Recently, the People’s Bank of China released the Circular on Relevant Issues concerning the Implementation of Renminbi Interest Rate Swap. On February 9th, China Development Bank (CDB) and China Everbright Bank (CEB) completed the first transaction of Renminbi Interest Rate Swap. This marks the formal entrance of Renminbi interest rate derivative instruments in the financial market of China and the beginning of a new phase for the interest rate liberalization and the financial market construction.

As explained by relevant department heads of CDB and CEB, the preliminary agreement for the interest rate swap transaction was reached on October 10th, 2005 with a nominal principal of RMB5 billion and a maturity period of 10 years. CEB agreed to pay for fixed interest rate and CDB agreed to pay for floating interest rate (interest rate of one-year term deposit). The two parties agreed at the time that the agreement would come into force when relevant policies were introduced by the People’s Bank of China.

Interest Rate Swap (IRS) is one of the most important instruments used in the capital market. Its main functions include price discovery, risk hedging and asset allocation. The extent of liquidity and depth of the IRS market are important indicators of the maturity degree of a financial market. After many years’ development, the financial market in China has made significant headway, but a huge gap remains between it and the international financial market. In the international financial market, multiple options are available for enterprises to raise capital, and investors can choose from a wide range of products to invest in. In order to diversify risks and avoid losses, investors and bond issuers in international financial market can choose from a range of financial derivative products including interest rate swap, interest rate options and swaption so as to diversify risks by hedging and avoid the impact of interest rate fluctuations on normal operations of enterprises. Contrastingly, in domestic financial market, does not yet provide interest rate derivatives are unavailable, and effective financial derivative instruments to avoid risks are not in place either. As China promotes the interest rate liberalization and capital market construction, there emerges great demand for risk-evading derivative instruments by financial institutions and enterprises. In the process of interest rate liberalization, the timely launching of Renminbi IRS is of great significance to improve the effectiveness of domestic financial market and the interest rate management capability of financial institutions, hence raising the risk tolerance ability of the financial system and promoting market stability. From macro perspectives, the development of RMB IRS market can actively boost the liquidity of the securities market, form an efficient and uniform securities market, create price connections among securities market, money market, loan market and personal consumption credit market, improve the efficiency of securities yield curve, refine the transmission mechanism of monetary policy, and strengthen the macro controlling capability of the central bank. From micro perspectives, the development of RMB IRS market can create a sound environment for financial institutions to avoid asset-liability interest rate mismatching risks through IRS transactions and provide enterprises and individuals with loans and wealth management products of different interest-rate structure, which is of great significance to boosting innovation of interest-rate products and upgrading service quality of financial institutions. For instance, the absence of long-term fixed interest rate for personal housing mortgage loan imposes the risk of more interest resulted by floating upward interest rate on consumers who purchase properties through mortgage loans. Recently, on the basis of IRS, CEB launched Renminbi fixed rate mortgage loan to individual customers, so that the interest rate risk of mortgage loan is diverted to the capital market via the bank. Similarly, in accordance with their business needs, enterprises may use IRS to avoid interest-rate risks in financing and investment, optimize their capital structure and utilize capital market for financing more effectively.

Relevant department heads of CDB and CEB stated that in the coming future, they would make use of the favorable condition created by the launching of Renminbi IRS to boost products innovation and improve pricing mechanism of products, so as to meet the rising demands of customers for banking products and services in the process of interest rate liberalization and the development of capital market.