Exchange Settlement and Exchange Surrendering Regulatory Update

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1 Exchange Settlement and Exchange Surrendering Regulatory Update By Lisa Yu, Banking Regulatory Intelligence Expert, Wolters Kluwer Financial Services The term Exchange Settlement and Exchange Surrendering refers to RMB vs foreign currency exchange services in which a bank either buys foreign currency and sells RMB in an exchange settlement, or sells foreign currency and buys RMB in an exchange surrendering. Generally, it can be divided into business of exchange settlement and exchange surrendering, and the business of derivatives of RMB and foreign currencies, including forwards, options and swaps. Since 2014, The People s Bank of China and the State Administration of Foreign Exchange, have issued multiple circulars including the Decree of the People s Bank of China [2014] No.2 Administrative Measures on Foreign Exchange Settlement Business of Banks 1 (herein after referred to as Administrative Measures on Foreign Exchange Settlement); Hui Fa [2014] No.53, Rules for Implementation of Administrative Measures on Foreign Exchange Settlement Business of Banks 2 (herein after referred to as Implementation Rules); Hui Fa [2014] No.48, Notice of the State Administration of Foreign Exchange on Adjustments to Polices for the Administration of Financial Institutions' Access to the Interbank Foreign Exchange Market 3 (herein after referred to as Market Entrance Policy). The purpose of these regulations is to change the function of foreign exchange management, to simplify supervisory procedures and to lower the market entrance level for foreign exchange settlement business. Main updates The main revisions outlined in the Administrative Measures on Foreign Exchange Settlement include: Simplify the qualification approval procedures and lower the market entrance level: Banks may simultaneously apply for the qualification for both the business of spot exchange settlement and exchange surrendering, and the business of derivatives of RMB and foreign currencies. Until the new regulation is launched, banks have to separately apply for the above qualifications step by step. 1 Issued by the People's Bank of China on June 22, 2014 and became effective on August 1, Issued by the State Administration of Foreign Exchange on December 25, 2014 and became effective on January 1, Issued by the State Administration of Foreign Exchange on December 05, 2014 and became effective on January 1, 2015.

2 Banks may simultaneously apply for the qualification for both the business of spot exchange settlement and exchange surrendering, and the business of derivatives of RMB and foreign currencies. Until the new regulation is launched, banks have to separately apply for the above qualifications step by step. Lower the entrance level for the bank to enter the foreign exchange settlement market, further streamline administration procedures, delegate powers and simplify market entrance management. For example, the requirement of practitioners passing the exams organized by SAFE is no longer compulsory, and now the only related requirement is relevant working experience. Change the bank s foreign exchange settlement position management function and grant more power to the bank s self-management, to bring banks initiatives into full play: Delete certain items, for example, "(The bank shall) apply for the limit of turnover position for foreign exchange settlement from SAFE within 30 business days from the date on which the qualification of foreign exchange settlement business is obtained", " the bank shall not hedge foreign exchange settlement demand of capital and financial projects without the approval of SAFE ", "major foreign exchange settlement registration mechanism", "qualification review mechanism for the governor and the in charges of foreign exchange settlement". Modify certain items, for example, "the bank can self-decide the quotation currency and its exchange rate in accordance with relevant regulations", the assessment on comprehensive position of foreign exchange surrendering is changed from daily to fixed interval, all of which have sowed the seeds for further modification of regulations by SAFE. Simplify penalty provisions by using the foreign exchange management regulations. The original penalty provisions clearly specified the circumstances for the suspension and cancellation of qualifications for foreign exchange settlement business. And foreign exchange management provisions are applied in the Administrative Measures on Foreign Exchange Settlement, which has significantly simplified the penalty provisions. Other provisions. In the Administrative Measures on Foreign Exchange Settlement, specific provisions on the management of the bank s own foreign exchange settlement business and the management of clients foreign exchange settlement business by the banks are deleted.

3 Main revisions in the Implementation Rules are as follows: The assessment cycle for the comprehensive position management of foreign exchange settlement is changed from daily to weekly. It is required that the bank should keep the average position of each business day in the week within the limit set by SAFE, thus improving the flexibility of foreign exchange position application as well as the flexibility for holding foreign exchanges. Cancel the policy that the comprehensive position of foreign exchange settlement should be linked to foreign exchange loan-to-deposit ratio. The linkage policy in 2013 is a temporary measure for controlling capital inflow and excessive increase of foreign exchange reserve and is no longer necessary. Delegate the power of approving the conversion of the bank s capital (working capital) between local currency and foreign currency, and cancel the approval of foreign exchange settlement handled by the bank for debtors. Integrate relevant regulations on the market entrance of the bank s foreign exchange settlement business, management on spot exchange settlement and exchange surrendering business, management on derivatives of RMB and foreign currencies, and comprehensive position of banks foreign exchange settlement. Subsequent influences Administrative Measures on Foreign Exchange Settlement, Implementation Rules and Market Entrance Policy are important measures to adapt to the development of foreign exchange settlement business and the change of foreign exchange management functions. They are also helpful to enrich the varieties of foreign exchange product varieties and transaction subjects and to drive healthy developments of the foreign exchange market. The subsequent influences include the following:

4 Improve the compliance requirements of relevant businesses and standardize the operating procedures of RMB derivatives business. Before 2014, the role played by option products was limited as the foreign exchange market in China had unilateral appreciation expectations. Since the beginning of 2014 the foreign exchange rate has been changed for a two-way fluctuation and the demand of foreign exchange products, such as options and swaps, has been increased continuously. As a result, the bank should enhance customer risk exposure and internal risk management when handling businesses on derivatives of RMB and foreign currencies, and should carry out the business in a prudent and compliant manner by following three principals for business operations, further controlling the operating procedures for foreign exchange products and improving competitiveness. Reduce administrative intervention and approval, and promote the reform of RMB exchange rate marketization. Administrative Measures on Foreign Exchange Settlement and relevant implementation rules reflect the direction of RMB exchange rate marketization and RMB globalization, and deepen the policy intention of the regulators to promote RMB two-way fluctuation. Moreover, SAFE also issued the Implementation Rules to support the banks to increase foreign exchange products and to lower the market entrance level for some products. Together with the Administrative Measures on Foreign Exchange Settlement, these measures will enhance the foreign exchange market and provide more foreign exchange risk hedging instruments for enterprises and market subjects under the current twoway fluctuation foreign exchange market. Streamlining of administration and power delegation will give more freedom to the banks for foreign exchange settlement, so that the banks can use derivative instruments for hedging and can reduce the loss of foreign exchange fluctuation resulting from regulatory approval. Management measures by the banking industry The banks should transform the foreign exchange system in accordance with relevant regulatory provisions, and the original parameters in the system for daily control should be modified, particularly after the assessment cycle of comprehensive position in foreign exchange settlement changing from daily to weekly.

5 Establish and improve risk management systems to dynamically monitor the position of all currencies. The new regulations also propose higher requirements on the internal control process of the bank while granting more power to the bank for foreign exchange settlement business. The bank should establish and improve risk management systems for foreign exchange settlement business and should establish its operation and risk management assessment systems to cope with regular external evaluation by SAFE. Pay attention to the foreign exchange rate risk pricing. Along with opportunities to enrich products, the new regulations also bring intense competition and foreign exchange market risks. The bank should, considering its business characteristics, manage foreign exchange market risks by hedging with derivatives in a prudential manner. Please visit WoltersKluwerFS.com for more information.