Member Article

On 1 March 2004, the Provisional Administrative Rules Governing Derivative Activities of Financial Institutions were implemented by the China Banking Regulatory Commission (the "CBRC") and constituted the first set of substantive regulations governing the derivatives business in China. These rules which apply to all banks, most non-banking financial institutions and branches of foreign banks in China, require these institutions to seek CBRC approval prior to conducting derivatives business in China. The rules define the term derivative, set out the approval requirements for qualifying financial institutions and controls that such institutions must put in place when entering into derivatives transactions. On 2 December 2005, the CBRC implemented the Circular on the Relevant Issues of Business Scope of Derivatives Product Transactions by Chinese Owned Commercial Banks which lifted the prohibition on Chinese owned commercial banks engaging in derivatives transactions linked to equities and commodities. The CBRC now assess such products on a case by case basis but this circular does not apply to foreign banks or financial institutions. On 1 February 2006, the CBRC introduced the Implementation Measures on Administrative Licensing Items Relating to Foreign-Invested Financial Institutions. These licensing measures provide that a foreign owned financial institution can apply to carry on derivatives business that is not explicitly provided for in existing laws and regulations. If the CBRC does not approve an application made pursuant to these licensing measures, it must provide a reason for its refusal. The effect of such licensing measures is to put foreign banks and financial institutions and Chinese branches of foreign banks on a similar footing to Chinese owned banks in terms of the development of derivatives products which are not authorised under the 2004 Interim Rules or otherwise. Several problems remain relating to the enforceability of ISDA documentation and collateral arrangements in China. Chinese law does not currently provide for close out netting and contractual provisions for close out netting may be challenged. In response to a request from the CRBC, ISDA submitted to it a first draft of proposed netting rules in September 2005 which were based on the ISDA Model Netting Act but adapted to suit the Chinese legal system. Legislation is currently being drafted, which, it is hoped, will address this issue. In addition, problems arise relating to the use and enforcement of collateral arrangements. The concept of title transfer (as it arises in the ISDA Credit Support Annex) is not recognised by Chinese law and perfection of security involves complicated procedures.