IS CHINA THREATENING TO DEFAULT ON WORLD-WIDE DERIVATIVES?
The term Financial Derivative is a broad term which has come to mean any financial transaction whose value depends on the underlying value of the asset concerned. Advanced statistical modeling of derivatives enables practitioners in the banking industry to reduce financial risk and ultimately increase profits from these transactions.
According to the Wall Street Journal (dated 9-13-09), on September 16th 2009, China will put into effect an agreement
governing how banks trade domestic derivative products among themselves. But as a condition of dealing with foreign banks, China’s five largest commercial banks are seeking to impose tough credit demands that will be difficult to comply with, according to lawyers and knowledgeable people at several foreign banks.
Bank of China Ltd., Industrial & Commercial Bank of China Ltd., China Construction Bank, Agricultural Bank of China Co. and Bank of Communications dominate the domestic money markets, supplying as much as 80% of market liquidity. Not being able to deal with them would punch a big hole in the operations of foreign banks in China.
In the same article from the Wall Street Journal it states that under the new trading regime, banks will be allowed to trade only with counterparties with whom they have signed a master agreement. That agreement will initially cover existing trading in interest-rate swaps, bond forwards, foreign-exchange swaps and forwards and cross-country swaps.
The Wall Street Journal article continues by stating the five big banks are insisting that foreign banks, and in some cases their major shareholders, guarantee the credit of their China units before they sign any agreement, according to foreign bankers with direct knowledge of the situation.
If you would like to read the full article from The Wall Street Journal on this topic it was issued on September 3rd 2009.
All five banks declined to comment on the new arrangements and this has caused much tension world-wide. Bottom line is that if China follows through with this, they are large and powerful enough to make the rules and change the rules as they see fit. At this point, it appears that if a bank can’t bring a “big enough check” to back up what they claim, they will not be allowed to “play with the big boys” anymore in foreign banking.