REGIONAL e-FX PERSPECTIVEkiss-trader.com/freetradingarticles/ChinaForexScene.pdfrose to 4.4% in 2007, from 4.2% in 2004, and the Hong Kong dollar’s percentage share of turnover rose

China has come a longway in eFX over thepast four years. Hosan

Chan, the manager at FortuneFree Holding, says that in1994, the central bank, whichis the People’s Bank of China,and the State Administrationof Foreign Exchange (SAFE)clamped down on all margintrading activity in China. Shesays that is because manyinvestors lost a lot of moneyon the market due to poorlyjudged risk management.

As most of these investorswere state owned banks,organisations or enterprises,the central bank and SAFEacted quickly. Chan says FXthen disappeared from theChinese market. However, shestates that the situation hasgreatly improved in morerecent times. Chan claims all

the evidence is indicating thatafter over 10 years in exile, FXhas come back to the Chinesemarket, sneaking in the backdoor and making itself knowngradually.

“A lot of major market makersand brokers have beenpromoting their activities inmainland China in FX,” Chancomments. “Most of theinvestors are individuals,because SAFE has strictregulation for wiring outforeign currencies. Thepotential market has attracteda lot of international FXorganisations to open theirbusiness here. Now there arefour commercial banks thathave licences to openderivatives businesses. As aresult of this, we are seeing anoptimistic, very bright futurefor FX in China.”

REGIONAL e-FX PERSPECTIVE

China

88 | april 2008 e-FOREX

China is the word on trembling lipsacross the world. This enormousmarket is opening up andexpanding, getting online andlearning how to take advantage ofits mass and its closeted economy,to make money on an ever-granderscale. From the eFX perspective thecountry has just started makingtentative inroads. The Chinesegovernment has a strong grip on thecountry’s finances and informationcirculation. It is learning to relax thathold and to allow electronic tradingto take place, yet this is just thebeginning of that process; for eFX toreally be able to take off in China,the government needs to place moretrust in people and systems.

By Heather McLean

088-092 094 096 098-099 Regional Perspective 18/3/08 19:50 Page 1

Increasing importance of China inFX market

The country’s FX reserves grew inthe fourth quarter of last year tohit $1.528 trillion, up by a healthy$94.6 billion from the thirdquarter, the central bank stated.That amounts to a rise of 43.3%for the same period in 2006.Altogether for 2007, China’s FXreserves rose by $461.9 billion.

Additionally, the latest BIS surveyreported that the renminbi saw itsmarket share rise from 0.1% in2004 to 0.5% in April 2007, withChina as a market centre registeringa market share (0.2%) for the firsttime on $9 billion a day.

In 2007, Singapore joined the UKand Switzerland as one of the topthree major financial centres bygaining market share, while theUS and Japan dropped down thelist as they lost market share.Hong Kong’s share of the marketrose to 4.4% in 2007, from 4.2%in 2004, and the Hong Kongdollar’s percentage share ofturnover rose from 1.9% to 2.8%in that period. This, the BISsurvey concludes, is a reflection of

the increasing importance ofChina in the foreign exchangemarket.

Customers everywhere arebecoming increasingly aware ofthe FX market, says ToddCrosland, CEO at InterbankFX.He comments: “It seems withrecent economic concerns in theUS, people are not only hearingabout a looming recession but alsohow the US Dollar is droppingagainst its counterparts. We feelFX will be very important in thedays to come as investors becomemore and more familiar with it.And as their concerns with the USeconomy increase, investors willseek out other forms of investmentthat will provide returns.

“Forex in China is equallyimportant, but the situation is abit different,” Crosland continues.“The stock market in China hasbeen booming recently, with asurprising amount of everydaycitizens trading the stock marketthemselves. There will be a lot ofhype once the Chinesegovernment allows the Yuan to betraded, and this hype will attractmany of these individual stock

>>>

april 2008 e-FOREX | 89

Hosan Chan“..after over 10 years in exile, FX has

come back to the Chinese market,sneaking in the back door and making

itself known gradually.”

Todd Crosland“There will be a lot of hype once theChinese government allows the Yuan

to be traded, and this hype will attract many of these individual stock

traders over to Forex”


traders over to Forex, because, asthey say, the grass is always greeneron the other side.”

Growing Investor confidence

Like most emerging markets, Chinaseems to have been unaffected by theworst of the US sub prime lendingfallout, and there is a growingconfidence in the robustness of thismarket. If this confidence ismaintained then it can be assumedthat foreign investor interest willcontinue, leading to further growthin the FX market, with aproportionate increase in eFX,comments Rob Close, President andCEO at CLS Bank International.

