A long and interesting article from China about developing the IR market, an IR benchmark in SHIBOR (Shanghai IBOR), and the intention to launch clearing of OTC IRS in 2012.  The original article is here, if you browse using Google Chrome it will offer to translate into English, which I’ve pasted below. The format is questions posed by “International Finance”, the interviewee is Xu Zhen, Chairman of the Shanghai Clearing House, here.

A benchmark interest rate system is the key

“International Finance“: At present, regulatory authorities, including the community, to speed up market-oriented reform of interest rates to reach a consensus. Specific path of interest rates market-oriented reforms, how do you see?

Xu Zhen: the recent discussion on accelerating the market-oriented reform of interest rates is very warm, also put forward many good suggestions on a specific path, I would like to be stressed is that the “12th Five-Year Plan clearly stated,” steady progress in the interest rate market reform, strengthening of financial market benchmark interest rate system, national financial work conference also made it clear that “accelerating the development of a market benchmark interest rate system, and guide financial institutions to enhance risk-based pricing, and steadily push forward market-oriented interest rate reform,” This shows that the financial market benchmarks The interest rate system is market-oriented interest rate reform in a bid to “very critical. Based on current conditions, I think, interest rate swaps and interest rate derivatives product innovation and development, is an important part of the benchmark interest rate system for financial markets. Shanghai Clearing of OTC interest rate through the safe and efficient net derivatives clearing services, escort for the market-oriented reform of interest rates.

“International Finance“: on several occasions stressed that the interest rate swaps to accelerate the development of financial market benchmark interest rate system has an important role.

Xu Zhen: Yes. The interest rate market, simply put, is the interest rate is mainly determined by market supply and demand, but the interest rate market is not “put it”, but stressed that the policy control should be the benchmark interest rate system successfully converted to autonomous decision-making benchmark interest rate system, around transparency, integrity, fair benchmark interest rate system, the main players in the market actively and enthusiastically participate in interest rate products trading, the regulatory body is flexible and prudent implementation of macroeconomic regulation and control interest rates, and ultimately achieve the optimal capital allocation efficiency. People’s Bank study reported that in the control of interest rates have been gradually reduced to the case of the upper limit of financial institutions, renminbi deposits and loans lower limit management, at this stage of SHIBOR the central counting the interest rate and the Treasury yield curve constitute China’s financial markets, the benchmark interest rate system . ” The existing experience shows that the full price discovery and effective management of risk is not enough, the only interest rate spot tool, but also attach great importance to the long-term interest rate, interest rate futures, interest rate options, interest rate swaps and other interest rate derivatives, including interest rate each other change worthy of focus.

First of all, the interest rate swap is the most interest rate derivatives. According to the latest statistics of the Bank for International Settlements (BIS), the end of 2011, the global derivatives the outstanding notional principal (hereinafter referred to as contract principal) for $ 706.09 trillion, interest rate derivative contracts principal amount of $ 557.4 trillion, accounting for 78.94 %, of which the principal of interest rate swaps $ 402.61 trillion, accounting for 72.23% in the global interest rate derivatives.

Secondly, the interest rate swap is a very mature and interest rate derivatives. On the international market, the interest rate swap in the emergence of time with minor later than the interest rate futures, but quickly developed into the largest interest rate derivatives, and all bilateral OTC inquiry designed to be flexible contracts, the period of structural integrity, participation The main broad, especially close to the real economy needs.

Finally, the interest rate swap is a key interest rate derivatives. Specific performance of financial markets, the benchmark interest rate system is the yield curve, compared to other interest rate derivatives, interest rate swaps that have distinct characteristics in the constructed yield curve, one is directly linked with the money market benchmark interest rate (contract principal international financial markets, 55 percent of the interest rate swap LIBOR for the floating-side reference rate), to strengthen the money market benchmark interest rate, while its organic linkage; two by creating trading opportunities and improve market liquidity in the protection of the short period play a significant role in the reliability of the yield curve, also have some contribution to the integrity of the yield curve; three interest rate swaps curve implied the level of inter-bank institutions credit, to solve the credit of using the risk-free yield curve The level of mismatch, the more precise management of interest rate risk faced by the real economy.

The challenge of the two over-the-counter derivatives settlement mechanisms

“International Finance”: So I want to know, interest rate swaps included in the central counterparty clearing mechanisms, before the international community had successfully put into practice?

Xu Zhen: international financial markets, interest rate swaps and long-term prosperity and development is an important reason, is the successful exploration and extensive use of central counterparty clearing mechanism. The Financial Stability Board (FSB) latest survey report pointed out that the global interest rate swap has more than 50% of the proportion included in the mechanism of central counterparty clearing, far ahead of other over-the-counter derivative products.

