2019.11.26 XIE, Qing (Natasha)、Austin Zhang
On November 14, 2019 the State Administration of Foreign Exchange (SAFE) issued the Consultation Paper of the Circular on Improving the Management of Foreign Exchange Risks Regarding Foreign Institutional Investors Trading in the Interbank Bond Market (“Consultation Paper”) to solicit public comments.
Pursuant to the Consultation Paper, all foreign institutional investors that are allowed to trade in the interbank bond market under the Announcement No.3  issued by the People’s Bank of China (PBOC) may use the domestic RMB/foreign exchange derivatives (“forex derivatives”) to manage their forex risk exposure in the interbank bond market in accordance with the hedging principle.
The Consultation Paper outlines the routes available to foreign bank-type institutions and non-bank-type institutions in trading forex derivatives:
(i)For bank-type institutions, they may trade via three routes: (a) trading with a domestic bank as its customer; (b) trading in the interbank forex market directly after becoming a member of the China Foreign Exchange Trade System (CFETS); or (c) trading in the interbank forex market through engaging the prime brokerage services after becoming a member of the CFETS.
(ii)For non-bank-type institutions, they can only trade through the aforesaid routes (a) and (c).
Additionally, if a foreign institutional investor decides to trade forex derivatives with domestic banks as a bank customer, it may do so with no more than three domestic banks and shall file the list of those banks with the CFETS before commencing trade. In the event that a foreign institutional investor decides to move to any other domestic bank, it shall file the proposed change to the CFETS before commencing trade with the new bank(s).
We note that the Consultation Paper reiterates some basic principles under the Circular on Issues Concerning the Management of Foreign Exchange Risks Regarding Foreign Institutional Investors in Interbank Bond Market issued by the SAFE (“Circular  No.5”). For example, the exposure to forex derivatives shall be reasonably correlated with the forex risk exposure.
Unlike the Circular  No.5 which allows foreign institutional investors to trade forex derivatives only out of real necessity, the Consultation Paper merely requires the foreign institutional investors to manage their forex risk exposure in accordance with the hedging principle and to submit written undertakings with the domestic banks or the CFETS to document their compliance with the hedging principle before commencing trade.
Moreover, unlike the Circular  No.5, which provides that foreign institutional investors can only trade forex derivatives via their settlement agency banks, the Consultation Paper allows a foreign institutional investor to engage banks other than its settlement agency bank to facilitate its trading of forex derivatives. Under this mechanism, foreign institutional investors may reduce their hedging costs by trading via banks charging lower fees, thereby optimizing the management of forex risks in regard to their bond investments.
Once the Consultation Paper is officially implemented, it will supersede the Circular  No.5.
Following the Circular on Further Facilitating Investments by Foreign Institutional Investors in Interbank Bond Market issued jointly by the SAFE and the PBOC in September 2019 (please refer to JunHe Client Briefing: PBOC Consultation on Allowing Transfer of Bonds and Funds between QFII/RQFII and CIBM Direct Accounts), the Consultation Paper proposes to further facilitate the investments by foreign institutional investors in the interbank bond market, which is expected to be another measure facilitating the further opening up of the domestic interbank bond markets.
We will continue to monitor the situation and keep our clients apprised of any important developments.