Provisional Administrative Rules Governing Derivatives Activities of Financial Institutions

Chapter I General Provisions

Article 1       The Provisional Administrative Rules Governing Derivatives Activities of Financial Institutions (hereinafter referred to as the Rules) is formulated in accordance with the "Law of the People’s Republic of China on Banking Regulation and Supervision", the "Law of the People’s Republic of China on Commercial Banks" and other applicable laws and regulations for the purpose of regulating and supervising the derivatives activities conducted by financial institutions, thereby effectively controlling the risks associated with the derivatives activities of financial institutions.

Article 2       The term "financial institutions" referred to in the Rules shall mean the financial institutions incorporated in the territory of the People’s Republic of China, including banks, trust and investment companies, finance companies, financial leasing companies, auto financing companies, and branches opened by foreign banks in China (hereinafter referred to as foreign bank branches).

Article 3       The term “derivatives” referred to in the Rules shall mean the financial contracts that derive their values from the prices of one or a number of underlying assets or indices, and that are basically classified as forwards, futures, swaps and options. The term “derivatives” shall also mean the structured financial instruments with the characteristics of forwards, futures, swaps, and options, and various combinations thereof.

Article 4       The derivatives activities referred to in the Rules may be classified into two types.

(1)          The first type is the derivatives transactions conducted by a financial institution for the purpose of its own profit or hedging the risks arising from its own balance sheet positions. The financial institution engaging in this type of derivatives activities is considered as the end-user of derivatives.

(2)          The second type is the derivatives services provided by a financial institution for its customers (including financial institutions). The financial institution engaging in this type of derivatives activities is considered as a derivatives dealer. Among the financial institutions acting as derivatives dealers, those further providing derivatives quotes and derivatives services for their customers or other dealers are considered as the derivatives market-makers.

Article 5       China Banking Regulatory Commission (hereinafter referred to as the CBRC) shall be in the position of regulating and supervising the derivatives activities of financial institutions. A financial institution seeking to conduct derivatives activities shall obtain a prior approval from the CBRC, and shall be subject to the oversight and examination by the CBRC.

Non-financial institutions shall not provide derivatives services for their customers.

Article 6       A financial institution engaging in derivatives activities that involve foreign exchange, stocks and commodities, or in the exchange-based derivatives activities shall comply with applicable rules and regulations including those on foreign exchange administration.

Chapter II     Regulation of Market Entry

Article 7       A financial institution applying to conduct derivatives activities shall meet the following conditions:

(1)   It shall have in place complete and sound policies and procedures for risk management and internal controls of derivatives activities;

(2)   It shall have in place a sound processing system for derivatives transactions that automatically connects the front, middle and back offices, and a real-time risk management system;

(3)   The managerial personnel in charge of the derivatives activities shall have more than five years’ experience of direct involvement in derivatives activities and risk management, and shall have a clean record;

(4)   It shall have at least: (a) two professional traders who have more than two years’ working experience in derivatives or related transactions and who have received professional training of more than six months on derivatives business skills; (b) one personnel responsible for risk management of derivatives activities; and (c) one personnel responsible for research and development of risk models or risk assessment related to derivatives activities. All such personnel shall serve in full time, shall not act concurrently in each other’s positions and shall have a clean record;

(5)   It shall have proper premises and facilities for derivatives activities;

(6)   Where the applicant is a foreign bank branch, its home country or region shall have in place a legal framework for the regulation and supervision of derivatives activities and its home country supervisor shall have relevant supervisory competence; and

(7)   It shall meet other conditions set out by the CBRC.

Where the applicant is a foreign bank branch who does not meet the aforementioned conditions of (1) to (5), it shall meet the following conditions in addition to the aforementioned conditions of (6) and (7):

(1)    It shall have a letter of authorization from its head office (or      regional head office) to specify, among others, the types and     size of the derivatives activities it is authorized to conduct; and

(2)    Except as otherwise prescribed by its head office, its derivatives    transactions shall be uniformly executed in a real time manner    through the systems run by its head office (or regional head      office), and the related transaction settlement, exposure   management and risk controls shall be   uniformly conducted at    its head office (or regional head office) level.

