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	CIRCULAR OF CHINA BANKING REGULATORY COMMITTEE ON RISK REMINDING IN THE DEALINGS OF DERIVATIVE PRODUCTS OF CHINESE-FUNDED BANKS

	(China Banking Regulatory Committee, March 22, 2005)


SUBJECT : CHINESE-FUNDED BANKS; DERIVATIVE PRODUCTS; RISK
ISSUING DEPARTMENT : CHINA BANKING REGULATORY COMMISSION
ISSUE DATE : 03/22/2005
IMPLEMENT DATE : 03/22/2005
LENGTH : 1,150 words
TEXT :

In October, 2004, China Aviation Oil (Singapore) Corporation, when engaging in the transaction of derivative products, incurred a huge loss of $554 million (hereinafter referred to as the event of China Aviation Oil), which indicates that there exists a huge risk in derivative product transactions. In order to learn a good lesson therefrom, further intensify the awareness to prevent risks, develop derivative products in a healthy way, provide better services to clients and strictly implement the provisions of the Interim Measures for the Management of the Dealings of Derivative Products of Financial Institutions and the Market Risk Management Guidelines for Commercial Banks so as to carry out effective management on credit risks, market risks, liquidity risks, operational risks and legal risks of derivative product transactions. We hereby remind you again as follows of the management of dealing risks of derivative products:

1. Strictly implementing the authorization and the stop-loss systems. China Aviation Oil (Singapore) Corporation, in the dealing proceedings of derivative products, severely violated the internal control procedure so that the authorization and the stop-loss systems practically did not work at all, which led to a huge loss. People in all banks shall learn lessons from previous errors. Any derivative product transaction shall be subject to the graded authorization system and exposure risk management system that has been established. Any big transaction or new business operation of derivative products shall be subject to the approval of the board of directors or be subject to the senior management as designated by the board of directors. The stop-loss system that has been established shall be strictly implemented where there is any book loss as incurred by any market change or decision-making blunder.

2. Perfecting the Internal Control and Improving the Corporation Management

(1) The board of directors in all banks shall carry out appraisals on the existing risk management policies and procedures of derivative products on a periodical base so as to ensure that the policies and procedures thereof are in compliance with the capital strength and management capacity of the organizations concerned.

(2) The senior managerial personnel of all banks who take charge of the risk management and control of derivative product operations shall not hold concurrent posts of the senior managerial personnel who take charge of the transactions or marketing of derivative products.

(3) The personnel who engage in the measurement, monitoring or control of risks shall not hold concurrent posts of those personnel who engage in the transactions or marketing of derivative products; those personnel who engage in the measurement, monitoring or control of risks may directly report the risks to the senior managerial personnel.

(4) All banks shall clarify the power limits and responsibilities of their persons-in-charge and dealers regarding derivative product transactions in written form, and adopt a strict accountability system. A clarified punishment system shall be applied to those dealers and the persons-in-charge thereof who go beyond their powers or violate any relevant regulation.

(5) All banks shall improve their internal systems as soon as possible in accordance with such requirements as the Interim Measures for the Management of the Dealings of Derivative Products of Financial Institutions and the Market Risk Management Guidelines for Commercial Banks.

(6) All banks shall formulate a reasonable mechanism for the analysis and calculation of costs and assets and an incentive & restriction mechanism. They shall not simply link the payment of those personnel in charge of derivative product transactions and risk management with the proceeds as generated from derivative product transactions in an effort to avoid adding any transaction risk as incurred by excessive pursuit of interests.

(7) All banks shall apply the system of rotating posts regularly and compulsory paid vacation system to the persons-in-charge and dealers of derivative product transactions.

3. Upgrading the capability of monitoring risks. The lack of adequate capability of monitoring transaction risks of derivative products is an important cause for the accumulation of hidden risks. All banks shall not spare efforts to attract and retain talented personnel well-versed in risk identification and measurement, perfect the operating system for derivative product transactions with automatic links between the foreground, mid-ground and background platforms and the real-time risk management system and shall, according to the principle of ¡°mark-to-market ¡±, conduct the market value revaluation of open positions of derivative products and establish reserves for the market value revaluation of derivative products. For those derivative products as created and traded in any market with little liquidity (such as the over-the-counter market), it shall be more imperative to conduct the examination of the frequency and quality of market value revaluation thereof.

With the development of risk management technologies of derivative products, all banks shall attach great importance to the correct use, appraisal and amendment of the quantification risk model. In particular, where any non-standard off-the-counter transaction of derivative products is made, an in-depth research and verification shall be conducted on the market parameters as used in the quantification risk model so as to ensure the correctness thereof, and no model or parameter as provided by any foreign financial market or any foreign transaction counterpart may be applied mechanically.

The parent bank and its branches as authorized to engage in derivative product transactions shall establish an automatic link between the transaction system of derivative products and the risk management system. Those branches shall not have any position dissociating from the supervision and control of the parent bank.

4. Intensifying the examination and establishing a risk report system. The internal examination departments of all banks shall carry out examinations over the execution of the risk management system of derivative product transactions. Where there occurs any big risk in a derivative product transaction, effective measures shall be adopted without delay so as to check and any expansion of loss, at the same time, the relevant situation shall be reported to the regulatory institutions thereof in a timely manner.

A bank as authorized to open or planned to open derivative product transactions shall carry out an in-depth self-examination regarding the aforesaid requirements in an immediate term so as to form a self-examination report, which shall, before April 30, 2005, be reported to the immediate regulatory institution. The content of the self-examination report shall include any hidden risk as found in the self-examination and the corresponding rectification measures as well.

All banking supervisory bureaus shall take initiative to investigate into the varieties and exposure of derivative product transactions as undertaken by banking financial institutions within their jurisdictions. Where any severe problem is found in the daily supervision or in the self-examination of banks respectively, it shall be reported in a timely manner. Any banking financial institution that engages in any dealing of derivative products without authorization shall be punished according to law and the relevant persons shall be subject to liabilities.

All banking supervisory bureaus shall forward the present circular to urban commercial banks, rural commercial banks and rural cooperative banks within their jurisdictions.