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Cablegate: Chinese Banks Demanding Assurances On Foreign Banks'

VZCZCXRO1037
RR RUEHCN RUEHGH
DE RUEHGH #0401/01 2650556
ZNR UUUUU ZZH
R 220556Z SEP 09
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 8290
INFO RUEHBK/AMEMBASSY BANGKOK 0228
RUEHBJ/AMEMBASSY BEIJING 3078
RUEHRL/AMEMBASSY BERLIN 0020
RUEHBS/USEU BRUSSELS 0030
RUEHBY/USDAO CANBERRA ACT AS
RUEHCN/AMCONSUL CHENGDU 2212
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHGV/USMISSION GENEVA 0070
RUEHGZ/AMCONSUL GUANGZHOU 0670
RUEHHI/AMEMBASSY HANOI 0042
RUEHHK/AMCONSUL HONG KONG 2377
RUEHJA/AMEMBASSY JAKARTA 0036
RUEHLO/AMEMBASSY LONDON 8778
RUEHML/AMEMBASSY MANILA 0105
RUEHMO/AMEMBASSY MOSCOW 0079
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC
RUEHNE/AMEMBASSY NEW DELHI 0069
RUEHOT/AMEMBASSY OTTAWA 0043
RUEHFR/AMEMBASSY PARIS 0017
RUEHRO/AMEMBASSY ROME 0018
RUEHUL/AMEMBASSY SEOUL 0562
RUEHGH/AMCONSUL SHANGHAI 8942
RUEHSH/AMCONSUL SHENYANG 2203
RUEHIN/AIT TAIPEI 2008
RUEHKO/AMEMBASSY TOKYO 0773

UNCLAS SECTION 01 OF 04 SHANGHAI 000401

SENSITIVE
SIPDIS

DEPT FOR EAP/CM
NSC FOR LOI, MEDEIROS
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/KATZ/MAIN
GENEVA ALSO FOR USTR
USDOC FOR ITA DAS KASOFF, MELCHER, SZYMANSKI, MAC/OCEA
TREASURY FOR OASIA/INA -- DOHNER/HAARSAGER/WINSHIP
TREASURY FOR IMFP -- SOBEL/CUSHMAN
STATE PASS CEA FOR BLOCK
STATE PASS CFTC FOR OIA/GORLICK
MANILA FOR ADB USED

E.O. 12958: N/A
TAGS: CH ECON EFIN EINV PGOV
SUBJECT: CHINESE BANKS DEMANDING ASSURANCES ON FOREIGN BANKS'
DERIVATIVE TRANSACTIONS

1. (SBU) Summary: New Chinese regulations governing
derivatives trading that went into effect September 16 are
having a disproportionate negative impact on foreign-invested
firms. In the face of efforts by foreign-invested banks to
modify or roll back the requirements, the major Chinese banks
are acting in unison to largely refuse compromise. As a result,
foreign-invested bank market share and profits are at risk. End
Summary.

==========
Background
==========

2. (SBU) One year after the Lehman bankruptcy, China's Central
Government and domestic banks are beginning to implement
measures to reduce counterparty risk in financial transactions.
Beginning September 16, the largest Chinese domestic banks, with
the support of the People's Bank of China (PBOC) -- are
requiring their foreign-invested counterparts to obtain credit
guarantees from their parent companies before engaging in
over-the-counter foreign exchange derivatives transactions. The
banks' demand is part of a new master agreement structure
announced on March 16, 2009, by the National Association of
Financial Market Institutional Investors (NAFMII) -- nominally
an industry self-regulatory body spun off from the PBOC -- and
formally endorsed by the PBOC in a notice dated March 11, 2009.
Under the measures, counterparty banks had six months to sign
agreements, and the major domestic banks have elected to make
the parent guarantee a precondition.

3. (SBU) EconOff spoke about the impact of the new regulations
with several senior executives in Shanghai-based
foreign-invested banks that are prominent players in the Chinese
over-the-counter derivatives market, as well as with an academic
contact. Foreign-invested banks with operations in Shanghai
include Citibank, HSBC, Standard Chartered, JPMorgan, and
Deutsche Bank. The Big Five Chinese domestic banks are
Industrial and Commercial Bank of China (ICBC), China
Construction Bank, Bank of China, Agricultural Bank of China,
and Bank of Communications; in addition, China Development Bank
was mentioned by contacts as among the major domestic players in
derivatives trades.

=====================================
New Guarantees Seen As Discriminatory
=====================================

4. (SBU) Most foreign-invested banks view as discriminatory the
demands by their domestic counterparts to obtain parent-bank
guarantees for over-the-counter derivatives trades. Starting in
2006, said several contacts, the China Banking Regulatory
Commission and other Chinese regulators put pressure on
foreign-invested banks to incorporate locally. This placed a
substantial compliance burden on the foreign-invested banks,

SHANGHAI 00000401 002 OF 004


including: a lengthy application process; continued monitoring
that the locally incorporated subsidiary has decision making
authority independent of its parent bank; and minimum paid-in
capital of RMB one billion (approximately US$150 million). Now,
the largest domestic Chinese banks are, in effect, seeking to
renege on the benefits foreign-invested banks were supposed to
enjoy as a result of local incorporation, said the contacts --
creating the perception of arbitrary rulemaking. In addition,
Chinese domestic banks are not requiring their domestic bank
counterparties to offer additional guarantees for derivatives
trades. One contact also noted that this requirement has not
been imposed on foreign subsidiary banks in any other market
around the world, and another said that multinational bank
holding companies are not structured to provide guarantees to
their overseas subsidiaries.

