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Recent Updates on the Opening-up of Inter-bank Foreign Exchange and Bond Markets

2020.06.09 XIE, Qing (Natasha)、ZHANG, Chi

I.Introducing Prime Brokerage Business in CFIXM


The State Administration of Foreign Exchange (SAFE) officially issued the Circular on Improving the Management of Foreign Exchange Risks Regarding Foreign Institutional Investors Trading in the Inter-bank Bond Market (Hui Fa [2020] No. 2) (“Circular [2020] No. 2”) on January 13, 2020, effective as of February 1, 2020. 


Pursuant to the Circular [2020] No. 2, foreign institutional investors eligible to trade in the inter-bank bond market (“CIBM”) may use domestic RMB/foreign exchange derivatives (“forex derivatives”) to manage their forex risk exposure arising from their CIBM investments in accordance with the hedging principle, and may choose to do so with no more than three domestic financial institutions. The Circular [2020] No. 2 sets out the following routes available to foreign institutional investors in trading forex derivatives:


Type of Institution

Trading Routes

Type of Institution

Trading Routes

Foreign bank-type investors

Trading with a domestic financial institution as its customer

Foreign non-bank-type investors

Trading with a domestic financial institution as its customer

Trading in the China Inter-bank Foreign Exchange Market (CIFXM) through engaging the prime brokerage services after becoming a member of the China Foreign Exchange Trade System (CFETS)

Trading in the CIFXM through engaging the prime brokerage services after becoming a member of the CFETS

Trading in the CIFXM directly after becoming a member of the CFETS


With respect to the options available for foreign investors to trade in the CIFXM through the prime brokerage business as specified in the Circular [2020] No. 2, on May 29, 2020, the CFETS issued the Notice on the Launch of the Prime Brokerage Business in the China Inter-bank Foreign Exchange Market (the "Notice") and the Guidelines for the Prime Brokerage Business in the China Inter-bank Foreign Exchange Market (for Trial Implementation) (the “Guidelines”) for official implementation of the provisions of Circular [2020] No. 2. 


According to the Notice, the prime brokerage business in the CIFXM refers to a client using the credit facility and/or in the name of a prime broker to enter into forex transactions with counterparties via the prime brokerage function on the CFETS Trading System. 


We briefly summarize the key points specified in the Notice and the Guidelines that may be of particular interest to foreign investors in the following table: 


Prime 

Brokerage 

Client

Foreign investors, who satisfy requirements in the Announcement No. 3 [2016] of the People’s Bank of China (“No. 3 Announcement”) and other relevant regulations to enter the CIBM through the CIBM Direct program, including foreign non-bank-type investors and foreign bank-type investors that intend to participate in the prime brokerage business, may file with the CFETS to become a prime brokerage client.

Prime 

Broker

Domestic market makers in the interbank RMB/FX market or market makers and members in the interbank G10 currency pairs market may file with the CFETS to become a prime broker for corresponding market. A prime brokerage client may engage one or more prime brokers.

Applicable 

Market

  • RMB/FX market (currently only available to the CIBM Direct program)

  • Inter-bank G10 currency pairs market

Available

Products

  • RMB/FX Market: Prime brokerage clients in this market may act as a “Taker” to trade forex forwards, swaps and other forex derivatives through bilateral RFQ and other trading modes, for the purpose of hedging against the forex risks arising from their investment in the CIBM.

  • G10 Currency Pairs Market: Prime brokerage clients in this market may act as a “Maker” or “Taker” to trade spot, forward, swap and other derivatives transactions in G10 currency pairs, through modes of matching (ODM), bilateral trading (including RFQ and ESP), and other trading modes.

Available

Trading

Modes

  • Anonymous Mode: Anonymous trading occurs when prime brokerage clients execute trades with counterparties but do not reveal their identities throughout the process.

  • Real Name Mode: Prime brokerage clients and counterparties are aware of the identity of each other in the course of executing trades.

Requirement

on

Agreement

Anonymous Mode: Execution of an agreement between prime broker client and prime broker.

Real Name Mode: Execution of a tripartite agreement among prime broker client, prime broker and counterparty.

  • An agreement shall specify the conditions and restrictions for the prime broker to provide services to its prime brokerage clients such as trading products, currency, term of trading, trading quota, risk exposure, settlement method and division of responsibilities.

  • Such agreement shall be filed by prime broker with the CFETS. Prime broker shall promptly notify of the CFETS in the event of any amendment to or termination of such agreement.

Hedging 

Principle

  • The exposure of a foreign investor to forex derivatives shall be reasonably correlated with its forex risk exposure, and corresponding adjustments shall be made upon the occurrence of any change.

  • A foreign investor shall submit undertakings in writing with the domestic financial institutions or the CFETS to document its compliance with the hedging principle.


Prime brokerage business is of great significance to foreign exchange market participants, because it lowers the threshold for a prime brokerage client to enter the market. Customers -- who would have had to enter into an agreement with each counterparty, obtain a credit facility or even provide additional collateral -- may enter into trades with more counterparties in the market through the credit and trading services offered by a prime broker with a high rating. To start trading, a prime broker client only needs to contract with a prime broker, and then conduct transactions with counterparties rightly after obtaining a one-time credit approval. Each prime brokerage transaction will then be automatically split into two back-to-back trades by the CFETS Trading System: one between the prime broker and the counterparty, and one between the prime broker and the prime brokerage client. The Guidelines also explicitly mention that the main purpose of offering prime brokerage services is to facilitate market participants who cannot conduct trades due to restrictions of credit facility or trading quota and allow them to enter into forex trades through prime brokers. Launch of prime brokerage business by the CFETS enables foreign institutional investors to choose one or more prime brokers to enter into forex derivative trades with more counterparties, further facilitating foreign institutional investment in the CIBM. 


II.Introducing More Measures of Opening-up in the CIBM


At an online conference held on May 30, 2020, a spokesperson for CFETS mentioned the following plans for the CIBM:

  • Extending CIBM trading hours


At present, the trading hours of T+0 transactions including the purchase and sale of cash bonds, pledge repo, outright repo, cash bond lending and bond forward in the CIBM ends at 16:50 p.m. Beijing time, and the trading hours of T+1 transactions and interest rate swap ends at 17:00 p.m. Beijing time. Initially, the CFETS plans to extend the trading time to 20:00 Beijing time with the intention of gradually aligning CIBM’s trading hours with that of the global market. 


  • Promoting more participation in the interest rate derivatives market


With the promulgation of No.3 Announcement, foreign institutional investors may carry out not only trading of cash bonds, but also other type of trading such as forward rate agreement or interest rate swaps based on the needs of hedging. In addition, CFETS announced the trial operation of interest rate options trading and related services starting from March 23, 2020. The linked target is the loan quotation rate (LPR), i.e. LPR1Y/LPR5Y interest rate swap options and interest rate upper/lower limit options. Notably, the CFETS is continuously promoting the expansion of interest rate derivatives market, diversifying product types and formulating ancillary policies. As for the next step, we may expect an expansion of the scope of trading to include interest rate derivatives under the northbound trading of the Bond Connect program as well. 


  • Launching a direct trading function in the CIBM Direct program


Foreign institutions under the CIBM Direct program will be able to conclude transactions with domestic market makers directly. 

The aforesaid opening-up measures aim to improve the services and provide convenience for foreign investors to enter the CIBM and to attract foreign institutional investors to enter the inter-bank foreign exchange and bond markets. We will continue to monitor the situation and keep our clients apprised of any important developments. 

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