Article 8       Where a policy bank, a Chinese commercial bank (excluding the city commercial bank, rural commercial bank and rural co-operative bank), a trust and investment company, a finance company, a financial leasing company or an auto financing company seeks to conduct derivatives business, the application shall be filed by the applicant as a legal entity and submitted to the CBRC’s headquarters for approval.

                   Where a city commercial bank, a rural commercial bank or a rural co-operative bank seeks to conduct derivatives business, the application shall be filed by the applicant as a legal entity, and the application documents shall be submitted to the CBRC’s local office in the location of the applicant, and, following the approval of the CBRC’s local office, to the CBRC’s headquarters for final approval.

Where a foreign-funded financial institution seeks to conduct derivatives business, the application documents shall be signed by the delegated person(s) and submitted to the CBRC’s local office in the location of the applicant, and, following the approval of the CBRC’s local office, to the CBRC’s headquarters for final approval. Where the foreign-funded financial institution seeks to conduct derivatives in more than two of its branches in China, the application shall be filed by the applicant’s head office if the applicant is a locally incorporated legal entity or the applicant’s lead branch in China if the applicant is a foreign bank, and the application documents shall be submitted to the CBRC’s local office in the location of the entity who files the application, and, following the approval of the CBRC’s local office, to the CBRC’s headquarters for final approval.

Article 9       A financial institution applying to conduct derivatives activities shall submit the following documents and information (in triplicate) to the CBRC’s headquarters or local office:

(1)   an application letter, a feasibility study and a business plan or business expansion strategies;

(2)   internal management policies pertaining to derivatives activities;

(3)   accounting rules and procedures pertaining to derivatives activities;

(4)   names and biographical information of the managerial personnel in charge of derivatives activities and of the principal derivatives traders;

(5)   policies and procedures for the quantification of risk exposures and the management of risk limits;

(6)   a report of the safety test of the premises, facilities and systems for derivatives activities; and 

(7)   other documents and information deemed necessary by the CBRC.

                   Where the applicant is a foreign bank branch who does not meet the conditions of (1) to (5) provided in Article 7 of the Rules, it shall submit to the CBRC’s local office the following documents or information in addition to those provided above:

(1)      the letter of authorization issued by the applicant’s head office (or regional     head office) to authorize, among others, the types   and size of derivatives activities conducted by the applicant;     and

(2)        except as otherwise prescribed by its head office, the document     issued by the applicant’s head office (or regional head office)       to provide assurance that all derivatives transactions     conducted by the applicant shall be executed in a real time manner through the systems run by its head office (or regional head office), and the related transaction settlement,  exposure management and risk controls shall be conducted at its head office (or regional head office) level.

 Article 10  The internal management policies and procedures of a financial       institution pertaining to its derivatives activities shall at least contain the following:

(1)   derivatives business guidelines, business operating processes and procedures (the processes and procedures should reflect the segregation of duties among the front, middle and back offices) and the contingency plan for emergency situations;

(2)   parameters used for risk models and quantification;

(3)   types of derivatives activities and risk controls policies;

(4)   policies and procedures for risk reporting and internal audit;

(5)   policies and procedures for the management of derivatives activities research and development as well as for the ex post evaluation;

(6)        rules of conduct observed by derivatives traders; 

(7)        a description of responsibilities and accountability of the managerial personnel at various levels in charge of derivatives activities and of the derivatives traders, and a description of the associated incentives mechanisms;

(8)        a description of the training programs provided for managerial personnel and employees in the front, middle and back offices; and

(9)        other aspects required by the CBRC.

Article 11     Upon receiving from a financial institution a complete set of application documents and information specified in the Rules, the CBRC shall provide its decision of approval or denial within 60 days.

Article 12     Where a financial institution incorporated in the territory of the People’s Republic of China authorizes its branch or subsidiary to conduct derivatives activities, it shall conduct stringent review of the branch or subsidiary’s capability of relevant risk management and issue a letter of authorization to authorize, among others, the types and size of derivatives activities conducted by the branch or subsidiary. The branch or subsidiary shall conduct derivatives business transactions in a real time manner through the systems run by its head office, and the related transaction settlement, exposure management and risk controls shall be conducted uniformly at its head office level. 

