China approves cross-currency master agreements

Lawyers hailed the release of a long-awaited master agreement for renminbi cross-currency forwards and swaps by China’s foreign exchange regulator, saying it was a big step forward in bringing onshore documentation closer to international standards.

The agreement, approved by the State Administration of Foreign Exchange (Safe) and published by the China Foreign Exchange Trade System (Cfets) on July 21, is designed to govern renminbi foreign exchange forwards and swaps, but could also be used for other transactions, lawyers said.

The agreement does not specify what the "other transactions" include, but Benjamin Liu, managing associate at Linklaters in Hong Kong, said the agreement could be extended in future to cover currency options when these are eventually allowed by the relevant government authority.

However, he said it is not clear at this stage whether the agreement could cover RMB interest rate swap transactions that are regulated by the country's central bank, People’s Bank of China (PBoC). Safe, as the regulator for foreign exchange, is not authorised to regulate RMB interest rate swap transactions.

Liu said he expects the PBoC to eventually come out with its own principal agreement to cover RMB interest rate swaps, but this is unlikely to happen in the near future as market liquidity is still very thin. "I don’t think the PBoC has any immediate plans to issue an agreement for RMB interest rate swaps as trading volume has just started to pick up," Liu said. "Ultimately, the PBoC may issue its own agreement to cover RMB interest rate swaps, or allow these transactions to be documented under the RMB-FX Forward/Swap Principal Agreement. Some market participants have already suggested to the regulators that legal and credit risks could be reduced if they are allowed to use one single principal agreement to govern all types of derivatives transactions."

The Safe master agreement was released after months of consultation with market players, including local and foreign banks. Safe had circulated two drafts to participants at a meeting in May, with one modelled after the 1992/2002 International Swaps and Derivatives Association Master Agreement and the other a more localised version with more focus on operational and settlement issues. Market participants were more positive about the Isda version, and the final guidelines were issued after making a few amendments to the draft.

The master agreement brings in key Isda concepts, such as single agreement and close-out netting – two areas the market had been keen to see covered. Both were not included in the initial regulations for forwards and swaps that were issued last August. The agreement also brings in other provisions relating to credit support, event of default under specified transaction and cross default. All RMB forwards and swaps going forward will be mandatorily covered by the agreement, and swap transactions that took place prior to the agreement will also be covered.

Among the issues market participants were concerned about was that the agreement will be governed by Chinese law. It is known that foreign banks had been keen to get Safe to use western law as the governing law as they prefer the tried-and-tested legal systems to China’s developing one. While the agreement allows parties to amend most of the provisions, there are some provisions they cannot amend, and these include the Chinese law governing provision.

The agreement also says that if there are issues not addressed by the PRC law, “market practice” may be adopted. In the case of disputes, the parties may choose to settle via either a Chinese court or through arbitration in China. If parties do not elect any arbitration forum, the case will by default be arbitrated by the China International Economic and Trading Arbitration Commission (CIETAC) in Beijing. Lawyers said the power of interpretation of “market practice” is likely to rest with the Chinese court or arbitrator.

The draft that Safe had circulated earlier had required that all disputes be resolved by the CIETAC. However, market participants felt this clause was too limiting, and the final version gives more flexibility for the use of other means of arbitration, lawyers said.

The document was issued in Chinese.