Emerging markets

The Chinese derivatives market has never been black and white – more a murky shade of grey. Even with the publication of the China Banking Regulatory Commission's (CBRC) derivatives regulations in March 2004, bankers have often had to rely on legal interpretation and opinion. And it's not uncommon to find different law firms interpreting aspects of the rules slightly differently.

This is illustrated by the emergence of equity-linked structured deposits last year. Most lawyers and dealers were under the distinct impression that banks were not allowed to touch equity derivatives with a bargepole. The regulations issued in 2004 covered all derivatives, but clearly stated that institutions would have to abide by existing regulations on equities and commodities, which are overseen by the China Securities Regulatory Commission (CSRC). As the CSRC had not released any guidance on equity derivatives, and as Chinese banking law prohibits banks from holding or dealing in shares, it was taken to mean that banks couldn't offer derivatives referenced to equity underlyings.

How wrong they were. In the middle of last year, UBS received approval to offer a US dollar-denominated structured deposit linked to the performance of the Dow Jones Industrial Average. Now, a string of dealers are looking to follow suit with deposits linked to a variety of equity indexes, including the Xinhua FTSE China 25 index.

Given the huge amount of cash sitting in Chinese bank deposits, it's no surprise that virtually every Hong Kong-based equity derivatives desk is now exploring what can and can't be done in equity derivatives. Given the absence of regulations, banks need to get case-by-case approval from the regulators.

But with no clear regulatory guidelines to refer to, there is unlikely to be 100% legal certainty on these products – remember the Guangdong International Trust and Investment Corporation (Gitic) fiasco. Then, a Chinese court ruled that a number of swaps conducted with foreign counterparties were invalid, apparently because they hadn't been properly registered by the State Administration of Foreign Exchange, even though the People's Bank of China later stated that no such registration was required.

Some Chinese retail investors are rumoured to have complained to the CBRC that they were mis-sold structured deposits. If any of these cases go to court, could the same problems that plagued Gitic affect equity-linked structured deposits?

Nick Sawyer, Editor