                   Upon receiving the letter of authorization from its head office to provide or change the authorization, the branch or subsidiary mentioned in the above paragraph shall present the letter of authorization to the corresponding CBRC’s local office within 30 days.

Chapter III    Risk Management

Article 13     A financial institution shall determine whether it is positioned to conduct the derivatives business, and if it is, the appropriate types and size of its derivatives activities, by taking into account its business goals, financial strength, management competence and the risks inherent in the derivatives.

Article 14     A financial institution engaging in derivatives activities shall, in accordance with the classification of derivatives activities provided in Article 4 of the Rules, have in place risk management and internal controls policies and a transaction processing system that are consistent with the nature, scale and complexity of its derivatives activities.

Article 15     The senior management of a financial institution engaging in derivatives activities shall have adequate knowledge of the risks associated with the financial institution’s derivatives activities; shall review, approve and appraise the policies, procedures, organization and delegation of powers in respect to the derivatives activities and risk management; and shall, by establishing an independent risk management unit and a sound examination reporting system, have adequate access to the information of the risks exposed in the financial institution’s derivatives activities, and on this basis provide effective oversight and guidance on the derivatives activities.

Article 16     The senior management of a financial institution engaging in derivatives activities shall choose the parameters and methods for measuring the risk exposures in accordance with the nature and complexity of the financial institution’s derivatives activities; shall stipulate and regularly update the relevant risk limits, stop loss limits, the contingency plan in consistency with the financial institution’s overall strength, capital base, profit earning capacity and business principles as well as its projection of market risks; and shall put into place the relevant monitoring and processing procedures in accordance with the limits. The senior management in charge of derivatives activities shall be properly segregated from those in charge of risk management.

Article 17     A financial institution engaging in derivatives activities shall have in place specific requirements on the qualifications of the derivatives traders, analysts and other professional staff, and provide training for its employees involved in derivatives marketing and other related activities with the curricula designed to reflect the nature and complexity of the financial institution’s derivatives activities and risk management and intended to help the employees acquire necessary professional skills and meet the qualification requirements.

Article 18     A financial institution engaging in derivatives business shall have in place policies and procedures for assessing the suitability of its counterparties, including, among others, assessing whether the counterparties are capable of understanding the terms of the contract and of fulfilling their obligations under the contract, identifying whether the proposed derivatives transaction meets the business objectives of its counterparties, and assessing the credit risks of its counterparties.

                   When dealing with derivatives activities that involve high risks, the financial institution shall have in place specific requirements on the qualifications and obligations of its counterparties.

                   When performing as required in this article, a financial institution may to some extent rely on the written documents provided by its counterparties in good faith.

Article 19     A financial institution providing derivatives services for domestic corporations and individuals shall fully disclose to the corporations and individuals the risks associated with its services, and shall obtain from the corporations and individuals a letter of confirmation to provide the assurance that they fully understand and are capable of accommodating the risks.

                   The information disclosed by the financial institution to the corporations and individuals shall contain at least the following:

(1) a description of the terms and inherent risks of the derivatives contract; and

(2) a description of the material factors that lead to the potential loss in the derivatives.

Article 20     A financial institution engaging in derivatives activities shall make appropriate use of such credit risk cushions as collateral to reduce the credit risks of its counterparties, and develop appropriate methods and models to assess the credit risks as well as effective measures to control the risks.

Article 21     A financial institution engaging in derivatives activities shall have in place appropriate methods or models to assess the market risks arising from derivatives activities, and follow the mark-to-market approach to manage the market risks and make adjustments to the scale, scope and risk exposures of derivatives activities.

Article 22     A financial institution engaging in derivative business activities shall have in place adequate liquidity arrangements that are consistent with the scale and scope of its derivatives activities, and that provide the assurance of its ability to perform contractual obligations under abnormal market conditions.

Article 23     A financial institution engaging in derivatives activities shall have in place sound mechanisms and policies to control the operational risks.

