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China's FX regulations: Better Safe than sorry?

Tight restrictions on the new Chinese FX options market might lead to a slow start.

China’s decision to allow companies to begin using foreign exchange options, announced by foreign exchange regulator Safe on February 16, was a long-awaited development for the market. It will give corporates more tools to hedge against currency risk, but not to enter into the speculation that has caused chaos in other markets when companies have strayed from their core business areas to try to pump up profits through gambling on the markets.

The fear of that practice developing further in China has led to a set of regulations from Safe that live up to the regulator’s name. They permit companies only to buy put or call options, not to sell them. It is this stipulation that has led to a note of caution in the market’s reaction to the news. The banks as a group will have to be net sellers of the options, as the only entities permitted to do so. This, some of them are concerned, will make pricing the options difficult by restricting the usual market flow of buying and selling positions to a large group of one-way trades between the corporates and the banks.

The documentation requirements are also said to be fairly onerous, with bankers preparing their markets departments to sell the options, already worrying about the possibility of a slow start to the market as both sides make the first tentative steps.

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