China to start FX Swaps

China’s aim to be a true liberal economy is heading in the right direction as the state regulator for FX

China’s aim to be a true liberal economy is heading in the right direction as the state regulator for FX over comes another hurdle and sets out the new offering of FX Swaps. The State Administration of Foreign Exchange (SAFE) announced Monday that China’s financial institutions will be allowed to carry out currency swaps without exchanging principal starting June 11.

Currency swaps, a contractual agreement which involves the exchange of principal and interest payments in one currency for an equivalent amount in another currency over a certain period of time, have been used by China’s financial institutions since 2007, according to the People’s Bank of China (PBC).

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By abolishing the compulsory requirement to swap the principal in currency exchanges, the government has lowered the cost of transacting the trade to expand the use of the lightly traded product, Chen Xuebin, deputy director of the Institute for Financial Studies at Fudan University, told the Global Times.

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“Until now, only banks that needed to do barter transactions – that is, to exchange two currencies – would use currency swaps. But with the new regulation, I expect the product will also attract financial institutions who want to hedge against, or speculate on, interest rate risks from foreign currency-denominated debts,” Chen said.

This latest move is among a set of policies unveiled this year which aim to open the country’s foreign exchange market, explained Chen. In April, the PBC widened the yuan’s trading band against the US dollar to 1 percent above or below a daily reference rate, up from its previous 0.5 percent trading range. Also, on June 1, China and Japan started direct trading of the yen and the yuan.

In the notice released Monday, the SAFE also simplified the registration procedures for financial institutions to enter the currency swap business. Institutions that are allowed to trade foreign exchange forward contracts will automatically be qualified to transact currency swaps, the foreign exchange regulator said.

But, as foreign exchange derivatives require much expertise, the trading volume is expected to stay small after the new regulations take effect, exerting little influence on the foreign exchange market in the short run, said Zhou Yu, director of the Research Center of International Finance at the Shanghai Academy of Social Sciences.

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