Q1: To which investment models for the interbank bond market does the Circular apply with regard to the improved management of foreign exchange risk?

A1: The Circular applies to direct investments in the interbank bond market i.e. CIBM Direct, and does not apply to bond investments under Bond Connect, QFII or RQFII, or by foreign central banks and similar institutions. The Circular also applies to investments in bonds transferred from QFII/RQFII program to the CIBM Direct program through a non-trading transfer.

Q2: Can foreign institutional investors change their foreign exchange hedging channels?

A2: Foreign institutional investors (“foreign investors”) may freely choose among the foreign exchange hedging channels listed in Articles 2 and 3 of the Circular, and change them as necessary, but they have to choose either “entering and trading on the interbank foreign exchange market” or “trading directly with domestic financial institutions as their customers,” not both. 

Q3: For foreign investors who choose to directly trade with domestic financial institutions as their customers, do “domestic financial institutions” also include settlement agents?

A3: When foreign investors trade directly as customers with domestic financial institutions, the latter can be settlement agents or other domestic financial institutions, but at most three may be chosen.

Q4: What types of foreign investors are allowed to trade foreign exchange derivatives in China?

A4: Pursuant to Public Notice No. 3 [2016] of the People’s Bank of China (PBC), foreign investors include (i) commercial banks, insurance companies, securities companies, fund management companies, and other asset management or financial institutions duly registered or incorporated outside the Chinese mainland; (ii) investment products lawfully issued by the aforementioned institutions; and (iii) pension funds, charity funds, endowment funds, and other medium and longterm institutional investors confirmed by the PBC. Therefore, the answer to whether a foreign investor is trading foreign exchange derivatives as an institutional entity or an investment product, is dependent on the identity of the investor in the interbank bond market.

Q5: What is “prime brokerage” mentioned in the Circular?

A5: Prime brokerage is transaction model whereby a foreign investor (the prime brokerage client) enters into a trade using the name and credit limit of a domestic financial institution (the prime broker). Specific guidelines will be published by the China Foreign Exchange Trade System (CFETS) in due course.

Q6: What is the foreign exchange exposure of foreign investors in the interbank bond market?

A6: “Foreign exchange exposure,” or exchange rate exposure, refers to the position (including principal, interest, and market value of a bond investment) of a foreign investor in the interbank bond market that is exposed to volatility in RMB exchange rate when investing in RMB-denominated bonds with inward remittances. Foreign exchange exposure is a precondition for foreign investors to establish a position in foreign exchange derivatives in the domestic market.

Q7: If foreign investors invest in the interbank bond market with inward RMB remittances, can they manage foreign exchange risk inthe domestic market?

A7: Regardless of whether investment is made with inwardly remitted RMB funds or inwardly remitted foreign currencies, foreign exchange exposure arising from a bond investment can be managed with foreign exchange derivatives offered in the domestic market.

Q8: Do domestic financial institutions need to review the genuineness and reasonableness of the foreign exchange derivatives transactions when trading with foreign investors?

A8: The Circular requires foreign investors to submit a written commitment to domestic financial institutions or CFETS, undertaking that they will engage in relevant transactions for hedging purposes, before they trade any foreign exchange derivatives. On this basis, domestic financial institutions need not to specifically review the genuineness and reasonableness of the needs of foreign investors.

Q9: Article 5 of the Circular provides that where foreign exchange exposure changes due to a change in bond investments, foreign investors should adjust their position in foreign exchange derivatives within five working days or within the first five working days of the following month.How are the five working days counted?

A9: “Five working days” means that the time interval from the date that the change in bond investment takes effect (exclusive), or the last working day of the month (exclusive), to the trade date on which position in foreign exchange derivatives is adjusted, should be no longer than five working days.

Q10: Are there any rules for the terms of a foreign exchange derivatives trade (such as trading model, currency, tenor, and price) conducted by foreign investors for bond investments?

A10: When foreign investors trade directly with domestic financial institutions as their customers, they may choose forwards, foreign exchange swaps, currency swaps and options, and other product combinations. The terms of the trade – such as currency, tenor, and price – should be determined by the trading parties in accordance with market principles. Foreign investors trading in the interbank foreign exchange market, either directly or through a prime broker, must abide by the rules of that market.

Q11: Can foreign investors hedge risks with foreign exchange swaps and currency swaps through domestic financial institutions other than settlement agents?

A11: The near- or far-leg of a swap is a part of the overall transaction, not a separate spot or forward trade. Foreign investors may, after completing inward remittance, engage in foreign exchange swaps or currency swaps by exchanging their foreign currency funds for RMB on the near-leg through channels (including but not limited to settlement agents) specified in the Circular, according to their investment and hedging needs. The RMB funds obtained in a swap should be used for investment in the interbank bond market, and the foreign exchange exposure arising from such investment should substantially correspond to their position in the swap transaction.

Q12: How are option premiums and gains/losses arising from foreign exchange derivatives trades handled?

A12: Trading foreign exchange derivatives may give rise to option premiums and gains/losses (in RMB or foreign currencies) from rollover, close-out, net settlement, etc. These receipts and payments should be managed through foreign investors’ special RMB and foreign exchange accounts, and may be exchanged for RMB or foreign currencies as needed.

Q13: If a foreign investor chooses the first channel listed in Articles 2 and 3 of the Circular and its counterparty is not a settlement agent, is the foreign investor required to open a special foreign exchange account at relevant financial institution?

A13: Foreign investors may choose whether to open a special foreign exchange account based on their needs. To open such an account at a domestic financial institution other than its settlement agent, they may use the business registration certificate mentioned in 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]). Cross-border receipts and payments relating to bond investments should be conducted through settlement agents.

Q14: If a foreign investor has a non-settlement agent as its counterparty and does not hold an account with it, can funding transfer without account be achieved through a settlement agent account?

A14: The current policies governing RMB and foreign-currency accounts of foreign investors allow funding transfer without account. When a foreign investor trades foreign exchange derivatives with a non-settlement agent, the receipts and payments may be conducted directly through a settlement agent special account in a manner agreed by the relevant parties.

Q15: When foreign investors trade directly with domestic financial institutions as their customers, what information should the latter submit to authorities?

A15: Domestic financial institutions are required to report information on foreign investors’ trades in foreign exchange derivatives on a daily basis in accordance with CFETS rules. They are also required to compile and submit data on their customers’ trades in foreign exchange derivatives to the State Administration of Foreign Exchange in accordance with Statistical System for the Bank’s Foreign Exchange Settlement and Sales (Huifa No. 26 [2019]).

Q16: Can gains/losses arising from net settlement of trades in foreign exchange derivatives outside the scope of the Circular be settled in foreign currencies?

A16:Net settlement of foreign exchange derivatives trades outside the scope ofthe Circular must still be settled in RMB in accordance with the Circular of the State Administration of Foreign Exchange on Improving Foreign Exchange Administration for Forward Foreign Exchange Sales and Settlement (Huifa No. 3 [2018]).

[Note]: In the event of conflicts, contradictions, imprecision, mistakes or omissions between the Chinese version and the English version, the Chinese version shall prevail as the only version of this Q&A.