The international financial crisis, central counterparty clearing mechanisms to guard against systemic risk functions are fully reflected. The most typical case is the event of bankruptcy of Lehman Brothers, the London Clearing House (LCH.Clearnet) quickly disposed of the huge amount of open positions, including the $ 9 trillion interest rate swap, there is no other market players and the London Clearing arising from any loss. However, Lehman Brothers has not been included in the mechanism of central counterparty clearing $ 72 billion of credit default swaps (CDS) on open positions and brought about $ 5.2 billion net loss, and ultimately to other market players.

It is based on a profound reflection on these experiences and lessons, the 2009 G20 summit in Pittsburgh on the OTC derivatives market reforms to reach a consensus, a clear commitment of all standardized OTC derivatives, central counterparty clearing “before the end of 2012 at the latest. Currently, the U.S., EU, Japan and other developed economies has been the first to complete the legislative process for OTC derivatives reform, regulatory requirements and are made on the interest rate swap mandatory central counterparty clearing.

“International Finance: compared with the trades derivative products, over-the-counter derivative products, the introduction of central counterparty clearing mechanism in which the objective difficulties?

Xu Zhen: Generally speaking, there are three main aspects: First, standardization is not enough. Degree of standardization of OTC derivatives is reflected not only in terms of the contract level, is also reflected in the level of the processes; The second is the limited mobility. Get fair, timely and reliable price information is relatively difficult, central counterparty clearing organizations MtM margin calculation is facing more challenges, but also on its own deeper involved in the breach of the disposal process, and other clearing members, more bear the penalty disposal responsibility to make special arrangements; The third is to consider more ancillary services. Since not all OTC derivative products can be incorporated into the central counterparty clearing mechanism, the net settlement business running smoothly, with the industry standards or market practice coordination, and transaction information centralized registration agency support and cooperation of. In addition, the OTC derivatives market is more international, the net liquidation business cross-border regulatory cooperation is also very important.

“International Finance”: how to begin to resolve these difficulties?

Xu Zhen: In order to solve these problems, the central counterparty clearing organizations, international financial markets in a series of innovative design in the net interest rate swap clearing business. 1999, to take the cross-market, multi-product, independent mode of operation of the London Clearing the successful launch of direct-to-OTC interest rate swaps, net settlement services SwapClear changed other agencies OTC derivative products into the venue derivative products, and then into the common practice of trades derivative products net liquidation. Standardization issues, due to interest rate swaps contract terms and risk characteristics are relatively clear, the transaction processing process is to enhance the focus of the standardization work. In international financial markets, interest rate swaps reached through the electronic trading platform for less than 10% (the ISDA report pointed out that the interest rate swaps to suitable reached through the electronic trading platform for less than 30%), interest rate swap electronic confirmation services system for Worldwide Interbank Financial Telecommunication (SWIFT) of the Accord, Affirmations and SwapsWire has been acquired by Markit, the London Clearing only the net settlement services through the “approved transaction resource system” submitted by interest rate swaps; in liquidity problems, the London Clearing House The first is strictly set the clearing member access standards to ensure a high level of its financial and operational strength, followed in gathering market intelligence to build a benchmark yield curve, basis for clearing members, variation margin, to achieve MtM on the basis of the city of innovation and development of the PAIRS model used to calculate the initial margin of the clearing member, managing risk exposure, and finally disposed of in accordance with the non-breaching clearing member directly involved in the concept of risk-sharing and constantly improve the default procedures; in supporting service issues, TriOptima in 2003, interest rate swaps write-off service has been transferred and led by the London Clearing House. 2011 as a whole, dominated by the London Clearing completion of the $ 48.3 trillion contracts principal, interest rate swap write-off, the market share of 85.64%. Centralized registration service since 2012, the interest rate swap transactions (DTCC to turn to bear the liquidation managed by the National Group, as well as exchange rates, commodity, credit, equity and other OTC derivatives transaction information centralized registration service), in order to better resolve many of the world’s central counterparty clearing organizations co-exist to the market needs to the reality of a unified information collection contradiction.

