Light at the end of the tunnel for China derivatives

CLP: Counterparties have also pushed back against collateral calls based on mark-to-market valuations. But are these issues merely a natural part of the Chinese derivative industry's development?

CCL: Chinese banks and corporates are very concerned about risk now. Before, when they signed, they asked very few questions. Now they look at the contract in a big way.

The volume of China derivatives has receded in the last 12 months but it has been a real growth period in terms of people's understanding of them. So it's not just quantitative but qualitative. At times, it may seem like it's three steps forward, two steps back, but it's still growth.

CLP: Following Sasac's (State-owned Asset Supervision and Administration Commission) criticism of foreign banks for their “malicious” derivatives sales in December, should international financial institutions and professionals take positive steps to change this perception – for example, forging better relationships with Chinese authorities over corporate use of derivatives?

CCL: There's been serious misinformation and miscommunication over foreign banks selling derivatives to Chinese corporates. You can see this polarisation taking place and it's not a good sign. China is still a closed market. Sasac has not had much international exposure and we have a role to play in bridging that gap.

CLP: Last year, the regulator also reminded corporates that derivatives should be used for hedging alone, not speculation. Where do you draw the line between what's hedging and what's not?

MW: As a regulatory tool, the requirement for a trade to be for hedging purposes can be seen as ambiguous. If a trade goes well, it's hedging; if the trade isn't going well, people would argue that it is not hedging. So it's hard to say you can only use derivatives for hedging as that contains a great deal of ambiguity.

CCL: The focus on 'hedging' is good from a risk management perspective, but perhaps not from a legal perspective as it breeds uncertainty.

CLP: In her recent interview with China Law & Practice, Li Lian Khoo described many of these issues and obstacles as merely “growing pains” for the China derivatives industry – with the country's financial regulators committed to the markets operating in accordance with international best practices. China is reportedly keen to implement international best practice with close-out netting requirements. What progress are you seeing here?

WT: We had informal discussions with regulators at the end of 2009. They appear keen to see close-out netting become enforceable soon. But while they accept that to manage systemic risk close-out netting should apply to big institutions, there seems to be some resistance to applying it to corporates.

MW: Regulators associate bankrupt companies with big seals on doors, liquidators coming in and workers hunger striking outside the company. Close-out netting for corporates will always have to be stage two.

This article was written in conjunction with IFLR