September 14, 2010 (Chinavestor) China will allow the introduction of credit default swaps, the complex derivative instruments that gained notoriety during the global financial crisis, by the end of this year. China plans to take a more conservative approach to credit default swaps than has been applied in the U.S. and Europe, limiting the use of leverage on the swaps and banning the use of swaps on high-risk assets.
Credit default swaps are supposed to insure against issuer default on bond issues, but the instruments were used by U.S. and European investment banks and hedge funds to make large-scale bearish bets on stocks and other securities while global markets were plunging in 2008.
A popular tactic would be to short a company's stock, forcing the price down, and then go long that credit default swaps on that company's debt, profiting two ways as investors worried that the company was in danger of defaulting on its debt obligations due to the plunging share price.
It appears that China will allow no such chicanery when it allows credit default swaps into its financial markets. China plans to introduce credit derivatives to help manage risk in the nation’s growing domestic bond market, Bloomberg News reported. China says it has learned from the CDS mistakes made in the U.S. and Europe.