The China Banking Regulatory Commission (CBRC) Wednesday announced the nation's first regulation on derivatives transactions, which bankers hailed as giving a strong impetus to the risky yet lucrative business.

The Interim Rules on Derivatives Business of Financial Institutions, which take effect on March 1, detail qualification requirements and required procedures for financial institutions in using financial derivatives to either hedge risks or broker for clients, and include risk control measures.

As Sino-foreign competition intensifies following China's accession to the World Trade Organization more than two years ago, financial institutions, mainly banks, are increasingly resorting to derivative products to hedge risks and improve profits, a CBRC spokesperson said.

Most of the 62 foreign banks operating in China have been offering derivatives products on the local market, while only some Chinese commercial banks have started such business, he added.

"The guideline (while drafting the rules) is to avoid opening up financial institutions' derivative product business in a simple way, but to specify qualifications, standardize trading behaviour, contain trading risk and ensure financial safety," the spokesperson said.

Commercial banks, which have been doing the business by referring to a package of foreign exchange regulations promulgated by the People's Bank of China (PBOC) and the State Administration of Foreign Exchange, welcomed the new regulation which is expected to make matters easier.

"We commercial banks have long hoped there could be something clear like this to follow," said Ling Wanma, financial derivatives division chief under the International Department of the Industrial and Commercial Bank of China (ICBC), the nation's largest local commercial bank.

Last April, the ICBC became the second local bank to win a formal approval from the PBOC, the central bank, to conduct derivatives business, a few months behind the Bank of China.

The new regulation will help standardize the behavior of commercial banks by providing a uniform rule for them to follow, and will be conducive to the long-term growth of the market, he said.

It will also give a strong boost to the business as, given the long absence of a pertinent regulation, many clients have worried about the validity of contracts.

"They can now rest assured as with legal reference and protection out there," Lin said. "The business will grow faster in the future as demand will possibly rise rapidly."

Although financial derivatives remain new to most Chinese enterprises and individuals, the market experienced great growth in recent years as businesses were increasingly exposed to foreign exchange risks.

Given the partial-convertibility of the local currency, or renminbi, nearly all financial derivatives banks offered in China are based on foreign currencies.

Lin declined to disclose the scale of his bank's derivatives business, but said about 80 per cent of the turnover comes from the brokerage business.

The bank's proprietary trading witnessed relatively slow growth as its foreign-currency liabilities did not increase fast in recent years, he added.

Local commercial banks, led by major State-owned banks like the ICBC, still hold the lion's share of China's derivatives market largely as a result of their long-standing ties with Chinese enterprises.

But foreign banks, especially those with a long local presence like Citibank and the Hongkong and Shanghai Banking Corporation Limited, are quickly gaining strong competitive edge in areas such as product development and personnel, bankers said.

More business opportunities lie in the local currency business which remains prohibited, analysts say, as China continues to move toward liberalizing the exchange rate and interest rates of its local currency.

The new regulation defines derivatives transactions as transactions the product price of which are determined by reference to one or more underlying financial assets or indices, including forward, future, swap, option and other transactions with derivatives features.

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