Article 24     A financial institution shall have in place sound mechanisms and policies to control the legal risks, and stringently examine the legal status and business qualifications of its counterparties. When entering into a derivatives contract with its counterparties, a financial institution shall make reference to the relevant legal documents that prevail in international derivatives market, give due consideration to such elements as the protection of interests through legal enforcement in case of defaults, and take proper measures to prevent the legal risks that may arise during the drafting, negotiation and signing of the derivatives business contract.

Article 25     A financial institution engaging in derivatives activities shall submit to the CBRC its financial statements, statistical reports and other statements in respect to its derivatives activities.

                   The financial institution shall, in accordance with the disclosure requirements specified by the CBRC, disclose to the public the risk exposures, losses, profit changes of its derivatives activities, and, if there is any, the extraordinary situation in its derivatives activities.

Article 26     The CBRC shall have the power to examine at any time the documents and statements of a financial institution’s derivatives activities, and conduct regular examinations to check whether the financial institution’s risk management policies and internal controls as well as transaction processing system are consistent with the nature of its derivatives activities.

Article 27     A financial institution engaging in derivatives activities shall promptly report to the CBRC any significant risks and material losses incurred in its derivatives activities, and submit to the CBRC its remedial proposals.

                   The financial institution shall promptly report to the CBRC any significant changes in its derivatives activities as well as its transaction processing and risk management systems.

                   Where the cases mentioned in the preceding two paragraphs involve foreign exchange administration and external payments, the cases shall be reported at the same time to the State Administration of Foreign Exchange.

Article 28     A financial institution engaging in derivatives activities shall properly maintain, among others, all derivatives business records and related documents, accounting books, original certificates, telephone tape-recording and other materials and information. For the purpose of review, the telephone tape-recording shall be maintained for no less than six months, and other documents or materials shall be maintained for three years starting from the expiry date of the derivatives contracts, unless otherwise required by the accounting rules.

Chapter IV    Legal Liability

Article 29     Where a derivatives trader of a financial institution is found in the operation that violates the Rules or the financial institution’s internal rules, and the case causes material economic loss to the financial institution or its customers, the financial institution shall impose a penalty on the senior management, the managerial personnel and the trader that are held directly responsible for the operation. The penalty shall range from recording the personnel’s demerit to removing the personnel from the office depending on the severity of the offense. If the case constitutes a criminal offence, it shall be delivered to the judicial authority to pursue criminal liability.

Article 30     Where a financial institution is found in the unauthorized derivatives activities, it shall face a penalty imposed by the CBRC in accordance with the Rules on Penalty for Illegal Financial Activities.

Where a non-financial institution is found in violation of the Rules to provide derivatives services to its customers, the CBRC shall have the power to terminate such services and confiscate the illegal income if there is any. If the case constitutes a criminal offense, it shall be delivered to the judicial authority to pursue criminal liability.

Article 31     Where a financial institution is found in violation of the Rules to have failed to submit to the CBRC the required reports, statements and information, or to disclose the required information of its derivatives activities, it shall face a penalty imposed by the CBRC in accordance with the Law of the People’s Republic of China on Banking Regulation and Supervision, the Law of the People’s Republic of China on Commercial Banks, and the Regulation of the People’s Republic of China on Foreign-funded Financial Institutions, as well as other applicable laws, regulations and financial rules.

                   Where a financial institution is found to have provided the derivatives activities information that is proved to be false or have concealed important facts, it shall face a penalty imposed by the CBRC in accordance with the Rules on Penalty for Illegal Financial Activities.

Article 32     Where a financial institution is found to have failed to implement the risk management and internal controls policies pertaining to its derivatives activities, the CBRC shall have the power to suspend or terminate the financial institution’s derivatives activities.

Chapter V     Supplemental Provisions

Article 33     The CBRC shall have the power of the interpretation of the Rules.

Article 34     The Rules shall enter into effect on March 1, 2004, and shall prevail where there is any discrepancy between the Rules and the formerly promulgated rules in respect to the derivatives activities of financial institutions.