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Notice on Further Strengthening the Risk Management of Derivative Product Transactions between Banking Financial Institutions and Institutional Clients
Yin Jian Fa [2009] No.74
In order to further regulate the management of derivative product transactions between banking financial institutions and their institutional clients, effectively prevent the risks and promote the healthy development of derivative product business, the CBRC issued the following notice.
ARTICLE 1 Banking financial institutions shall place great emphasis on the risk management of the derivative product transactions with their institutional clients, carefully assess the risks in each phase of such transactions, including the suitability of institutional clients and their real underlying demand, sales management, information disclosures, risk control, appraisal and incentive mechanism, post-sales evaluation, legal documentation and management information system, etc. and shall strengthen the risk prevention in the phases with weakness.
ARTICLE 2 Banking financial institutions shall formulate or improve suitability assessment for institutional clients and fully assess the suitability for each derivative product transaction, taking into account the classification of derivative products and institutional clients, including:
(a) assessing the risks and complexity of derivative products traded with the institutional clients and classifying the derivative products accordingly, reviewing the classification at least once a year and conducting corresponding dynamic management; and
(b) assessing the sophistication of the institutional clients based on their business nature and derivative product transaction experience and classifying the institutional clients accordingly, reviewing the classification at least once a year and conducting corresponding dynamic management.
ARTICLE 3 Banking financial institutions shall, based on the suitability assessment result, conduct derivative product transactions with the institutional clients that have matching risk tolerance and real underlying demand, and shall obtain the written documents from the institutional clients proving their real underlying demand, such as statement or confirmation, including but not limited to the following contents:
(a) the authenticity of the underlying assets or underlying liabilities directly linked with the derivative product transactions;
(b) the purpose or objective of the institutional clients for conducting the derivative product transactions; and
(c) whether there is any unsettled derivative transaction exposure linked with the underlying assets or underlying liabilities confirmed in paragraph (a) of this article.
ARTICLE 4 There shall be reasonable relevance between the key risk characteristics of the derivative products traded between banking financial institutions and their institutional clients and the key risk characteristics of the underlying assets or underlying liabilities as the real underlying demand. Banking financial institutions are prohibited to take the RMB debts of institutional clients as the underlying demand to conduct derivative product transactions linked to non-RMB market indicators.
ARTICLE 5 Banking financial institutions qualified for derivative product transactions are entitled to conduct such business with institutional clients based on their underlying demand. In the marketing and trading process, priority shall be given to the basic and simple derivative products which banking financial institutions are capable to price and value.
ARTICLE 6 Banking financial institutions shall formulate or improve the system of internal training, qualification verification and authorization management on the derivative product salesmen, strengthen the continuous professional training and professional integrity education, timely follow up with the training and qualification verification for new products and new business and establish strict liability system. Only salesmen duly qualified and authorized are entitled to introduce and market derivative products to the institutional clients. When introducing derivative products to institutional clients, salesmen shall, in a proper manner, explicitly inform the institutional clients that their qualifications have been verified internally and they have been validly authorized.
ARTICLE 7 Banking financial institutions shall provide the institutional clients with written documents containing the introduction of the derivative products and risk disclosure in clear, understandable and brief expression, including but not limited to:
(a) complete introduction of the product structure and basic transaction terms and complete legal documents of such a product;
(b) explanation on the index linked with the product, rate of return or other parameters;
(c) disclosure of major risks associated with the transaction;
(d) product cash flow analysis and stress test, simulation of worst case senario analysis and greatest cash flow loss based on certain assumptions and confidence level, and the rationale analysis of the abovementioned assumptions and confidence level; and
(e) other information which should be fully disclosed to the institutional clients.
ARTICLE 8 Before entering into the derivative product transactions with institutional clients, banking financial institutions shall obtain the written documents from the institutional clients, such as statement or confirmation, including but not limited to:
(a) compliance of the derivative product transaction to be conducted with the institutional client;
(b) whether the signing persons of the documents such as the agreement and instruction of the derivative product transactions are duly authorised;
(c) whether the institutional client fully understands the terms and risks of the derivative product transaction and whether such a transaction complies with the purpose or object confirmed in Article 3(b);
(d) whether the institutional client is capable to sustain the worst situation of the derivative product transaction described in Article 7(d); and
(e) other matters which need to be stated or confirmed by institutional clients.
ARTICLE 9 Banking financial institutions shall strengthen the authorization management over the branches conducting the derivative product transactions. For the branches which have relatively weak capability of operating derivative products and poor risk prevention or management, the banking financial institution shall shift the authorization to a higher level as appropriate; for those where material risks of derivative product transactions incur, the banking financial institution shall revoke its authorization to such branches in a timely manner.
ARTICLE 10 Banking financial institutions shall state the profit and risks of the derivative products on sale in an objective and fair manner during the marketing process. Banking financial institutions are prohibited to mislead the institutional clients' views on the market, exaggerate the strong points or minimize the risks of such products, or make any commitment on the return to institutional clients in any manner.
