Wall Street Derivatives Face Great Wall In China

The Wall Street Journal han article today that is likely to anger Wall Street. And no, it has nothing to do with bonuses, at least not directly. According to the article, China intends to make it very difficult for foreign banks to participate in its derivatives market. That would be a huge blow to the potential profits that foreign banks might hope to make off derivatives in the rapidly growing Chinese market.

Here's some detail, from the WSJ:

Starting Sept. 16, China will put into effect a new agreement governing how banks trade domestic financial 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 hard to comply with, according to lawyers and sources at several foreign banks.

Under the new trading regime, banks will only be allowed to trade 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 currency swaps.


But 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. All five banks declined to comment on the new arrangements.

Needless to say, foreign banks aren't going to be crazy about the idea of setting aside capital to guarantee their Chinese subsidiaries. This would result in their derivatives activities in China involving far less leverage than in the rest of the world, and consequently, much less profit.

Another provision that the Journal explains would allow Chinese banks to more easily back away from their derivatives exposure to foreign banks as a result of loan defaults anywhere in their business. The motivation here stems from the financial crisis and Chinese banks getting burned by Wall Street exposure. Think Lehman Brothers.

Of course, I'd argue that Wall Street really only has itself to blame on this one. It lost Chinese banks money, and they don't intend to let that happen again. While Wall Street might argue that its influence in the Chinese market would benefit China in the end, the current moment in economic history is hardly one where that argument sounds compelling. The result will likely be that, if Wall Street wants to do business in Chinese derivatives, then it won't be nearly as profitable as it had hoped.