China’s capital market creaks open wider with ‘gamechanger’ law to slash transaction costs for over-the-counter derivatives
- China’s recognition of so-called close-out netting is seen lowering the cost of trading by reducing the funds that would need to be set aside to protect against credit risks
- Without close-out netting, financial institutions face higher transaction costs and have to provide margin on a gross basis, depriving them of cash
A regulatory breakthrough is expected to slash costs for investors trading over-the-counter derivatives in China, the latest step in opening up the nation’s capital markets to foreign investors.
A Chinese law that takes effect Monday enforces a mechanism used around the world for determining payouts if a derivative counterparty defaults, bringing the standards there in line with those used in other major markets. This recognition of so-called close-out netting is seen lowering the cost of trading by reducing the funds that would need to be set aside to protect against credit risks.
The development, which follows decades of lobbying by the finance industry, will remove a major barrier to international participation, according to Bloomberg Intelligence. While there’s set to be some adjustment as market participants shift to the new system, it holds the promise of eventually revolutionising cross-border trading in an economy that still remains significantly cut off from international markets.
“It’s absolutely a game-changer,” said Liew Chin-Chong, a partner at Linklaters in Hong Kong, adding it will fuel growth in the Chinese over-the-counter market. “International houses will not only be able to deal with Chinese counterparties, but go into China and be a real player, a market maker. Chinese houses can also be more active internationally.”
The trading in Chinese OTC derivatives accounted for just around 1 per cent of global turnover in 2019, compared with 3.3 per cent for Japan, according to a 2021 report by the International Swaps and Derivatives Association (ISDA).