Close continues: “We may also seeChinese investors beginning tolook abroad, driving further FXgrowth. In the medium termmarket liberalisation, which hasmany other facets than justallowing faster renmimbiappreciation, will further drivegrowth. We believe this growthwould be assisted by the renminbibecoming in the medium term aCLS currency, and we are havingdiscussions in relation to this.

“The cost of execution anddemand for greater efficiency will

also help fuel growth in the use ofelectronic platforms [in China],”states Close. “Key platformsalready exist in China, which isprobably already exceedingpredicted global market growth ofaround 20% in platform basedtrading. The caveat is that if wecontinue to see the volatilityexperienced over the last fewmonths, then these growth figurescan be doubled. A proportionateincrease in the Chinese market isto be expected.”

As of 11 December 2006, theprotective period for Chinesebanks following China’s entry intothe World Trade Organisationcame to an end, so China’sfinancial industry opened fully.This has meant that more banksare increasing investment intechnology and managementresources to be more competitive,both onshore and offshore.

Importance of Hong Kong

While there are differences intechnology and infrastructurebetween mainland China andHong Kong, those are a mootpoint given that eFX is designedto be traded at any time, fromanywhere, at least in theory.

K.C. Lam, director and head ofAsian FX sales at CME Group,states: “Hong Kong has alwaysprided itself as the gateway toChina, and has benefitedtremendously from the growthand trading going via Hong Kongto the rest of the world. The HongKong economy has a free andfriendly business environmentwith excellent infrastructure, andabsence of FX and capital controls.It also has a good pool of talent inthe FX and e-commerce arena thatwill be very helpful in maintaining



Rob Close“The cost of execution and demand

for greater efficiency will also help fuelgrowth in the use of electronic

platforms [in China],”

KC Lam“there has been a major investmentin infrastructure that will only help

to improve the environment for electronic FX trading.”


Hong Kong’s lead in theutilisation of FX e-commerce.CME Group has had an office inHong Kong since 2006.”

Lam adds: “Infrastructure in HongKong and major cities in China isgenerally very good. Other citiesin China lag behind, althoughthere has been a major investmentin infrastructure that will onlyhelp to improve the environmentfor electronic FX trading.”

Yet Crosland points to theenormous class divide that resides inChina, making Forex most readilyavailable to residents of the EasternTier-1 cities such as Beijing,Shanghai, Tianjin and Chongqing.Crosland continues: “The lack oftechnology in rural areas, though, isnot the only hindrance to tradingForex online; there’s also thefundamental fact that they areextremely poor and can barely feedthemselves, let alone dabble in amarket like this. As far as the largercities are concerned, sincetechnological advances are mostlydependant on the brokers, [forinstance those companies withadequate servers, software, and thelike,] a client only needs a computerand basic internet connection [inorder to trade].”

Network Buildout

There is a large difference betweenthe technological infrastructure ofmainland China and Hong Kong,Chan agrees. She comments: “Wehad a wide application ofbroadband in 2000, and then eFXcame to individual investors inChina. However, the broadbandfrom China to overseas is narrowcapacity, and there is very strictsurveillance of what is sent outonline. On top of that, the datatransfer is not steady, so data loss

and going offline occurs often. Yetin July this year, China andAmerica will be working togetherto build a high speed broadbandnetwork, which will greatly impactonline trading. We will still havethe worry of the National SecurityBureau, however, as thisorganisation can interfere or blockany website.”

The network build out that Chanrefers to is a deal between Verizonand five major Asian telecomscompanies - China Telecom,China Unicom, China Netcom,Korea Telecom and Taiwan’sChunghwa Telecom – to increasethe current capacity of China’sbroadband networks by 60 times.

eFX is becoming increasingimportant for China as thecountry moves rapidly to integrateitself to the rest of the world.CME Group has noted increasingliberation of trade policies and amore flexible regulatoryenvironment, conducive for theflow of trades and investment, inthe country.

Yet regulation is a big issue inmainland and offshore China, forboth its restrictions and also itslooseness. On the loose side, thebulk of FX regulations in Chinaare fuzzy at best, Crosland claims.He says the majority of lines aresimply not clearly drawn out.

“Although I doubt this ambiguityis deliberate, it nevertheless leavesinvestors and organisations opento trying new things, to push thesemi-existent boundaries, thusspurring additional growth,”Crosland states. “But that’s not tosay the regulatory bodies arepassive and don’t play a role,either. Yet the market is growing

april 2008 e-FOREX | 91

>>>China

Richard Koh“If a trader goes online and prefers

a multibank platform to a single bank platform, we are presented with another challenge because how would you do a pre trade

documentary proof?”

