Focus “Further liberalisation is required before RMB derivatives emerge.” 16 Commission (CSRC). So under current rules, it would seem unlikely that banks would be able to structure any product with an equity or commodity derivative component, at least without separate approval from the CSRC. The problem is that no approval process exists to allow the CSRC to give banks a waiver. In fact, there are currently no rules governing equity derivatives in China, <strong>and</strong> it’s unclear as to whether the regulator would be able to give banks the go-ahead to structure products with an equity derivatives component even if there were. However, if a bank structured a note with returns linked to the performance of a fund of hedge funds, <strong>and</strong> some of those underlying hedge funds invest in equity in offshore markets as a part of their strategy, would that fall under the remit of the CSRC? Questions like this will probably have to be worked out in practice, say lawyers. “The regulations are about getting a financial institution a licence to trade derivatives. It’s not about the derivatives products financial institutions can do,” says Dare Bryan at Clifford Chance. “There are still lots of issues, <strong>and</strong> I think the questions that will follow from banks will be about bringing in structured notes or swaps, <strong>and</strong> working out how to use these rules to make money or service their clients.” Philip Tsao, UBS, Hong Kong Foreign currency vs. Renminbi The regulations themselves do not differentiate between foreign currency <strong>and</strong> renminbi-denominated derivatives, <strong>and</strong> the CBRC has indicated that a bank with a derivatives licence (<strong>and</strong>, in the case of a foreign bank, a renminbi licence) will not need to get a separate licence to deal in renminbi (RMB) derivatives. However, the caveat that banks have to rely on existing rules for foreign exchange, equities <strong>and</strong> commodities, including those on foreign exchange administration, regulated by the State Administration of Foreign Exchange (Safe), means that banks will most likely focus on foreign currency-denominated derivatives in the near-term. Currently, “In 2003, China received $53 billion foreign direct investment.” the only local currency derivatives product available to onshore firms is a 12-month RMB forwards contract, offered on a trial basis by the four largest Chinese banks – Agricultural Bank of China, Bank of China, China Construction Bank <strong>and</strong> the Industrial <strong>and</strong> Commercial Bank of China. The contract is designed for short-term traderelated purposes, <strong>and</strong> the size of the trade is limited to the value of the imported or exported goods. However, the renminbi is currently non-convertible on the capital account, meaning that RMB cross-currency swaps are a nonstarter. “There isn’t really a renminbi derivatives market at the moment other than renminbi forwards of not more than one year, which can only be dealt with by the big four banks,” says Liew at Allen & Overy. “The regulations state that Safe has its rules on foreign exchange, <strong>and</strong> you have to comply with those rules. I think people have read a bit too much into it <strong>and</strong> talked about doing renminbi derivatives straight away.” There’s potentially more flexibility on the development of RMB interest rate swaps. However, the PBOC has tight control of interest rates, both for loans <strong>and</strong> deposits, meaning there’s no efficient, market-driven floating rate index. “The only thing I am really interested in is the establishment of an acceptable floating rate index in China,” says a Hong Kong-based derivatives trader. “How can you have an interbank market with a government fixed rate? The rates are managed, <strong>and</strong> as a result, you can’t write swaps on them.” Most bankers agree that further liberalisation, or at least some sign from the PBOC, CBRC or Safe, is required before RMB derivatives emerge. “The regulations do not explicitly specify the currency covered. I think the intention of the regulations is to make it broad enough so that the CBRC doesn’t need to keep amending the rules as time goes by,” says Ivan Wong, head of risk management advisory, Asia- Pacific, at HSBC, in Hong Kong. “We expect the RMB derivatives market to grow strongly once interest rates are liberalised <strong>and</strong> the RMB itself becomes freely convertible on the capital account.” Certainly, bankers are eagerly awaiting the emergence of a renminbi derivatives market. “[The foreign currencydenominated derivatives market] will be a profitable business in its own right, bearing in mind it’s not just access to the corporate sector, but also potentially an increasing amount of structured investment products to retail <strong>and</strong> wealth management customers,” comments Mike Bass, head of rates <strong>and</strong> foreign exchange, at St<strong>and</strong>ard Chartered, in Singapore. SWISS DERIVATIVES REVIEW <strong>26</strong> – NOVEMBER 2004
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