ARTICLE 11 Banking financial institutions shall fully respect the independent discretion of institutional clients and are prohibited to conduct the derivative product transactions as the additional condition to conduct other businesses or products with the institutional clients.
ARTICLE 12 Banking financial institutions shall market the derivative products independently. Banking financial institutions are prohibited to market the derivative products to the institutional clients jointly with the sales staff engaged by offshore institutions in any manner (including in any disguised way) and are prohibited to enter into derivative product transactions by accepting institutional clients' designated offshore institutions as counterparty in back-to-back square-off transactions.
ARTICLE 13 Banking financial institutions shall choose relevant credit and credit risk mitigation measures based on the institutional clients' credit rating, financial status, profitability, net asset and cash flow, etc. Credit without credit risk mitigation measures shall be adopted cautiously in the derivative product transactions with the institutional clients and those institutional clients below certain credit rating shall be restricted from derivative product transactions.
ARTICLE 14 Banking financial institutions shall establish or improve relevant credit risk management system for the derivative product transactions and shall clarify the specific manners or amount/ratio of the credit risk mitigation measures to be adopted by banking financial institutions when the derivative products traded with institutional clients are in mark-to-market loss or cash flow loss, such as requiring institutional clients to provide additional margin or collateral or provide qualified security. Banking financial institutions shall explicitly explain to institutional clients in an appropriate manner about the potential influence of the risk mitigation measures on institutional clients.
ARTICLE 15 Banking financial institutions shall pay attention to all the risks in the back-to-back square-off transactions, in particular, the credit risk of institutional clients and the offshore counterparties, impact of the market value change of the derivative products on the credit risk, risk of applying different laws for onshore and offshore transactions and the reputation risk.
ARTICLE 16 Banking financial institutions shall, after the transaction, provide market information of the derivative products to institutional clients in a timely manner and shall re-value the market price of such products at least once a month. Banking financial institutions shall provide the result of the re-valuation (in the form of valuation report, risk warning letter, etc.) to institutional clients through recordable ways such as mail, email and fax, etc. and ensure relevant documents are delivered to the institutional clients in a timely manner. When the market fluctuates greatly, the frequency of the re-valuation shall be increased and the result of such re-valuation shall be provided to institutional clients in a timely manner. Banking financial institutions shall review the frequency and quality of the abovementioned market value re-valuation at least once every half-year.
ARTICLE 17 Banking financial institutions shall improve their capability on innovation, transaction management and risk management, and shall cautiously engage in the derivative product transactions which they are not capable to value. For the derivative products which banking financial institutions are not capable to value, banking financial institutions shall obtain from the quote provider the essential parameters and information for valuing the products and provide such information to institutional clients through recordable ways such as mail, email and fax, etc. in order to increase the transparency of the market value re-valuation process.
ARTICLE 18 Banking financial institutions shall set reasonable profit target for the derivative product transactions with institutional clients and formulate scientific and reasonable appraisal and long-term incentive and restriction mechanisms to guide relevant departments and persons to perform in integrity and compliance. Banking financial institutions are prohibited to pursue the profit excessively or directly link the profit generated from derivative product transactions with institutional clients with employees' salaries, or profit target or appraisal and incentive mechanism of their departments.
ARTICLE 19 Banking financial institutions shall establish or improve the regular post-sales evaluation system for the derivative product transactions with institutional clients, including the regular post-sales evaluation on the internal management systems such as sale compliance, risk control and appraisal and incentive mechanism. In addition, banking financial institutions shall establish or improve the regular client review system with institutional clients through recordable ways such as on-site visit, email, fax, telephone recording, etc. to listen to the opinions of institutional clients on sales compliance and risk disclosure etc. and give feedbacks in a timely manner.
ARTICLE 20 Banking financial institutions shall establish or improve the appraisal and management system on the legal documents of derivative product transactions such as the master agreements and contracts, etc. and effectively prevent relevant legal risks by appraising relevant transaction agreements and contracts, their force and effect at least once every half-year based on the status of institutional clients and the transaction counterparties and by further understanding and grasping the texts of relevant agreements and contracts which apply domestic or foreign laws.
ARTICLE 21 Banking financial institutions shall establish or improve relevant management information system for the derivative product transactions to ensure the completeness and effectiveness of the management information which is classified by product or by counterparty.
ARTICLE 22 This notice shall apply to restructuring the existing derivative products traded between banking financial institutions and their institutional clients. Institutional clients referred to in this notice mean the clients other than individuals and financial institutions.
Banking financial institutions are required to formulate implementing rules based on the requirements of this notice, improve relevant management systems and submit written reports in two copies to the CBRC on the implementation and improvement by 31 October 2009.
The CBRC local offices shall forward this notice to all legal person banking financial institutions and the managing branch or single branch of the foreign banks in your local area.
31 July 2009
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