Hosan Chan"the charge for FX trades in domesticbanks is very high, so most buyers are

not willing to trade with them"


so fast and attracting such a myriadof new investors, I feel, to someextent, that it is the investor andorganisations shaping theregulations; investors spur the speedof growth, and inspire marketevolution, whereas a regulatorybody is slower to adjust.”

Regulation lost in translation

Regulation is literally getting lostin translation in mainland China.Whereas in Hong Kong there areclear guidelines in gettingapprovals, in China, providers aresometimes left trying to interpretand reinterpret the state andnational level guidelines. Thisoccurs because the translation ofregulation from Mandarin intoEnglish is often not done byagencies that have anunderstanding of the market theyare writing about, which is one ofthe reasons that eFX regulation inChina is so vague.

Most of the banks that have gotthe capability to operate in Chinatend to be foreign players. Thesebanks, states Richard Koh,Director/Regional Head of eSales -Asia at Standard Chartered, getregulation translated by

professional departments andbusinesses which may not be wellversed in the language of trading,technology and financial markets.This means many interpretationshave either lost their meaning orbeen over interpreted, so thetranslator creates a hurdle evenhigher than the regulationrequires.

In terms of regulation, theChinese government hascommitted itself to greater FXflexibility, which involves both thepace of liberalising andrationalising capital controls, suchas relaxing administrativeconstraints on FX transacting, andthe optimal degree of flexibility inthe exchange rate. With thedevelopment of various hedginginstruments, China is increasingthe options of FX trading for bothbuy side and sell side. This in turnwill hasten the use of electronicFX trading, as this is a moreefficient way to scale in country aslarge as China.

Yet, the advance of eFX remains achallenge in China due to theregulatory requirement for strictdocumentation supporting eachtrade on a pre trade basis.

Regulators impose a stringentneed for documentary evidence inorder to prove a trade can beachieved. In other words, trades,other than those done by banks,cannot be done for speculativereasons; it must be for a genuinetrade reason, Koh says.

“Because of the need for pre tradedocumentary proof, trading isseverely challenged,” Koh says. “Ifyou are on the phone, you have tosay you will send an email or fax thedocument over, then ask ‘Are youstaring at it?’, ‘Are you happy withit?’, get verbal confirmation, andthen do the trade. It becomes veryawkward if you were to require pretrade documentary proof and thengo online to do an actual execution.It’s two separate, disparate processesrather than one single phone call.”

Yet this also explains the lack ofmultibank platforms on Chinesesoil. Koh continues: “If a tradergoes online and prefers amultibank platform to a singlebank platform, we are presentedwith another challenge becausehow would you do a pre tradedocumentary proof? You have tosend a document to five banksbefore you decide which price youwant to take? This is why most ofthe multi bank platforms do nottry very hard to operate in Chinaas it is operationally verycumbersome in order to achievethis requirement for pre tradedocumentary proof.”

The solution to this issue, Kohclaims, would be for the Chinesegovernment to emulate those inTaiwan and Thailand, and even inKorea to a large extent. Theregulators in those countries haveunderstood that e-trading makesthe process of pre trade contracts



>>>


093 Standard Chartered Ad 18/3/08 19:51 Page 1


>>>

cumbersome, so they allow tradesup to a certain size followed bydocumentary proof sent at the endof the trading day.

Chan states the regulatoryenvironment for FX trading inChina is still intangible, but thatshe can see that the government ispreparing the way for a more openmarket. “The government needs tobuild up a good environment forthe domestic banks to have a goodshare of this market before it isopen,” she explains. “However, thecharge for FX trades in domesticbanks is very high, so most buyersare not willing to trade with them.If there is open policy for thebanks, they are going to have greatmarket margin.”

SAFE

One organisation working toimprove the FX situation in Chinais SAFE. SAFE works from aregulatory, policy and riskmanagement perspective in China,with responsibility for managingand monitoring foreign exchangetransactions under capitalaccounts, including inward andoutward remittance and payments.It is responsible for managing theforeign exchange reserves of thecountry in accordance to the rulesand regulations set by the Chinesegovernment, Lam says.

SAFE has many functions coveringthe Chinese FX market. SAFE istasked with designing andimplementing the balance ofpayments (BOP) statistical systemin conformity with internationalstandards, developing andenforcing the BOP statisticalreporting system, and collectingrelevant data to compile the BOP

statement; it is analyzing the BOPand foreign exchange positions,providing policy proposals withthe aim of achieving anequilibrium BOP position, andconducting feasibility studies onthe convertibility of the renminbiunder capital account; draftingrules and regulations governingforeign exchange market activities,overseeing the market conduct andoperations, and promoting thedevelopment of the foreignexchange market.