5. (SBU) Major domestic banks are currently acting in unison
with respect to the parent-bank guarantees. One contact
mentioned that Bank of China is the strongest proponent of the
requirement. (Note: Bank of China is historically the most
exposed among the Chinese domestic banks to overseas
transactions, as it has the largest overseas branch network and
dominates the market for foreign-invested enterprise services.
End note.) At one point, ICBC was not requiring a parent
guarantee in its revised master agreements, and contacts stated
that Citi and Deutsche Bank had signed with ICBC without giving
one. However, the other large banks then put pressure on ICBC
and it fell into line.

6. (SBU) NAFMII is not seen by foreign-invested banks as
completely neutral in the process of rolling out the new master
agreements. One bank executive said that NAFMII tends to
represent the interests of domestic banks, since Citi and HSBC
are the only foreign banks represented on the board. (Comment:
This limits the role that NAFMII might play in brokering a
compromise between the major Chinese banks and the
foreign-invested banks. End comment.)


===========================================
Compromise Has Been Struck In Limited Cases
===========================================

7. (SBU) Some locally incorporated foreign-invested banks have
been able to sign master agreements with smaller banks,
providing some cause for hope that major Chinese banks may also
eventually do so. One contact put the number at around twenty
for all foreign-invested banks, about half with other
foreign-invested banks and the other half with local Chinese
banks. For example, one executive said his bank had signed
master agreements without the parent guarantee with several
local medium-size banks.

8. (SBU) Other banks are seeking to modify the major Chinese

SHANGHAI 00000401 003 OF 004


banks' parent guarantee requirement. For example, one contact
said that foreign-invested wholesale banks such as JPMorgan had
trouble meeting the paid-in capital standard when applying for
local incorporation, and in the end had used a form of parent
guarantee. These banks are working with local counterparties to
see if this will cover the new requirement. An executive in one
bank in these circumstances said that an agreement under these
conditions had been negotiated with ICBC, but that ICBC had not
signed it before the September 16 deadline because the relevant
bank official was said to be "on travel."

9. (SBU) One bank executive suggested that the problem between
the foreign-invested banks and the major domestic banks could
resolve itself with time. It has been a relatively short time
to negotiate this complicated issue, he said, and it is possible
that more agreements will be announced shortly.

=========================
Market Volume Has Dropped
=========================

10. (SBU) The volume in the derivatives market was down
significantly in the days following the September 16 deadline.
According to the head of trading at a major derivatives trading
firm among foreign-invested banks speaking on September 21,
volume has been consistently half the normal level. Others
pointed out that the lower volume could be due, in part, to
other factors as well. For instance, interest rates have been
relatively stable recently, meaning that firms have less reason
to purchase derivatives to arbitrage or hedge against changes.

=====================================
Foreign-Invested Bank Profits at Risk
=====================================

11. (SBU) Over the next few weeks, the lack of master
agreements with Chinese domestic banks will start to cut into
the profits of foreign-invested banks. Banks that have not
signed are prohibited by the PBOC from trading in derivatives
markets, according to the March 11 PBOC notice. Currently,
foreign-invested banks have a strong market share, with
approximately one-third of the volume of foreign-exchange swaps
-- the larger and more liquid derivatives market in China -- and
approximately half of the volume of interest rate swaps.
(Comment: Derivatives trading is an area of competitive strength
for foreign-invested banks, which by comparison only account for
a little over 2 percent of total banking system assets in China.
End comment.)

12. (SBU) Even if master agreements are signed, domestic banks
may be able to take advantage of the parent guarantee
requirement to gain market share from foreign-invested banks.
One bank executive said that adding the parent guarantee would
force them to widen the bid-offer spread, due to additional

SHANGHAI 00000401 004 OF 004


transaction costs. This would make foreign-invested banks less
competitive vis-a-vis their domestic counterparts. Since
Chinese banks have a bigger customer base, they will be able to
leverage this cost differential over time to sway customers
towards their services.

=======
Comment
=======

13. (SBU) The Chinese financial system's view of
foreign-invested banks is shifting in the wake of the global
financial turmoil that broke out in the fall of 2008. Both
Chinese domestic banks and Chinese regulators are taking a more
cautious approach to financial derivatives and other
foreign-developed products that they blame for instigating that
crisis. While the fears raised by the crisis may take time to
work out -- and the Chinese authorities are looking in part to
regulatory changes that their counterparts in the United States
and other developed markets put in place -- there also appears
to be room for the Chinese side to compromise on the demands for
parent guarantees of over-the-counter derivatives transactions.
The PBOC, for example, could extend the September 16 deadline
for banks to negotiate amongst themselves while not disrupting
the market, and perhaps also indicate to Chinese domestic banks
that legitimate risk concerns can be accommodated without parent
guarantees. However, our Shanghai contacts did not offer
specifics on how internal PBOC dynamics must be realigned in
order to modify implementation of the new master agreement
structure.
CAMP

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