China Issues First Regulations Governing Derivatives Activities by Financial Institutions

By Lester Ross & Kenneth Zhou, Wilmer Cutler Pickering LLP

The China Banking Regulatory Commission (the CBRC) on February 4 2004 promulgated the Administration of Trading of Derivatives by Financial Institutions Tentative Procedures (the Procedures, effective from March 1 2004). The Procedures are the first to address the regulation of this type of trading in the history of the People's Republic of China. They provide a broad definition of financial derivatives and specify the categories of financial institutions eligible to engage in derivatives activities. The Procedures also establish unified standards and requirements for financial institutions to apply for permits to conduct financial derivatives activities. The Procedures require that financial institutions possess the necessary hardware and software to conduct derivatives businesses. "Hardware" refers to the necessary trading system, premises and facilities of a financial institution while "software" refers to the qualifications of relevant personnel, and systematic and comprehensive risk control and management policies and rules.

The CBRC and its local counterparts are responsible for examining applicants' qualifications based on a set of stringent standards. Once a financial institution is permitted to conduct derivatives transactions, it must maintain sound mechanisms and policies at all times to control and avoid operational and legal risks. Moreover, financial institutions are required to report promptly to the CBRC any significant risks and material losses incurred in their derivatives activities as well as relevant remedial measures. They also are required to report any significant changes in transaction processing and risk management systems.