SAFE is also involved withanalyzing and forecasting theforeign exchange supply anddemand positions and providingthe People's Bank of China (PBC)with propositions and referencesfor the formulation of exchangerate policy; promulgatingregulatory measures governingforeign exchange transactionsunder current account andsupervising the transactionsaccordingly; monitoring andregulating the foreign exchangeaccount operations both in Chinaand abroad; supervising andmonitoring foreign exchangetransactions under capital account,including inward and outwardremittance and payments;managing foreign exchangereserves of the country inaccordance with relevant rules andregulations; drafting foreignexchange administration rules,examining the domestic entities'compliance with foreign exchangeadministration rules andregulations, and penalizinginstitutions engaging in illegalpractices; participating in relevantinternational financial activities;and performing other duties andresponsibilities assigned by theState Council and the PBC.


Rob Close"continued economic growth and

related international investment will drive the growth in currency derivatives

in the Chinese market."

Todd Crosland"investors spur the speed of growth,

and inspire market evolution, whereas a regulatory body is slower to adjust."


095 Cognotec Ad 18/3/08 19:52 Page 1


Yet despite this massive remit,Chan says SAFE does still nothave clear regulation laid out forE-Forex. However, she adds that itdoes not forbid citizens ininvesting in foreign countries, buteach citizen can only transfer$50,000 in one year. “Thisallowance greatly limits thedevelopment of eFX,” she claims.

Retail FX potential

It seems obvious that China is onthe cusp of bigger and betterthings. So much so that retail FXprovider, Interbank FX, decided inlate 2007 to open a satellite officein Beijing. The company iscurrently focusing a lot of energyand manpower in that region andanticipates the number of newChinese accounts to quicklysurpass the number of new USaccounts it has, where most of itsbusiness in conducted.

Retail is thought by many torepresent the greatest potentialmarket for eFX, through retailbrokerages and aggregators, asevident by the same segment inJapan where households make upa large proportion of retail FXplayers, Koh claims. However, headds that comparing China to theJapanese market, as far as retail FXis concerned, is not a like for likecomparison. This is due to theinherent carry-trades in the latter,which is not present in the former;in fact, Koh says conventionalwisdom dictates to hold on toCNY due to its relativeundervaluation.

“Whereas in China, everyoneknows that the CNY isundervalued so keeping yourcurrency in your home country

where the interest rate is actuallyhigher, compared to the Yen,makes sense,” Koh states. “Thismeans eFX is not that popular inChina right now. However,everyone in China likes dealing inshares which means the market isstill vibrant.”

So retail FX in China is at an earlystage; while some offshore retailplatforms are making inroads intothe country, the market is far fromrealising its full potential.However, Lam says: “Mid to longterm, this is going to be one hugemarket, rivalling the size of theretail market of Japan.”

Lam continues that FX futures isimportant for the Chinese retailmarket. “Currently, there is not afutures FX market available forretail in China. Yet FX futures isideally suited for retail FX tradingas they are very liquid, with easyaccess and execution, fully disclosedpricing and a level playing field forall market participants, with thesafety and security of a regulatedFX environment. Most retailcustomers trading FX in a cashmarket will end up paying a pip ormore of the price on every trade.”

Pushing FX delivery through e-channels

In China, other than the big fourlocal banks, the middle tier bankslargely have insufficient liquidityso they source liquidity fromoffshore banks, Koh comments.He says most of these offshoreliquidity providers have in the lastcouple of years been consistentand successful in pushing FXdelivery through electronicchannels.


Richard Koh“Banks have largely converted to eFX for non strategic – read, non market

moving trades of less than $15 million to $20 million”

KC Lam“as a result of greater awareness on

various risk management and hedgingtools available in the market,

the future prospects for FX e-commerceis only going to improve.”

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097 SmartTrade Ad 18/3/08 19:52 Page 1

Local banks in China do around70% of all FX transactionselectronically, Koh states: “Bankshave largely converted to eFX fornon strategic – read, non marketmoving trades of less than $15million to $20 million - since2006, with the proliferation of e-platforms from foreign liquidityproviders and state driveninitiatives, such as CFETS. Fortrades that may move the market,deals are done largely over thetelephone still.”

The investment and assetmanagement community in Chinais likely to embrace the benefits ofe-trading, states Lam. He saysincreased awareness and trainingwill be key in propagating thebenefits of e-trading to the localinvestment and asset managementcommunity.

