China's financial supervisors have never been accused of rushing into things. Deliberate and considered would be one way to describe the opening up of China's financial markets. Another would be: very, very slow.
Take China's derivatives regulations. The first draft of the proposed regulatory framework for derivatives was published by the People's Bank of China back in 2002. After a couple of years of to-ing and fro-ing, consultations and redrafting – a process that was slowed further by the establishment of a new banking watchdog, the China Banking Regulatory Commission – the final version of the rules appeared two years later, in early 2004.
Then there was the pilot scheme for renminbi forwards. The Bank of China was chosen as a test case in 1997, allowing it to offer six-month renminbi forwards (then the only existing renminbi-denominated derivatives contract) to domestic firms hedging short-term trade-related exposures. It took six years before this pilot scheme was extended to the other three state-owned banks – Agricultural Bank of China, Industrial and Commercial Bank of China and China Construction Bank – and a further year before this was widened further to include three of the largest private banks in 2004.
In China, stability is the number-one, over-riding priority. Nothing is rushed, every step is measured, and there's usually a long pilot phase with a limited number of participants to ensure there's no destabilising effect on the economy from any change.
Which makes the events of the past month all the more surprising. An expansion of the number of currency pairs permitted to trade on China's interbank market and the establishment of a renminbi-denominated bond forwards market in June was followed by the long awaited revaluation of the renminbi in late-July. The currency is now referenced to a basket of currencies – although the steadiness of the currency since the 2.1% revaluation on July 21 suggests the floating basket regime has not yet kicked in, or the weightings are dynamically managed on a daily basis to ensure stability.
With stability the watchword, most observers were expecting that to be it for a couple of years. Not a bit of it. The People's Bank of China followed up in August with a change in regulations to allow all banks – foreign and domestic – with both derivatives licences and spot renminbi foreign exchange licences to trade renminbi forwards. The cap on the maximum tenor has been removed, and the underlying hedged item can include all current account item transactions and some capital account item transactions, including the capital of a foreign-invested company.
What's more, once a bank has traded renminbi forwards for six months, it will now be permitted to offer renminbi swaps to clients. With some of the Chinese banks having traded renminbi forwards for more than six months, it means a domestic currency swaps market could emerge almost immediately.
A few key hurdles remain. For a start, the new rules do not cover interest rate swaps. This means a bank will be able to enter into a renminbi/foreign currency swap with an initial and final exchange, but without any interim exchange of interest. But even if new rules are published to allow the development of renminbi interest rate swaps, the country first needs to develop a reliable floating-rate index – something that is conspicuously missing from the Chinese market. In addition, there needs to be greater certainty to China's legal framework. In particular, the bankruptcy law needs to be revised to give banks greater comfort in the case of a default of a domestic counterparty. If foreign banks are unsure whether netting and collateral agreements are legally enforceable in China, this could hamper the growth of the market.
Nonetheless, the changes over the past few months are a huge step. China represents a mind-bogglingly massive opportunity for both foreign and domestic banks. With around $1.5 trillion in bank deposits, $228.6 billion worth of foreign debt, inward foreign direct investment of $54.9 billion in 2004 and foreign exchange reserves of $711 billion at the end of June this year, this will easily be the biggest, most exciting market for derivatives players globally.
• This month marks the fourth anniversary of the September 11, 2001 terrorist attacks. We remember all our Risk Waters Group friends and colleagues who were attending the Waters conference at the World Trade Center: Sarah Ali Escarcega, Oliver Bennett, Paul Bristow, Neil Cudmore, Melanie de Vere, Michele du Berry, Elisa Ferraina, Amy Lamonsoff, Sarah Prothero, David Rivers, Laura Rockefeller, Karlie Rogers, Simon Turner, Celeste Victoria, Joanna Vidal and Dinah Webster.
We also remember the 65 delegates, speakers, sponsors and exhibitors who so tragically lost their lives.
Nick Sawyer, Editor
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