The Emerging Risk Environment in China Dr. Guangping (Peter G.) Zhang Deputy Director General China Banking Regulatory Commission Shanghai Bureau Asia-Pacific Finance and Development Center June 18, 2008

Major Contents  Risk Management Instruments in China On-shore Products FX Forwards (Merchant & Inter-bank), FX Swaps, Bond Forwards, IRS, Stock Warrants Off-shore Products Foreign CNY Derivatives Non-deliverable Forwards (NDF), Non-deliverable Options (NDO), Non-deliverable IRS (NIRS),H share stocks, Index futures and Options  Risk Management Supervision & Related Issues  BASEL II Implementation  Difficulties for Risk Management Practices in China Lack of Options Market and Implied Volatilities Low Liquidities of OTC Products Product Design & Pricing

CNY Forwards (Merchant) PBOC: “The Tentative Administrative Methods for RMB Forward Settlement” January 18, 1997 BOC: April 1st, 1997 CCB: April, 2003 ICBC: April, 2003 ABC : April, 2003

China Foreign Exchange Trade Center (CFETCS) China Foreign Exchange Trade Center (CFETCS) was authorized to trade CNY forwards on August 15, 2005 CNY/USD CNY/JPY CNY/HKD CNY/Euro

China Foreign Exchange Trade Center (CFETCS) Trading has not been active at CFETCS,Trading turnover in 1Q2006 RMB3420 million (430 million USD); 2Q2006 RMB7210 million (900 million USD) 3Q2006 RMB31.5 billion (3.98 biillion USD) 4Q billion USD 1Q billion USD 2Q billion USD 3Q billion USD 4Q billion USD 2006 $14.06 billion; 2007 $ billion

Liquidity of CNY Forwards (Merchant) BIS 2007: Daily Average FX Trading in April 2007 $9 billion (spot, forwards and swaps 61.4%, 31.3% and 7.4%), thus Total forwards 9*31.3% = $2.817 billion daily average in April 2007, $ billion in April 2007; April 2007 Forwards Inter-bank = $1.996; thus April 2007 forwards merchant trading = $ billion in April 2007; total forwards merchant around $680 billion for 2007, total forwards including inter-bank about $703 billion for 2007, or about 32.3% of total trade value of $2.175 trillion in 2007, compared to international ratio around 150%

Foreign Exchange Swaps Trading 3Q billion USD 4Q billion USD billion USD 1Q billion USD 2Q billion USD 3Q billion USD 4Q billion USD 2007 total $ billion Merely 17.6% of daily FX swaps trading in April 2007

Other CNY Derivatives in China Interest Rate Swaps –SHIBOR Swaps Bond Forwards Wealth Management Products Deposits with embedded options Deposits linked to Libor, commodity indexes, stock indexes, etc.

IRS Trading CNY (billion)$ billion 1Q Q Q Q

Offshore CNY Derivative Products Non-deliverable Forwards NDF Non-deliverable Options NDO Non-deliverable Forward Options NDFO Non-deliverable CNY Swaps NDS Non-deliverable FX Swaps Non-deliverable IRSNIRS Structured Notes Deposits with embedded Options

CNY NDF-most Popular Product offshore Came into existence in 1996 before Asian financial crisis, yet liquidity was extremely low Liquidity began to pick up late in 2002 Trading turnover estimated around US$ billion in 2003 & 2004! around US$250 billion in 2005 around US$300 billion in 2006 around US$360 billion in 2007

Revaluation Pips

CNY/USD Historical Volatilities

CNY/USD Historical Volatilities Compared to Euro & Yen Vols

Appreciation and Further Expectation for RMB

Onshore CNY Forward Rates vs. Offshore CNY NDF Rates

BASEL II Implementation in China Major Chinese Banks are Required to Implement BASEL II by 2010 Market Risk Management Credit Risk Management

Future Market Demand Hedging CNY FX Risk -Steady Growth of Foreign Trade -Expansion of QDIIs -International Investments -Foreign Participation of Domestic Capital Market, Banking Industry Need to Develop the Options Market

Challenges for Market Risk Management in China Construction of reliable Yield Curve Interest Rate Liberalization Structuring and Pricing Capacity Market Risk Management Models (VaR)

Challenges for Market Risk Management in China Lack of Exchange Trade Options No Implied Volatilities Low Liquidity of Existing Products

Comparisons with Indian Rupee Derivatives Markets Average Daily Trading Value of Foreign Exchange in China & India Foreign Exchange Trading ($billion) Spots Outright Forwards Foreign Exchang e Swaps China India China61.4%31.3%7.4% India42.6%27.5%29.8% Word %11.7%55.6% Average Daily IR derivatives in April $ 1 billion in 2004 and $ 3 billion in 2007, India, ---in China

“Exotic Options” 1997(1 st ),1998(2 nd ), 2008(3rd) “ Chinese Yuan Derivative Products ” (English,400p) World Scientific October 2004 (Peter G. Zhang) Chinese Yuan Derivative Products China Financial Press (in Chinese,900p), May 2006; 2nd Edition (around 1300p), April 2008

Thank You!