BGC plans to open China office despite derivatives documentation spat-Asia Risk Magazine

Interdealer broker BGC appears undeterred by a recent decline in China's foreign exchange and interest rate swaps activity, stemming from the failure by leading Chinese and foreign banks to sign bilateral contracts that support such trades, with the interdealer broker planning to open for business in Beijing as soon as March.

BGC says its money broking joint venture with its Chinese partner, investment trust company China Credit Trust, is currently awaiting the final product licences from the China Banking Regulatory Commission, which will pave the way for it to become the fourth Sino-foreign joint venture interdealer broker to offer derivatives and bond markets broking in China.

Len Harvey, executive managing director and general manager of BGC Partners in Hong Kong, says the broker will start by offering brokering services in over-the-counter interest rate products, such as interest rate swaps, interbank deposits, bills and bonds and other money market products.

"BGC is very strong in bonds globally, so I believe our expertise and experience will give us an advantage in the Chinese market," says Harvey.
 

Currently, three multinational interdealer brokers have already established businesses in China, a market where partnership with a local financial institution is a requirement. Tullett Prebon was the first mover in 2005 with its partner Sitico, a subsidiary of Shanghai Investment Group.

The others are Icap's Shanghai-based joint venture with the China Foreign Exchange Trade System & National Interbank Funding Center (CFets), called CFets-Icap, and Ping An Tradition International Money Broking in Shenzhen, a joint venture between Tradition and Ping An Insurance.

Harvey says being in Beijing, where the headquarters of most Chinese banks are located, gives BGC the advantage of proximity to potential clients. "I expect other interdealer brokers in China have plans to open up branches in other provinces and major cities when the opportunity arises in the future," he told Asia Risk.

BGC's expansion in China comes at a time when the big four state-owned commercial banks are involved in protracted negotiations with their foreign counterparts, regarding the signing of China's new OTC bilateral agreement issued by the National Association of Financial Market Institutional Investors (Nafmii) – the trade association of China's central bank.

Since March last year, all banks wanting to trade OTC derivatives with each other must sign the new Nafmii agreement, which is China's closest equivalent to the International Swaps and Derivatives Association master agreement. But demands by some top-tier Chinese banks on their foreign counterparts for their parent companies to provide guarantees to back up derivatives transactions in China has meant transition to the new Nafmii agreement has been difficult.

Some 585 bilateral agreements have now been signed, up from 470 on November 5 last year, as disagreement between Chinese and foreign banks over parent guarantees has left western firms previously active in forex and interest rate derivatives unable to sign Nafmii documents. As a result, they cannot trade with many key liquidity providers in the market.

"We heard the main source of opposition is from Bank of China," says a source close to Tullett Prebon Sitico in Shanghai. "They have deliberately not been providing liquidity to the market as a means to put more pressure on foreign banks. For a long time, Bank of China has been the biggest liquidity provider in foreign exchange, so these banks are having a hard time trying to find a big bank capable of taking on their positions."

 For example, subsidiaries of HSBC, Standard Chartered and BNP Paribas have not yet signed with any of the big four banks, namely Agricultural Bank of China, Bank of China, China Construction Bank and Industrial and Commercial Bank of China.

 "The net effect is that as some of the Chinese banks have not yet signed up with foreign banks, foreign exchange swaps counterparties have now skipped using interdealer brokers to broke a trade, as clearly they know which counterparties they could trade with and which they can't," the source says.

Meanwhile, a senior executive close to Bank of China in Beijing told Asia Risk one of the reasons Chinese banks have demanded parent guarantees when signing Nafmii agreements is linked to weak credit risk assessment capabilities at Chinese banks.

"Chinese banks in general lack the capacity to accurately quantify/assess risk for complex derivatives transactions. Thus, there is a possibility some local banks might take a more conservative approach to over-estimate the actual risk of those transactions. If this happens, it will use up credit limits," the source says.

In credit risk assessment, banks place credit limits on counterparties based on the strength of their financial standing. The limit is used in an effort to avoid concentration risk related to a particular counterparty. Chinese banks have tended to project higher rates for probabilities of default on Western bank subsidiaries in China than what might actually be the case.

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