Is worth noting that, although the London Clearing House’s global market share up to 95%, but net interest rate swap clearing business diversification trend is emerging. In Japan, the FSA made it clear that the main interest rate swaps, net settlement services should be domestic clearing agencies, licensed offshore clearing organizations, or the joint between the two. Japan Securities Clearing Corporation (JSCC) at the beginning of this year released a self-developed interest rate swaps, net liquidation business Outline. In addition, the Hong Kong Exchanges and Clearing Limited (HKEX) decided the new one in the end of 2012 for the OTC offshore yuan derivatives clearing organizations, the product of choice is one of interest rate swaps, the market expects the Hong Kong Stock Exchange clearing organizations, net interest rate swap The amount of clearing operations will be the main independent research and development. From existing interest rate swaps between the central counterparty clearing organizations net liquidation business division, will be mainly based in different currencies, as well as the formation of a specific market based on these currencies started.

3 of the preferred interest rate swap four factors

“International Finance: Shanghai liquidation of the selected interest rate swaps as the first interest rate derivatives, net liquidation varieties, but also the first OTC derivatives net liquidation varieties, What are the considerations?

Xu Zhen: The main consideration of the following four aspects:

First, the net interest rate swap clearing business has a good market base. 2011 as a whole, the Chinese over-the-counter interest rate derivative product transaction number and size of 20641 pen, 2.779238 trillion yuan year on year increase of 63.43%, 52.99%, of which the interest rate swap transaction number and size of the 20,202 pens, 2.67596 trillion yuan The market share of 97.87%, 96.28%, respectively, an increase of 73.51%, 78.36%. Be seen that the interest rate swap is not only an absolute market share, is also showing rapid growth. In addition, the interest rate swap of active participation in institutions close to one hundred, and the heterogeneous characteristics of the participating institutions have become increasingly prominent, the interest rate swap market price discovery, risk management function has been widely recognized. The above, the interest rate swap derivatives of this base rate by bilateral clearing model is converted to a central counterparty clearing model, both with the actual conditions, there are urgent needs.

Second, the interest rate swap products to the introduction of central counterparty clearing mechanisms to promote their accelerated development. In the context of the current market parties are more concerned about the restart of the floor interest rate of Treasury bond futures derivatives, the task is not to reduce the speed up the development of interest rate swaps, but heavier. First, the corresponding spot T-bond futures products is the national debt, the end of 2011, China’s balance of 7.38 trillion yuan of treasury bonds, but over the same period amounted to 53.28 trillion yuan of loans, bills discounting, commissioned by the balance of 8.47 trillion yuan of loans and trust loans, financial bonds and corporate debt balance of 12.62 trillion yuan, these rates much larger than government bonds, interest rate risk management is inseparable from interest rate swaps; Second, the Treasury bond futures physical delivery mechanism design, demanding the coordination linkage of the two market of derivatives, the spot objective to take longer to feasibility studies and explore the process of improvement. Interest rate swaps has entered a stage of rapid development, continue to maintain and to expand this a good momentum, help create a venue over-the-counter interest rate derivative products to drive each other, the common prosperity of the relaxed environment, to avoid the T-bond futures-man breaking into “may be encountered various difficulties; Finally, the introduction of central counterparty clearing mechanisms not only to expand interest rate swap market size, and improve market liquidity, more importantly, to strengthen the price discovery function of interest rate swaps. At present, China’s interest rate swap market operation has been achieved by the model pricing to traders pricing conversion, that is, from members of the market, period-based transaction / quotation, central counterparty clearing organizations can directly generated has been recognized by the market members, the fair interest rate swap benchmark curve, market members accordingly the transaction pricing and follow-up valuation, central counterparty clearing organizations accordingly to carry out the daily mark to market, breach of contract disposal. This means that, after the introduction of central counterparty clearing mechanisms, over-the-counter interest rate swap in the price signals are timely, objective, continuous, transparent side, there was no difference compared with the floor interest rate of Treasury bond futures and other derivative products, the subject and the dominant position must stronger.

Third, the net interest rate swap clearing business and the strategic layout of the Shanghai Clearing a high degree of fit. In interest rates, exchange rates, commodities and other OTC derivatives, net liquidation business, Shanghai Clearing your field of interest rate derivatives to prepare more fully. December 19, 2011, approved by the People’s Bank of Shanghai Clearing launched the innovative inter-bank spot bond trading net liquidation business, the first covering the clearing house to provide ultra-short-term financing bonds for the registration of managed services, non-public directional debt financing instruments, short-term financing bonds, small and medium collection of bills, short-term financing bills and innovations such as interest rate products, securities companies, the next phase of efforts to expand to other institutions registered managed interest rate products. Follow the “thinking of innovative products registration hosting – the net spot trading liquidation – derivatives net settlement”, Shanghai Clearing the first in the field of interest rate products to build complete service chain, the formation of the OTC market central counterparty clearing mechanisms reduce costs, improve efficiency, manage risk, support innovation, such as the demonstration effect of its expanding coverage to lay a solid foundation.

