China bond forwards represent move to more open market

The start of trading in bond forwards in China is a necessary step towards a more open market, but underlying markets are still too illiquid to allow other derivatives to be traded, said HSBC treasurer for China David Liao.

Trading in bond fowards opened last week on the Shanghai market, a move back towards liberalisation after the derivatives clampdowns by the Chinese government in 1995 and 1999.

Any licensed bank or corporation can now trade bond forwards with a contract length of less than 365 days, so long as the size of the contracts falls within a limit set by the buyer's own capital strength. But further classes of derivatives will probably have to wait for the underlying market to evolve, Liao said.

"The key to the success of China's financial market is to promote a liquid and representative underlying market. I expect the primary focus by regulators would be to continue to work on the liquidity of existing markets, such as the government bond market, People's Bank of China bill market and money market," Liao told RiskNews. "Once these markets are liquid and representative, you would have a useful foundation to build credible fixings for a swap market, credit spreads for corporate bonds, etc," he added.

The opening up of the bond futures market follows the publication last year of the China Banking Regulatory Commission's long-awaited derivatives regulations. The new rules mean that licensed local and foreign banks can trade derivatives on their own account. Previously, derivatives could only be used for hedging and not for speculative purposes.

The regulations also allow foreign banks to carry out business with domestic corporate clients in China. Previously, they could only trade foreign-currency denominated derivatives with Chinese institutions that had appropriate foreign exchange licenses (See: Asia Risk, September 2004, page 32; December, page 6)).

However, despite the new regulatory framework, the situation is still not entirely clear, said Liao. "The derivatives regulation stipulated by the China Banking Regulatory Commission (CBRC) specifies that license holders can trade derivatives for profit. However, the environment for a derivatives market in China is not entirely clear, as corresponding regulations for insurance companies, securities companies and funds are governed under different regulatory bodies, and have yet to appear," he said. "Products are also governed under different regulators, so the process to obtain approval is still unclear for cases where, for example, a bank (governed under CBRC) tries to structure an overseas equity index product (governed by the China Securities Regulatory Commission)."