EURO today and when the contract expires, will decide to buy EURO on the spot market and thus due to the decrease in the EUR/VND exchange rate after 2 months, X will earn profit from the forward contract. This is short selling - speculation on the price down.
And vice versa, today an investor can speculate on the price by signing a 2-month EUR forward contract and when the contract expires, the investor sells the EUR purchased on the spot market, the difference is the investor's profit.
Case 2: Using future business:
In many cases, compared to forward and swap contracts, futures have proven to be quite effective speculative tools. Indeed, in futures, there is a large trading volume, low transaction costs, can receive daily trading profits immediately, especially there is a mechanism that allows the contract to be settled before maturity, so that the contract can be canceled if the exchange rate fluctuates unfavorably for the investor. In futures contracts, there is short selling, which means that a trader can place an order to sell a foreign currency that he does not actually have, and then can place an order to buy that foreign currency later.
b) Speculating on interest rate differentials:
In case the quoted Swap rate is inconsistent with the spot rate and current interest rate in the market, the bank can take advantage of the opportunity of risk-free interest rate arbitrage.
For example: There are the following market parameters: Spot rate S(USD/SGD) = 1.7550 – 2.5450
3 Month Swap Rate = 300 – 220
3-month USD interest rate = 9.25 – 10.5%/year 3-month SGD interest rate = 3 – 3.5%/year
Fred suddenly announced an increase in the USD discount rate, the Eurodollar interest rate increased to 11.25/12% while the spot rate and the 3-month SGD/USD swap rate remained unchanged. The bank used the Swap and Profit service.
Table 3: Interest rate arbitrage trading process through Swap transactions
Value Date
Transaction | CF Cash Flow | Exchange rate (interest rate) | ||
SGD | USD | |||
Today | 1. Borrow USD | +1.7550 | 3.5% | |
2. Buy Spot USD | -1.7550 | +1 | 1.7550 | |
3. Deposit USD for 3-month term | -1 | 11.25% | ||
4. Net cash flow | 0 | 0 | ||
End of day net cash flow | 0 | 0 | ||
3 months later | 5. Forex principal and interest in USD | +1.0 | ||
6. Forward USD sell side | +1.77352 | - 1.02813 | 1.7250 | |
7. Repayment of principal and interest by SGD | -1.77035 | |||
End of day net cash flow | +0.00317 | |||
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The above are basic concepts that are often mentioned when studying foreign exchange trading. Based on these concepts, Chapter 2 will study and discuss the current situation of foreign exchange derivatives in the Chinese market and draw some lessons for the Vietnamese foreign exchange derivatives market.
CHAPTER 2: EXPERIENCE IN DEPLOYING FOREIGN EXCHANGE DERIVATIVES IN THE MARKET
CHINA
I. LEGAL BASIS FOR THE MARKET
1. General regulations on foreign exchange derivatives trading in the Chinese market:
The Chinese derivatives market first received formal government support in March 2004 with the promulgation of rules for derivatives activities by the Banking Regulation Regulatory System (CBRC). In July 2006, the State Administration of Foreign Exchange (SAFE) and the China Foreign Exchange Trading Center (CFETS) issued the RMB-FX forward and swaps master agreement (the 2006 agreement) to govern all RMB-FX forwards and RMB-FX swaps traded through the CFETS. The 2006 agreement was the first attempt by the Chinese government to develop a set of laws governing the foreign exchange market in general and the foreign exchange derivatives market in particular, which contained minimal provisions on the concepts and issues related to each type of transaction.
In August 2007, a new version of the 2006 Agreement, the CFET Master Agreement (2007 Version) was issued by SAFE and CFETS, which includes a new product type such as RMB-FX currency swaps. In October 2007, NAFMII (a self-regulatory trade for traders in the Chinese interbank market and operating under the guidance of the People's Bank of China - PBOC) issued a standardized set of master agreements and supplementary documents to manage derivative transactions among members in the Chinese interbank market.
While the above two agreements have been well received in the market, the interrelationships between the two agreements have raised a number of technical and legal issues. Therefore, the NAFMII Master Agreements (2009 version) issued by BPOC and SAFE clarify the controversial issues.
2. Specific regulations related to foreign exchange derivatives activities in China
2.1. Regulations on foreign exchange futures transactions:
- Members of the Center: participants in the interbank foreign exchange futures market.
Policy banks, commercial banks, investment companies, financial leasing companies, financial companies, etc. that are members of the Center and want to participate in foreign exchange forward transactions in the interbank market need approval from the China Banking Regulatory Commission - CBRC to trade financial derivatives.
Non-bank financial institutions require approval from government officials.
Non-financial businesses require SAFE approval.
- The SAFE foreign exchange regulator conducts the management of legal entities registered to participate in the interbank foreign exchange market and determines the maximum amount of transactions between domestic currency and foreign currency for non-financial enterprises and non-bank financial institutions on the basis of foreign exchange sales, capital or operating capital.
- The following rules shall apply to the supervision of forward transactions in the interbank market.