Local corporates are a lot slower incatching on to eFX, Kohcomments, primarily due to theirpreference for US dollaraccounting for international trade,which therefore requires onlyUSD/CNY trades that are still notvery widely available due toregulatory restrictions.

Chinese corporates’ response todevelopments in treasurytechnology and the use of onlineFX trading platforms offered bybanks and portals is still in theearly stages of development, Lamsays. In the interbank arena lastyear, CFETS launched cashtrading in five currency pairsagainst the reminbi, utilising anew trading platform customisedto support the reminbi.

Participants on the platforminclude the 300 CFET memberbanks as well as 20 large banks,many of which are large globalinstitutions. This adoption willeventually filter down tocorporates, says Lam, who addsthat although there are some largercorporates already using treasurytechnology offered by banks, it isstill not pervasive.

Demand for currency derivatives

Lam continues: “However, webelieve the treasury technologyuptake and online FX trading willbe greatly improve when CFETSstarts to offer currency derivativehedging for its members.”

As early as 2001, the CSRC andSAFE enacted regulationspermitting Chinese corporationsto trade foreign derivativesproducts to hedge corporate risks.Lam says his company is seeingthis demand increasing as theusers in China become moresophisticated in the way theymanage risks.

“There is also greater awarenessamongst investors,” Lamcontinues. “Recently, the ShanghaiFutures Exchange (SFE), wasgiven regulatory approval tolaunch gold futures. Recentcombined volume turnover of thenation's three commodity futuresexchanges totaled 40.97 trillionyuan in 2007, up 95% from theyear before.”

CME has entered into anagreement with the China ForeignExchange Trade System (CFETS)to which CFETS will become a‘super clearing’ member of CME,providing CFETS members(which include all of the majorChinese banks in China) withaccess to CME Group FX andinterest rate futures markets.

This agreement and proposal iscurrently being reviewed byCFTC, says Lam. “This agreementwill promote the infrastructurebuilding of China's FX marketand the further opening ofChina's financial markets,” Lamstates. “The agreement will be animportant step in the developmentof China's FX market. It will helpfinancial institutions in terms ofprice discovery and riskmanagement of their exposures inthese markets.”




The demand for currencyderivatives as hedginginstruments is quite high inChina, and is partiallydependent on the health of theUS economy. Take for instancethe recent economic stimuluspackage recently passed by theUS Congress; according toCrosland that money usuallycomes in the form of TreasuryBonds sold to foreign countries.“Estimates say China owns 10%of our [the US] debt,” Croslandelaborates. “China will be happyto loan us more as our economystruggles and their economybooms, as a good portion of themoney lent to us goes straightback to China soil in the formof purchased goods.”

Close says it is likely that thecontinued economic growth andrelated international investmentwill drive the growth in currencyderivatives in the Chinesemarket. As the renminbiremains a non-convertiblecurrency, derivatives are playingan increasing role for thosewishing to invest in China, andin hedging in particular, heclaims.

A key example is the growinguse of non-deliverable forwardswhich are used by corporationsand fund managers as theirpreferred hedging tool forshorter dated hedging, generallywith 90 day tenors, Closecontinues. He says several majorfund managers have indicated toCLS Bank International that asmuch as 20% of their daily andquarterly volumes are traded asNDFs rather than outright.

Close says: “CLS is supportingthis growth in NDFs byextending its service to processand settle these instruments,” hecomments. “We are deliveringautomation in an environmentwhere little automation exists,facilitating more convergence andstandardisation, bringingincreased efficiency and deliveringsignificant ticket cost reductions.NDFs have traditionally beenassociated with manual processes,long-form confirmations, and lackof standardisation. These factorscontribute to expensive processingcosts for NDFs, estimated at $20per trade or more, a multiple ofthe cost to process an FX spot orforward trade.”

Future eFX prospects

On the future for eFX in China,Lam says the regulatoryenvironment has become moreflexible. He adds: “Moreover, asa result of greater awareness ofvarious risk management andhedging tools available in themarket, the future prospects forFX e-commerce are only goingto improve.”

While Chan is enthusiastic. Shesays: “eFX has huge marketpotential in China. Theeconomics of China hasdeveloped for 26 years andaccumulated substantive wealth.Most of that wealth was saved,but when saving does not satisfyvalue increment expectations,people seek other tools ofinvestment. Now most of thatmoney is going to the stockmarket. With the developmentof regulation for FX, I believethe growth of eFX in China willbe explosive.”

China


Documents

REGIONAL e-FX PERSPECTIVEkiss-trader.com/freetradingarticles/ChinaForexScene.pdfrose to 4.4% in 2007, from 4.2% in 2004, and the Hong Kong dollar’s percentage share of turnover rose