The State Administration of Foreign Exchange recently issued the Circular of the State Administration of Foreign Exchange on Relevant Issues Concerning the Banks’ Handling of Renminbi-Against-Forex Options Portfolio Business (Hui Fa No.43 [2011], hereinafter referred to as the “Circular”), and a relevant official from the State Administration of Foreign Exchange accepted an interview with journalists on related issues.
Question: It has been learned that the Renminbi-against-Forex options trading was introduced in April 2011; why was the foreign exchange options portfolio business being introduced at this time?
Answer: An option is a kind of right to choose. The buyer, after paying a premium to the seller, has the right to buy or sell certain subject matter of an agreed quantity at an agreed price in the future. Compared with the forward settlement and sales of foreign exchange, a foreign exchange option has the advantage of flexibility. For example, export enterprises may choose to conduct forward foreign exchange settlement or to buy a foreign exchange put option in order to guarantee the value of their future revenue from payment for goods in a foreign currency. In particular, the advantage of conducting forward foreign exchange settlement business is that it avoids possible losses from a depreciation of the foreign currency and fixes the cost in advance and avoid paying any expenses. However, it involves the sacrifice of possible gains from the appreciation of foreign currency; in contrast, the advantage of conducting the option business is that it has flexibility, i.e., in the case of a depreciation of the foreign currency, the enterprise may choose to exercise the option to conduct foreign exchange settlement at the agreed upon price; in the case of an appreciation of the foreign currency, the enterprise may choose not to exercise the option and conduct the foreign exchange settlement at the market price. However, the enterprise will have to pay a relatively high premium in advance.
On April 1, 2011, the Renminbi-against-Forex options trading officially commenced on the domestic foreign exchange market whereby enterprises may buy options from the banks to hedge against exchange-rate risks. On this basis, in order to better satisfy the requirements of market players to hedge against exchange-rate risks, the Circular introduces the foreign exchange put and risk-reversal options portfolio business and the foreign exchange call and risk-reversal options portfolio business, both of which are options portfolio businesses at zero cost. The so-called options portfolio at zero cost means that the premium expenditure for the purchase of an option and the premium revenue from the sale of an option are offset by one another to make the net cost of guaranteeing the value equal to zero (or approaching zero) through the option purchase and sale portfolio. Consequently, flexibility in guaranteeing the value can be assured and the trading cost can be reduced.
The most prominent feature of the foreign exchange put and risk-reversal options portfolio business and the foreign exchange call and risk-reversal options portfolio business is that there is a cap on the greatest potential loss, i.e., when the market players use the two types of businesses to hedge against exchange-rate risks for their future foreign exchange revenue or expenditures, they can fix the price for the foreign exchange settlement or purchase within a pre-set range, regardless of the direction of the changes in the exchange or the extent of the changes. From this perspective, in terms of the aforesaid two types of businesses introduced by the Circular, the risks of their products are relatively low, and they are beneficial to satisfy market demand and to conform to the actual situation in the identification, management, and tolerance of the risks by enterprises and banks at the current stage.
Question: May clients sell the options from the options portfolio business that is being introduced at this time?
Answer: Because the risks assumed by the seller are far greater than those assumed by the buyer, the seller needs a relatively strong risk-management capability. Based on international experience, it is common practice in newly emerging market economies to restrict the “naked short sale” of options by clients. In view of the fact that the current risk-management capabilities of domestic enterprises are still at a growth stage, in order to avoid an over-commitment of trade risks by domestic enterprises, upon the introduction of the Renminbi-against-Forex options business in April 2011, it is provided that the clients can only purchase the options from the banks and may not sell the options. However, in the options portfolio business introduced in this Circular, through the option purchase and sale portfolio the clients are granted the right to sell the options based on the purchase of the option, which is beneficial to reducing the risks of only sales of the option by clients.
Question: What are the management requirements for the options portfolio business being introduced at this time?
Answer: First, adhering to the principle of trading on the basis of actual needs. In order to prevent large-scale sheer speculation, the clients must have a true trading background in trade and investment to handle the options portfolio business, and the banks shall conduct the necessary examinations of their authenticity and compliance to ensure compliance with hedging principles.
Second, emphasizing the principles of integrity. In the options portfolio business, the purchase and sale by clients of options from and to banks constitute a whole contract to prevent “naked short sales” of options by clients. Furthermore, the premium received by the clients from the sale of options shall not exceed that which they paid for the purchase of the options, in order to prevent an over-commitment of risks by clients due to a net receipt of the premium.
Third, simplifying market-access management. The banks that qualify for Renminbi-against-Forex options trading on the inter-bank foreign exchange market and that qualify to operate the Renminbi-against-Forex options business for clients may directly engage in the options portfolio business for their clients, and the foreign exchange authorities will not provide new measures to manage market access.
Question: What are the plans of the foreign exchange authorities to promote the development of the domestic and international options market?
Answer: The foreign exchange authorities will cooperate with the relevant departments to foster market players and to allow them play a leading role in product innovation, and will continue steadily promoting the development of the domestic and international options market.
