Derivatives 2006 - China opens up
China’s onshore OTC derivatives markets took important steps forward when the Chinese Banking Regulatory Commission and the People’s Bank of China (PBOC) gave permission to commercial banks with derivatives licences to trade forward products and then cross currency and interest rate swaps. This was followed by a master agreement for forwards and swaps transactions. Nethelie Wong reports.
The China Foreign Exchange Trade System and National Interbank Funding Centre (CFETS) in July published an improved renminbi/foreign exchange forwards and swaps principal master agreement for trades on the domestic interbank market. Deals are now governed by Chinese law, though Chinese courts have not been tested by derivative disputes.
The latest master agreement covers renminbi forwards and swaps trading between banks but not yet renminbi deals with domestic corporates or cross-border dealing. For now, these trades fall under the International Swaps and Derivatives Association’s master agreement, with which the Chinese provisions share some common features.
Although, the master agreement does not apply to renminbi interest rate derivatives, a market that is regulated by the People’s Bank of China (PBOC), it will act as the launch-pad for similar developments in other areas of the derivatives market should the PBOC decide to adopt it.
Permission to trade renminbi/FX forwards and swaps has been in place since August 2005, in the case of forwards, and since April 2006 for swaps.
According to the PBOC, the number of eligible forward trading interbank members had grown to 62 at the end of June 2006, from 48 in August 2005, while the eligible swap trading interbank members increased to 56 at the end of June 2006, from 54 two months earlier.
Those 56 financial institutions, all with derivative licences for at least six months, which are eligible to conduct swap businesses are mostly foreign banks including HSBC, Standard Chartered, Deutsche Bank and Citigroup, with only 15 Chinese lenders involved. They include the two policy banks, the Big Four state-owned commercial banks, Bank of China and the major joint-stock banks.
In April 25 2006, China officially launched cross currency swap trading in the interbank market after the first such deal was recorded on November 25 2005 – a US$6bn pilot trade involving several counterparties including the two policy banks and the Big Four state-owned commercial banks.
Technically, swaps among euros, Hong Kong dollars, Japanese yen, renminbi and US dollars are allowed. Trades so far have concentrated in the tenors of 15-days, 17-days, 30-days, 95-days and six-months.
Traders expect the volume of currency swaps to grow only gradually, given the government’s tight grip on the domestic currency. It will take a long time before the pricing of onshore currency swaps converges with similar transactions in the non-deliverable offshore market. Traders said the purpose of the product was to dampen speculative pressure in the NDF market and to effectively hint at the rates which the PBOC would like to see.
In February 2006, final clearance was received for an interest rate swap trade instigated in October 2005 that saw China Everbright Bank (CEB) and China Development Bank (CDB) enter into a 10-year Rmb5bn deal.
China’s onshore interest rate swap market is developing slowly, but dealers are working to prepare for an anticipated increase in flow. The longest tenor traded was 10-years, with most activity focused around the five-year maturity. Trades so far have been client driven.
To become a renminbi swap dealer a bank must first obtain a derivatives licence and then build risk management capabilities to meet regulatory standards and confirm this by filing reports with the CFETS.
Eighteen banks are understood to have submitted documents detailing their risk management and internal control systems for swap transactions to the CFETS. Of those, five were local banks and the rest were onshore branches of foreign banks in China.
On the equity front, the PRC warrants market has registered exponential growth despite having been relaunched in August 2005. The authorities pulled warrants from the market in 1996 in the belief that the instruments were encouraging highly speculative investment behaviour. But warrant trading quickly became hot again.
China’s stock index futures will probably start trading at the Shanghai-based China Financial Futures Exchange at the end of this year, said an officer from the China Securities Regulatory Commission in September. However, a long waited treasury bond futures contract is not likely to resume trading in the near future. The futures were listed in Shanghai in early 1990s, but trading was shut down after a scandal in March 1995.