Under the new draft guidelines – the first update since the initial consultative document in July 2002 – financial institutions will be able to trade foreign currency-denominated interest rate, credit and currency derivatives on behalf of clients and on their own account once they have received approval from the CBRC. Those banks applying for licences must have sound internal risk management and control systems, experienced dealers, and internal auditing and reporting systems.
Crucially, the new regulations state that those banks trading their own account can use derivatives for hedging and for ‘arbitrage-like’ trades to generate profit. This marks a seismic shift in attitude by the Chinese authorities. Currently, derivatives transactions can only be used for hedging and cannot be used for speculative purposes, a rule that has been in place since 1995.
The draft guidelines also define what a derivative is – an important step as there is currently no legal definition in China, creating uncertainty over what products are subject to the hedging-only requirement. Under the new guidelines, derivatives are defined as a transaction where the price is determined by reference to one or more underlying assets or indexes, including futures, forwards, swaps and options.