.4 trillion. This figure does not even include the financial bonds which reached more than RMB5 trillion. If so, the market now has about RMB50 trillion worth of credit products. Therefore, the vast size of credit products inevitably requires credit risk management. In particular, the risk structure in the market has shifted from single interest rate risk in the past to dualistic risk structure featuring the coexistence of interest rate risk and credit risk. Due to the long absence of credit derivatives in China, it was hard for market participants to efficiently hedge, transfer and stave off credit risk through market-oriented CRM instruments. This does not only lead to the risk accumulation, but also hindered the market development in depth. Therefore, the market had the urgent demand for management instruments. The establishment and optimization of the socialist market economy system objectively calls for mechanism arrangement to allow the flow, identification and transfer of risks in the market, and also the innovation of corresponding financial instruments. Only by this, it can realize sustainable and stable development and prevent the occurrence of systematic risk. Through CRM, credit risk will be transferable in the market, and shifting from persons who are unwilling to bear it to those who are willing to take it. This will greatly benefit the stable development of macroscopic finance.

Secondly, this is the need to carry out the policy of the CPC Central Committee and the State Council to “actively expand direct financing, and evidently increase the proportion of direct financing”. As an important part of direct financing, China’s bond market has developed quickly in recent years and played an important role in propelling the expansion of direct financing. However, accompanied by the rapid expansion of market size, the average credit rating of issuers has gradually declined and the characteristics of credit risk of bonds have been kept emerging. With a large number of low credit rating enterprises entering the market, the credit risk is bound to increase. It would be unimaginable if there are no corresponding instruments to manage credit risk. So far, a host of guarantee companies have been established. However, not all the risks can be transferred to these guarantee companies. Therefore, market development needs the establishment of the corresponding risk sharing mechanism in order to avoid systematic risk. At the same time, due to the lack of effective credit risk management instruments, investors are hard to manage the credit risk actively and dynamically in a market-oriented manner. As a result, investors have to bear the risk if they hold bonds, and have to buy bonds if they want to bear the risk. This greatly restricts risk-averse investors who have ample fund and risk-loving investors who are short of fund to participate in the market in depth and breadth, and causing the size of direct financing hard to expand effectively.

In addition, the unsoundness of credit risk sharing mechanism in the financial market leads to huge financial resources are held by large enterprises with low risk and high credit ratings. Small and medium enterprises with high risk and low credit ratings cannot obtain enough financial support. Thus, it is hard to exert the function of financial markets in promoting the adjustment of economic structure. Using CRM to promote optimized allocation of risks and returns and driving the development of direct financing market is the concrete reflection of the policy of the CPC Central Committee and the State Council to “actively expand direct financing, and evidently increase the proportion of direct financing”.

Thirdly, it is the need to effectively prevent systematic risk and promote the steady development of macroscopic finance. Despite the impact of international financial crisis, China’s economy has generally remained in the upward economic cycle since 2002, and maintained the momentum of rapid and steady growth. Credit risk of different assets has remained controllable, which has created a favorable overall environment for the synchronous enhancement of asset scale and asset quality. However, macroeconomic trend has its internal cyclicality and fluctuation, and the excessive concentration of credit risk in the financial system or certain financial segment will definitely cause risk hazards to the financial system. Through innovation and development of CRM and other credit derivatives, it can help improve the efficiency of systematic risk monitoring by timely and sufficiently disclosing relevant risk information such as market supply and demand, probability of default and recovery rate. Moreover, it can promote rational allocation and decentralization of the credit risk to different financial markets and economic sectors through CRM. This can help smooth the pro-cyclical macroeconomic phenomenon, mitigate the impact of credit risk on economic and financial systems, strengthen the economy’s flexibility against risk and safeguard overall financial stability.

III. Characteristics of CRM instrument and the arrangement of innovative mechanism

Based on the aforesaid factors, since December 2009, NAFMII has organized financial derivatives experts from both domestic and foreign financial institutions, market intermediary platforms and law firms to set up “Credit Derivative Research Team” and to conduct systematic research on CRM instruments. On the basis of thorough research, NAFMII has put forward CRM innovation pilot scheme according to the principle of “serving actual demand, pursuing simplicity and transparency and controlling leverage ratio”, and drafted the Guidance to the Pilot of Credit Risk Mitigation Instruments in the Interbank Market. CRM is different from CDS and other credit derivatives prevailing in the international market and has the following characteristics and innovative mechanism arrangement:

Firstly, manage the market participants in a hierarchical manner. As the number of interbank market participants is very large and their risk management ability varies, hierarchical management of the market is an effective measure to improve supervision efficiency and trading efficiency, reduce transaction costs and prevent market risk, and conforms to the internal requirement of market development. Therefore, the CRM pilot business has implemented the hierarchical market management by dividing market participants into core traders, general traders and non-traders. Core traders can trade with all market participants, general traders can trade with all traders for their own need, and non-traders can only carry out transactions with core traders for hedging purpose.

Second, the trading structure is simple. Internationally, CDS trading usually includes various debts in the scope of credit protection by designating reference entities, debt types and debt characteristics, and does not restrict debt types under credit protection. Any claim can become the subject of credit protection. CRM is different from this. It defines the credit protection of specific underlying debt and restricts the underlying debt types to bonds and other similar debts so that each transaction agreement corresponds to that specific debt. As a result, the trading structure of CRM, which fully reflects the principle of “penetration” for subject debts, is simpler and clearer than international CDS.

Third, the leverage ratio is strictly controlled. The absence of market supervision and risk prevention measures in the international credit derivatives market has led to continuous expansion of market size, excessive leverage ratio, and finally triggered systematic risk. By establishing risk control indicators, the Guidance restricts net purchase balance and net selling balance of buyers and sellers as well as the proportions in net capital to effectively prevent risks.

IV. The CRM pilot program

Market participants have displayed great enthusiasm to participate the CRM pilot after NAFMII published the Guidance to the Pilot of Credit Risk Mitigation Instruments in the Interbank Market on October 29, 2010. By December 9, there are 27 CRM general traders, 14 CRM core traders and 23 CRMW creation institutions.

On November 5, China’s first batch of CRMAs was formally launched. By December 9, 11 traders have reached 23 CRMA deals and the nominal principal reached RMB1.99 billion. The underlying debt types include commercial papers, medium term notes and other debentures, and terms of these agreements range from 36 days to 2.21 years.

After the launch of CRMA, the Professional Committee of Financial Derivatives of NAFMII held a special meeting on November 11. The experts examined and passed the creation registration of four CRMWs submitted by China Bonds Insurance Co., Ltd., Bank of Communications and China Minsheng Banking Corporation Limited. On November 23, four CRMWs were all successfully created, involving a nominal principal of RMB480 million, and indicating the launch of China’s first batch of CRMWs.

Respectable leaders and experts, the launch of CRM has benefited much from the vigorous support and instructions from competent authorities, and agglomerated the wisdom and efforts of all market participants. Here, on behalf of the NAFMII, I would like to extend the sincere gratitude to all of you!

Of course, we have soberly seen that the launch of CRM only resolved the problem of product availability, and there are still many obstacles for us to overcome, such as the complete exertion of product functions and market expansion. With the vigorous support from competent authorities and concerted efforts of all market players, I believe the development of CRM market will be standardized, healthy and sustainable.

Thank you!