Fourth, the net interest rate swap clearing business to the next stage will be to force the establishment of central counterparty clearing mechanisms to create the conditions. Repeatedly put forward in the implementation of the commitments of the G20 summit in Pittsburgh reform process, the Financial Stability Board, compulsory central counterparty clearing mechanisms will meet the standard over-the-counter derivative products, reasonable to set the terms of the exemption from mandatory central counterparty clearing mechanisms, as well as not OTC derivatives transactions into a central counterparty clearing mechanisms to provision for higher standards of risk capital and other measures to expand the central counterparty clearing mechanisms in the coverage of OTC derivatives products. Currently, the U.S., EU, Japan have been introduced for over-the-counter derivative products to make provisions for mandatory central counterparty clearing mechanism, and explicitly include interest rate swaps. From the trend, China is also necessary to timely introduction of the OTC derivatives mandatory central counterparty clearing mechanisms, policy guidance to accelerate the market development. Shanghai liquidation of the interest rate swap net settlement business as China’s first off-net derivatives clearing business, as soon as possible and continue to improve, is bound to the early establishment of the accumulation of experience, to create the conditions for mandatory central counterparty clearing mechanisms.

4 the formation of the settlement mechanism, “Chinese model”

“International Finance“: in the Lujiazui Financial Forum just ended, you mentioned, as soon as possible interest rate swaps, net liquidation business, can you give us details about the idea to open this business.

Xu Zhen: under the guidance of the People’s Bank of Shanghai liquidation in close collaboration with market members, the net interest rate swap clearing business program was carefully studied, in general, the characteristics of the following three aspects:

First, the selection of products adhere to encounter into the type of interest rate swaps net liquidation business to focus the floating end of a fixed rate to floating interest rates; focus on contract period of 5 days (inclusive) to less than 5 years (inclusive); Focus on the reference rate for the the SHIBOR overnight SHIBOR3 month and other four varieties. 2011 as a whole, in line with the requirements in the above period of interest rate swaps market share of 91.58%, in line with the requirements of the floating-side reference rate interest rate swap market share of 99.92%. Departure from the promotion of contract standardization, Shanghai Clearing House payment date business criteria, interest-bearing days of adjustment, interest payment, interest-bearing basis, the reference rate and method of choosing clear. In addition, the interest rate swap the stock of contracts in line in front of the net liquidation business, as long as they meet the contractual requirements stipulated by the Shanghai liquidation, can also be included in the net liquidation.

Second, risk management, strive to complete specification, the net liquidation business in spot trading, the full establishment of a clearing member, clearing limits, risk monitoring, margin, collateral, liquidation fund, the risk reserve, DVP, bank credit, securities lending on the basis of breach of contract disposal of central counterparty clearing mechanisms risk control system, according to the characteristics of interest rate swaps, Shanghai Clearing House will focus on improving the minimum margin and mark to market margin calculation methods, in particular, may arise to prevent the clearing member default handling open loss, designed to calculate the minimum margin based on exposure risk control mechanism. : Refer to the current internationally accepted exposure calculation, historical VaR + scenario method for clearing members, the interest rate swap contract portfolio risk exposure, and exposure to charge the appropriate margin (in addition to the minimum margin, there are overrun margin, special margin). Liquidation to confirm the contract alternative point, early termination, liquidation exit, regression testing, stress testing, risk monitoring, open processing sequence, and the Inter-bank Market Dealers Association (NAFMII) relationship of the Master Agreement, Clearing according to national circumstances, a reasonable design.

Of particular note is that the Shanghai Clearing House in strict accordance with the Guidelines on the latest release of the financial market infrastructure, the environment, institutions, mechanisms and requirements of the construction and operation of central counterparty clearing organizations were comprehensively reviewed. Especially feedback situation of foreign financial institutions from the market members, the business program of the Shanghai Clearing, timely and accurate monitoring, identifying, measuring and quickly and safely dispose of the interest rate swaps, net clearing operations launched various types of risk faced by contribute to a gradual improvement and expansion of OTC derivatives central counterparty clearing mechanisms, and widely recognized.

Third, the positioning of bodies stressed moderately forward-looking. Shanghai liquidation as the only central counterparty clearing organizations adhere to the independent path of development in China, over-the-counter derivatives market, not to open business outside the relevant market intermediaries, may also need a net liquidation services hub, an extension to provide the necessary value-added, complementary services, the pursuit of the greatest degree of financial market infrastructure to concentrate on building and intensive use of catch-up advantage after the formation reflects the Chinese model. Bank for International Settlements study reported that, compared to the global central counterparty clearing organizations, local and central counterparty clearing organizations to better adapt to specific market environment has a significant advantage.

