Focus “After the RMB products open, the revenue will just double or triple every year.” 18 “But in time, once there is a relaxation in the currency regime <strong>and</strong> interest rate regime, the big driver for us is going to be the development of the local currency market.” A huge market The potential size of the market is enormous, say bankers. China had around $202 billion of foreign debt as of the end of March <strong>and</strong> foreign exchange reserves of around $440 billion at the end of May. What’s more, China overtook the US as the biggest recipient of foreign direct investment last year, with $53 billion flowing into the country in 2003, according to the OECD. “After the renminbi products open, the revenue will just double or triple every year,” says Philip Tsao, managing director, joint head of debt capital markets group <strong>and</strong> head of risk management, Asia, at UBS, in Hong Kong. “The hedging needs are so huge, while the products – long-dated cross-currency swaps <strong>and</strong> interest rate swaps – are just not there.” But further liberalisation is on the horizon. As part of its commitments to the World Trade Organisation, China is committed to opening up its currency by the end of 2006. Once that happens, dealers anticipate the beginnings of an RMB cross-currency swap market. “The renminbi should open up in two years’ time with the WTO timetable, which means that the government <strong>and</strong> the regulators may allow for certain renminbi derivatives instruments to be developed,” says Dennis Wan, managing director <strong>and</strong> head of sales, credit <strong>and</strong> rates markets, at JP Morgan Chase, in Hong Kong. “And once they are developed, then we will have a much bigger population of end-users in China.” Nick Sawyer is the Editor of Asia Risk magazine, the leading risk management <strong>and</strong> derivatives publication in the Asia-Pacific region. This article was first published in the September 2004 edition of Asia Risk magazine (www.asiarisk. com.hk). Contact: nsawyer@riskwaters.com More clarity for close-out netting needed Now that a regulatory framework for derivatives is in place in China, bankers <strong>and</strong> lawyers are turning their attention to outst<strong>and</strong>ing legal <strong>and</strong> documentation issues. In particular, bankers are looking for greater clarity on close-out netting <strong>and</strong> the use of collateral. “Close-out netting <strong>and</strong> set-off has been one of the major concerns for the banks,” says Dennis Wan, managing director <strong>and</strong> head of sales, credit <strong>and</strong> rates markets, at JP Morgan Chase, in Hong Kong. “If banks want to do more business <strong>and</strong> if set-off is perfected in the bankruptcy law, then they can offer more credit lines to counterparties.” Close-out netting provisions exist in the International Swaps <strong>and</strong> Derivatives <strong>Association</strong>’s (ISDA) master agreement, <strong>and</strong> are aimed at reducing credit risk <strong>and</strong> freeing up credit lines by enabling banks to calculate derivatives exposures on a net, rather than gross, basis. However, while the China Banking Regulatory Commission (CBRC) seems to be encouraging the use of internationally accepted documents such as the ISDA master agreement, there is some question over whether some of the clauses in the document – <strong>and</strong> specifically those relating to netting – would be enforceable in China in the event of a bankruptcy. Close-out netting is not a legally recognised term in China, although set-off – a similar concept that allows a counterparty to offset debt owed to it by a company against the debts it owes that company – is recognised under Chinese law. However, there are several uncertainties on the interpretation of the set-off laws, particularly on whether set-off is allowed after liquidation proceedings have begun. “The next stage is for the law to change in China to create a netting law to assist the financial institutions in using ISDA documentation. The CBRC wants banks to use these types of documentation, but banks could find that some of the clauses in the master agreement don’t actually work in the situations you need them,” says Paget Dare Bryan, partner at law firm Clifford Chance, in Hong Kong. “The more ISDA master agreements are signed up, the more these issues will become apparent to the organisations.” Bankers hope that these uncertainties will be addressed in China’s new bankruptcy law, a draft of which is currently before the China’s National People’s Congress for review. However, the latest draft is not believed to make any significant changes to the set-off provisions. Nonetheless, it certainly won’t stop banks targeting the China derivatives market. “These are the things that any institution in China needs to manage,” says Ivan Wong, head of risk management advisory, Asia- Pacific, at HSBC, in Hong Kong. “[Close-out netting] is important, but I think the institutions that are serious about this huge marketplace probably need to come up with the appropriate policies to manage that.” SWISS DERIVATIVES REVIEW <strong>26</strong> – NOVEMBER 2004
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