Oct. 12 (Bloomberg) — ABN Amro Holding NV, Credit Suisse First Boston and ING Groep NV said they plan to start offering derivatives that give Chinese companies protection against fluctuations in currencies as soon as this month, the first overseas banks to gain such access in China.
Ten banks received licenses in the past two months to trade derivatives as they bid to offer a full array of banking services in the world’s seventh-biggest economy.
The Chinese government introduced new rules on March 1 enabling overseas banks to trade derivatives directly with Chinese companies, which account for 7 percent of global trade and need to hedge their risks. Chinese banks traded a record $151.1 billion of currencies in 2003, according to the Shanghai- based China Foreign Exchange Center.
“It’s ground breaking legislation that clarifies what’s allowed,” said Paul Calello, chairman of Credit Suisse First Boston in Asia about China’s new derivatives market. “The legislation previously allowed for hedging activity only for derivatives. The new legislation allows for asset-related derivatives in credit, in fixed income and in foreign exchange, as well as hedging instruments.”
Credit Suisse will start trading currency derivatives as soon as this month, spokesman John Gallagher said. ING also plans to have its China derivatives business operating by the end of this month, said Sheel Kohli, ING’s Hong Kong-based spokesman.
Good to Go
ABN is “good to go as of this month” to start trading currency derivatives in China, Jamie McWilliam, Asia-Pacific head of derivatives marketing at ABN Amro in Hong Kong.
Derivatives are financial contracts derived from and tied to the value of debt or equity securities, currencies, commodities or other assets. The products can be used to hedge against or speculate on future price fluctuations.
Bank of Tokyo-Mitsubishi, Citigroup Inc., HSBC Holdings Plc, Industrial Bank of Fujian, Mitsubishi Tokyo Financial Group Inc., Mizuho Financial Group Inc. and Standard Chartered Plc were among the 10 banks to receive licenses to trade derivatives in China last month. Deutsche Bank AG said it received approval yesterday.
JPMorgan Chase & Co. and nine other foreign banks applied for licenses and are waiting for approval from Chinese regulators.
Bankers say there is currently no data available on the size of China’s derivatives market. McWilliam at ABN Amro estimates revenue generated from China’s interest rate derivatives market is currently about $500 million a year and growing.
The banks plan to expand their business from foreign currency hedging, through interest rate swaps to credit derivatives such as commodity and equity derivatives. The banks won’t be offering local currency products.
“This opens the way for a slice of a much bigger pie down the road,” Fraser Howie, an author of two books on China’s stock markets and a former derivatives trader at Morgan Stanley. “By allowing overseas banks to trade derivatives the Chinese government will be able to watch, learn and then regulate a market that was previously opaque to them.”
The combined value of global trading in interest rate, stock index and currency contracts was $304 trillion in the second quarter, 12 percent more than in the first quarter, said the Swiss-based Bank for International Settlements in September.
Average daily trading in the Chinese yuan against other currencies totaled $600 million in 2003, an increase of 54 percent from 2002, according to figures on the Web site of the China Foreign Exchange Center. China’s share of world trade has tripled in the past decade to about 7 percent, and the nation is the world’s third-largest importer.
Datang International Power Generation Co., the second- largest Chinese power producer listed in Hong Kong, said derivatives, such as interest rate swaps are needed to help reduce potential losses.
“With the introduction of derivatives, both sides will have a winning chance and market fluctuation risks should be reduced,” said Liu Yan, deputy director of Datang’s international relations department. “The Chinese government would like to see this happen.”
Datang in August 2001, borrowed $250 million at an interest rate of 5.17 percent fixed for 10 years, betting rates would rise. The Sept. 11, 2001, attacks on the U.S. resulted in rates falling, forcing Datang to make provisions of as much as 200 million Yuan. Recent increases in interest rates have pared some of the losses. The swap contract was arranged by JPMorgan.
Still, derivatives have their risks.
Barings Plc, the U.K.’s oldest merchant bank, folded in 1995 after Nick Leeson, its head trader in Singapore, lost more than $1.4 billion on Japanese stock-index futures.
In the same year, Shanghai International Securities Co., then China’s largest brokerage, triggered a suspension in the trading of bond futures in Shanghai. Trading of one contract on one of the government’s bonds reached 854 billion yuan on Feb. 23, 1995, as Shanghai International dumped the bonds trying to recoup losses. Futures contracts amounting to 3,000 times the underlying value of the securities were sold.
The risks involved shouldn’t prevent the government from developing these markets, said ABN Amro’s McWilliam.
“I see a much bigger risk in China not increasing the number of players in the derivatives market,” McWilliam said. “Just like every economy on the planet, China needs a derivatives market to manage risks.”
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