Name: Notice of the General Office of CBRC Regarding the Implementation of the New Derivative Measures (银监会办公厅关于《银行业金融机构衍生产品交易业务管理暂行办法》实施中有关问题的通知)
Issuing authority: China Banking Regulatory Commission (the "CBRC")
Issue Date: 21 March 2011
Subject: China Derivatives
In January the CBRC published the amended Interim Measures on the Administration of Derivative Business of Banking Financial Institutions (the “New Derivative Measures”) (you may refer to the Linklaters bulletin and our English translation of the New Derivative Measures).
The New Derivative Measures introduced several major changes to the derivative business of banking financial institutions (“banks”) in China. However, there are also some important questions which have been raised in relation to the New Derivative Measures. On 11 February, the CBRC published a Q&A (the “Q&A”) which answered some of those questions (see our Alert regarding the Q&A). On 21 March 2011, the CBRC issued the Notice Regarding the Implementation of the New Derivative Measures (the “Notice”) which provides further clarification.
Highlights
- Application to Offshore Branches – The Notice clarifies that, in terms of banks incorporated in China, the New Derivative Measures apply to their onshore branches as well as offshore branches.
- Market Risk Capital Limit – One of the key provisions under the New Derivative Measures is the 3% limit – ie, the market risk capital for non-hedging derivatives shall be no more than 3% of the relevant bank’s total core capital. It is understood that some banks (in particular, the foreign owned banks) are well over this limit. Strict application of the 3% cap is likely to curb proprietary trading by those banks.
The Notice provides certain flexibility in this regard. Under the Notice, each bank needs to comply with either the 3% limit, or “any other requirement set by the regulators”. It is expected that the CBRC may set market risk capital requirement on a firm-by-firm basis.
- Products requirements – Under article 18 of the New Derivative Measures, banks are prohibited from entering into derivatives over derivatives, or naked short positions which may result in unlimited loss. The Notice clarifies that, if a bank has already entered into such transactions, it must unwind or hedge them out before the end of the transitional period.
In terms of naked short positions, this requirement may be less of an issue because, if a bank is not able to unwind the trade, it could do a hedge so as to comply with this requirement. However, complying with this requirement could be tricky in respect of derivatives over derivatives. Such transactions, hedged or un-hedged, are prohibited. As such, the only way to comply with this requirement is to unwind the trade. Early termination of a trade requires consent of the counterparty, unless the relevant agreement already contains early termination provisions. If the counterparty is also a bank regulated by CBRC, it is likely that both parties would want to early terminate the trade. In case the counterparty is an offshore entity, if the consent is not given, the relevant bank might need to consider whether it could rely on illegality or other early termination provisions (if any) in the relevant agreement to unwind the trade.
Another provision under article 18 is that, before a bank develops a new type of product or ventures into new markets, the bank should make an inquiry in writing to the CBRC. One of the questions raised is the meanings of “new type of product” and “new market”. In this regard, the Notice clarifies that “new type of product” means a transaction with a new type of underlying, a new type of transaction or any new combination of underlying and transaction type which has not been entered into by the relevant bank before; and “new market” means any location or area in which the relevant bank has not been conducting business before.
If you would like to discuss any matters regarding this Alert please contact Chin-Chong Liew, Benjamin Liu or Simon Zhang
