The State Administration of Foreign Exchange (SAFE) has recently released the Circular of the State Administration of Foreign Exchange on Foreign Exchange Risk Management for Foreign Institutional Investors in the Interbank Bond Market (Huifa No. 5 [2017], "Circular"). An official from the SAFE answered media questions on relevant issues.

1. What is the main background of promulgation of the Circular?

A: As the domestic bond market is liberalized, foreign institutions' participation in the domestic bond market is rising. As at the end of 2016, the foreign investors in the interbank bond market held bonds worth RMB 870 billion in total, up by RMB 83.4 billion year on year. As the two-way floating elasticity of RMB exchange rate is being strengthened, foreign investors holding RMB bonds will have the requirements for foreign exchange risk management. The foreign investors surely could manage foreign exchange risks in offshore RMB markets, but as China's foreign exchange market goes deeper, the condition will be ripe to support foreign investors to participate in China's foreign exchange market and to manage them in the bond and foreign exchange market. This Circular is released to help foreign institutional investors manage foreign exchange risks in the interbank bond market, and to boost the opening up of the bond and foreign exchange market.

2. Could you tell us what foreign institutional investors in the domestic foreign exchange market mean? Are foreign central banks and similar institutions the foreign institutional investors?

A: By definition by this Circular, foreign institutional investors in the domestic foreign exchange market are the foreign investors that meet the provisions under the Announcement No. 3 of the People's Bank of China [2016], which is consistent with the scope of opening up of the interbank bond market.

But foreign central banks and similar institutions are not foreign institutional investors, because they can participate in China's foreign exchange market through various channels and conveniently manage the foreign exchange risk exposure arising from the investments in interbank bond market, according to the Announcement No. 31 of the People's Bank of China [2015].

3. What kind of foreign exchange derivatives business are foreign institutional investors allowed to engage in?

A: To hedge against the foreign exchange risk exposure in the interbank bond market, foreign institutional investors could choose the RMB-foreign exchange derivatives laid out in the Detailed Rules for the Implementation of the Administration Measures for Foreign Exchange Settlement and Sales by Banks (Huifa No. 53 [2014]), including forward derivatives, foreign exchange swaps, currency swaps and options, and are subject to no restrictions on the trading categories within the existing types of derivatives in China's foreign exchange market.

4. How to understand the principle of transaction for actual requirements on foreign institutional investors in trading foreign exchange derivatives?

A: This principle means that foreign institutional investors trade foreign exchange derivatives to hedge against the foreign exchange risk exposure arising from the investment in the interbank bond market with remittances from abroad. In other words, the foreign exchange risk exposure under bond investment is the basis for trading foreign exchange derivatives. Under this principle, foreign institutional investors may flexibly choose foreign exchange derivative tools and use transaction mechanisms including reverse position closing, balance settlement or gross settlement, based on the foreign exchange risk exposure of a single bond or a bond portfolio that they face.

This principle is a basic requirement in the domestic foreign exchange derivatives market, inherently aligned with the prudential trading principle of the market participants. This helps maintain the order of the foreign exchange market and provides guarantees for the trading flexibility of market participants.

5. What are the policy considerations of requiring settlement agents to provide foreign exchange risk management services to foreign institutional investors?

A: Settlement agents are required to provide bond investment-related services such as trading and settlement to foreign institutional investors, in accordance with the existing policy arrangements for the interbank bond market. As a result, settlement agents could provide one-stop services covering bond investment and foreign exchange trading to foreign institutional investors in handling foreign exchange derivatives business, so as to better satisfy the investment demand of foreign institutional investors. Going forward, the SAFE will diversify the trading models for foreign institutional investors to participate in China's foreign exchange market, based on the policy arrangements for the interbank bond market.

6. Could foreign institutional investors participate in China's interbank foreign exchange market?

A: China's foreign change markets include the interbank market or wholesaling market, and the over-the-counter market, or retailing market or banking foreign exchange sales and settlement market. In the former market, financial institutions are responsible for providing market liquidity. Given that foreign institutional investors participate in China's foreign exchange market for the purpose of hedging against the foreign exchange risk exposure arising from investment in the interbank bond market, and are not the major providers of market liquidity at present, participating in the over-the-counter market as a client could fully satisfy their demand.

Foreign institutions participating in the interbank foreign exchange market shall still follow the Announcement No. 40 of the People's Bank of China and the State Administration of Foreign Exchange [2015].

7. What are the provisions on foreign exchange receipts and payments involved in the foreign exchange derivatives business handled by foreign institutional investors?

A: Where a foreign institutional investor, when handling the foreign exchange receipts and payments involved in the derivatives business under the interbank bond market investment in accordance with the Circular of the State Administration of Foreign Exchange on Foreign Exchange Administration for the Investments of Foreign Institutional Investors in the Interbank Bond Market (Huifa No. 12 [2016]), goes through the procedures for outward/inward fund remittances or foreign exchange settlement or purchases through the special account for domestic and foreign currencies directly with a settlement agent, and the currencies for inward and outward remittances are the same, the SAFE will not conduct ex-ante verification or approval.

8. Is it necessary for a foreign institutional investor to sign a master agreement with the counterparty in foreign exchange derivatives trading?

A: It is a universal practice in both domestic and foreign financial markets to sign a master agreement. The foreign institutional investor shall handle foreign exchange derivatives business with a settlement agent, and the two parties may select and sign a master agreement through consultation.

9. What are the considerations of the SAFE on the future development of China's foreign exchange market?

A: Looking ahead, the SAFE will continue to deepen the foreign exchange market, diversify trading instruments, increase the number of participants, expand opening up and refine infrastructure to better satisfy the demands for foreign exchange risk management from market participants, domestic or overseas, including the foreign institutional investors in the interbank bond market, serve the development of the real economy and support the liberalization of the financial market.