Both sides of the transaction will use the Central Trading and Negotiation Rate System quotation to determine the currency, amount, maturity
Payment, rate and date of payment, method of delivery and currency must be specified in the contract.
To clarify rights and obligations, parties participating in the foreign exchange futures market sign a master contract for foreign exchange futures transactions.
To prevent risks and ensure the performance of forward foreign exchange contracts, participants in the forward foreign exchange market may require their counterparties to deposit certain amounts at the Center.
Members participating in the foreign exchange futures market must complete internal management and risk prevention mechanisms, and have measures to monitor and manage risks associated with futures transactions.
The center is responsible for monitoring, recording futures transactions, and publicly disclosing information.
- Six months after a foreign exchange futures market participant receives permission to engage in forward trading, it is permitted to engage in swap transactions that are a combination of forward and spot transactions or a combination of both types of forward transactions.
- Designated banks must meet the following conditions to conduct foreign exchange forward trading:
Have a license issued by the Foreign Exchange Administration or local branch office to conduct foreign exchange trading business and have no record of administrative violations of foreign exchange management in foreign exchange trading and purchasing business in the last 2 years.
Licensed by the China Banking Regulatory Commission CBRC to conduct derivatives business.
Other requirements as prescribed by SAFE
- SAFE implements regulations for designated banks in foreign exchange trading through registration.
Policy banks and national commercial banks as legal entities must register with SAFE to conduct foreign exchange trading business. City commercial banks, rural commercial banks, rural cooperative banks and foreign-invested banks (commercial banks and foreign joint-stock commercial banks, branches of foreign banks) as legal entities must submit registration documents to the local branch office of SAFE (including the operating office, hereinafter referred to as SAFE branches). SAFE branches will conduct a preliminary examination of these documents and then report to SAFE for registration.
When engaging in foreign exchange forward trading, bank branches must register with the local branch office of SAFE presenting the authorization document issued by their legal entities. SAFE verifies the qualifications and compliance with business regulations for their foreign exchange forward trading.
- Banks must submit the following registration documents to conduct foreign exchange forward trading:
Report on registration of foreign exchange futures trading
repent;
Internal regulations and rules for management and trading of foreign exchange futures
including: Business operating procedures, reporting and analysis systems, position and risk control systems, pricing management systems and accounting verification systems
Legal documents proving eligibility to conduct derivative transactions
Other documents and materials as required by SAFE
- Banks must comply with the following regulations to conduct forward foreign exchange business:
Banks can conduct domestic foreign exchange derivatives business under current accounts…
When conducting foreign exchange forward trading, banks comply with the regulations of foreign exchange management and verify the honesty and compliance with the receipt and payment of domestic foreign exchange. On the maturity date of the foreign exchange forward contract, banks execute the contract after checking the valid documents provided by domestic entities as required by the regulations of foreign exchange management.
Banks decide at their discretion the maturity structure, payment terms and exchange rates.
- Banks that have been approved to conduct foreign exchange forward trading business with a term of over 6 months can conduct RMB swap business for other foreign currencies (not related to interest rate swap) after registering with SAFE:
Banks must comply with all regulations governing foreign exchange futures trading.
Outside the scope of regulated business, banks may conduct swap transactions with RMB funds of domestic institutions. The foreign exchange acquired by a domestic entity through swap transactions shall be used in accordance with the regulations of the State Administration of Foreign Exchange.
In case a domestic entity participates in foreign exchange fund exchanges in the current account, the foreign exchange results from contract settlement can be recorded in the organization's foreign exchange account according to the current account.
- Banks shall comply with SAFE regulations in the management of foreign exchange purchases and sales when conducting foreign exchange forward and swap business.
- Banks must report relevant statistics on foreign exchange forward trading and foreign exchange swap transactions to SAFE.
- The People's Bank of China shall supervise and regulate the designated banks in the foreign exchange forward trading and foreign exchange swap business through SAFE. SAFE at all levels shall strengthen supervision and regulation of the designated banks in accordance with the spirit of this Notice. In case of violation of the provisions of this Notice, the designated banks shall be punished by SAFE in accordance with the foreign exchange management regulations and other relevant regulations of the State Administration of Foreign Exchange.
2.2. Regulations on foreign currency swap transactions in the national interbank market
- Regarding the management of members participating in foreign currency swaps in the national interbank foreign exchange market:
Members covered by these Rules include financial or non-financial corporate institutions that have received full SAFE clearance for swap transactions for not less than six months and are conducting swap transactions in the Trading Center.
Traders who have received a certificate of qualification issued by the Trading Centre shall not be allowed to conduct swap transactions at the Trading Centre until they have attended relevant professional training courses offered by the Trading Centre. A member shall appoint qualified traders to conduct transactions on its behalf, and shall be responsible for the transactions conducted by these traders.
A member must establish and strengthen its internal risk management and technical risk avoidance system, have practical measures to measure the effectiveness of monitoring and managing foreign exchange swap risks, and sign an agreement