5 booster OTC derivatives reform

“International Finance“: In your opinion, the important role of interest rate swaps, net liquidation business is embodied in where?

Xu Zhen: Interest rate swap net settlement service launch marks the OTC derivatives reform of China’s implementation of the G20 summit in Pittsburgh International is committed to a major breakthrough is expected to net with developed economies in the interest rate swaps, the most important derivatives synchronization standards in the liquidation business, and is expected to have an important role in the following four aspects:

First, to promote faster development of interest rate swap market, including micro solution to the credit limit on the amount of market members in the bilateral liquidation mode, reduce the capital provision requirements of the market, members of the derivatives trading, to reduce the cost of the liquidation of market members to promote the interest rate each other change the standardization of the product elements, macro, timely and effective computing and master the market members of the exposure information, to improve market transparency, isolation counterparty risk, and to prevent default by market members to trigger a systemic risk, and so on. These will increase the interest rate swap market size and operation of quality, “off virtual reality”, under the joint efforts of the parties in the market to better serve the real economy.

The second is to promote the overall prosperity of the interest rate derivatives, interest rate swaps, net liquidation business successful exploration in addition to the expansion application in favor of central counterparty clearing mechanisms in other over-the-counter interest rate derivative products, will also work with the Treasury bond futures field within the interest rate derivatives, the formation of positive interaction, the first in the field of interest rate derivatives to achieve “interoperability”. Judging from past experience, the OTC interest rate swap and floor interest rate futures, options, there is a risk hedge effect, provides a convenient market members according to actual needs, the flexibility to choose the interest rate risk management tools, and scientific development of interest rate risk management strategy.

Is to consolidate the dominant position in the market-oriented reform of interest rates in the shore market, interest rate swaps, net clearing operations launched SHIBOR based market benchmark interest rate system at the operational level, will strengthen the authority of, and expand the influence; at the institutional level, will strengthen the voice of the onshore market, for example, the domestic Chinese banks can not participate in RMB outside the principal settlement of interest rate swaps (NDIRS), RMB deliverable interest rate swap (CNHIRS) market, compared to foreign banks at a competitive disadvantage, the territory of RMB interest rate swap market pricing under serious threat. If relying on the liquidation of Shanghai by the smooth flow of interest rate swaps in cross-border transactions, and orderly compliance “Please come in, going out”, bound to a dominant position in the onshore market. In another example, in the context of the rapid spread of mandatory central counterparty clearing mechanism, the major economies are actively fostering national central counterparty clearing organizations, to seek more interest in the OTC derivatives market development pattern, Shanghai Clearing House is to safeguard China’s market a powerful starting point for the overall interests of the expression of the reasonable demands of the local market.

Fourth, the scientific development concept to establish the over-the-counter derivatives risk control. Generally speaking, the international OTC derivatives market is taking a first development, after the specification of the road, lead to serious losses in the international financial crisis, the international community to agree on the introduction of central counterparty clearing mechanisms. China’s OTC market is the inter-bank market derivative products, though a late start, few products, but the situation is gratifying, with the deepening of market-oriented interest rate reform, the potential development of very large space. The net interest rate swap clearing business as a starting point, China’s interest rates, exchange rates, credit, commodities and other OTC derivative products from the early stages of development combined with the central counterparty clearing mechanisms, able to fully reflect the creativity and flexibility of the OTC market the actual needs, but also effectively improve the efficiency and effective risk, and thus out of a foreign mutual difference, suitable for China’s financial markets over-the-counter derivative products of scientific development, new road.

Shanghai Clearing House is the international financial crisis, following 2009, the Fed approved the establishment of the Intercontinental Exchange Clearing Corporation, the world’s second and Asia’s first directly by the central bank to promote the establishment of a central counterparty clearing organizations, bear exploration to establish a central counterparty settlement mechanisms, and improve the important responsibilities of the financial market infrastructure system is an important content of China’s financial markets “top-level design of the People’s Bank of China’s financial markets further to the depth and breadth make institutional arrangements.

January 30, 2012, by the State Council, the National Development and Reform Commission officially issued the “12th Five-Year” period of construction of Shanghai international financial center planning “and specifically pointed out:” Shanghai liquidation innovative over-the-counter market clearing mechanism, and actively explore the interest rate swap products such as centralized clearing model. ” Shanghai Clearing interest rate swaps as a breakthrough in the net derivatives clearing business, to be launched during the year 2012, formally launched.