Chinese insurance group (holding) companies, insurance companies and insurance asset management companies can engage in domestic financial derivative transactions following the implementation of Derivatives Measures by the CIRC.

Scope of financial derivative transactions

The China Insurance Regulatory Commission (the CIRC) implemented Administrative Measures on Insurance Funds Involved in Financial Derivative Transactions (CIRC Order No 94 2012) (Derivatives Measures) on 12 October 2012.

The Derivatives Measures define financial derivatives (derivatives) as financial contracts that have their value determined by considering one or more types of basic assets, index numbers or specific events. The specific types of derivatives that the Derivatives Measures mention include financial forwards, futures, options and swaps. Importantly, the Derivatives Measures make clear that the derivatives the Measures are contemplating are domestic derivative transactions, and the Measures specifically exclude offshore derivative transactions from being acceptable.

Entities that can invest in derivatives

The Derivatives Measures state that Chinese insurance group (holding) companies, insurance companies and insurance asset management companies (collectively Chinese Insurance Institutions) that are legally established within the People’s Republic of China may invest in derivatives by:

  • engaging in derivative transactions on their own; or
  • authorizing insurance asset management companies or professional management institutions to execute derivative transactions on their behalf.

Chinese Insurance Institutions that independently engage in derivative transactions must comply with the following requirements when they execute the transactions: the board of directors must understand the risks related to the transaction and accept responsibility for them; business operations, internal control, and risk management systems must be established which meet the standards set out in the Derivatives Measures; information systems and accounting and risk management systems must be established; professional staff must be engaged to conduct research, trading operations, accounting, risk management, auditing, and other necessary activities for derivative transactions; and all other requirements set out in the Derivatives Measures must be complied with. If a Chinese Insurance Institution authorizes an insurance asset management company or any other professional investment management institution to execute derivative transactions on its behalf, it must still assign professional staff to supervise and assess those transactions.

Goal for derivatives investments

The Derivatives Measures make it clear that Chinese Insurance Institutions are forbidden from engaging in derivative transactions for speculative purposes. Rather, the sole goal of derivative transactions should be to hedge or mitigate risks. The Derivatives Measures provide that these hedging and mitigating activities can include hedging or mitigating existing company assets, debts, or risks, hedging future risk, or locking in prices to protect against future volatility.

Management regulations and risk management

The Derivatives Measures establish that a Chinese Insurance Institution is ultimately responsible for its derivative transactions, even if it uses an asset management company to engage in derivative transactions. Chinese Insurance Institutions must create authorization mechanisms; business operation mechanisms; an internal control system; a risk management system; business guides; and risk hedging plans for derivative transactions. Chinese Insurance Institutions are also required to establish their information systems in a way that complies with the Derivatives Measures’ requirements for the systems’ business handling facilities, trading software, and operating systems. Moreover, each Chinese Insurance Institution’s information system must pass a CIRC required reliability test.

The Derivatives Measures’ requirements for Chinese Insurance Institutions’ derivative transaction risk management require Institutions to establish a dynamic derivatives risk management framework. This framework must be able to identify the risk limitation benefits that a derivative offers, and it must be able to check and update asset combinations regularly. Chinese Insurance Institutions are also required to establish a system to assess and select derivative counter-parties, create a firewall between the different departments involved in the institution’s derivative transactions, and create a system that ensures that all derivative transaction records are promptly entered, up to date, accurate and complete. Finally, the Derivatives Measures state that a risk management system must be created which allows for a certain percentage of an Institution’s assets to remain liquid to ensure that risk-hedging benefits are maximized.

Regulation and reporting

Chinese Insurance Institutions that engage in derivative transactions will now be required to provide the CIRC with reports on these transactions, in addition to providing any materials on transactions that the related derivatives regulations require them to provide.

The Derivatives Measures also establish that Chinese Insurance Institutions must provide the CIRC with a report where the Institution: has different rules for derivative transactions than those required by the Derivatives Measures; fails to establish its derivative transaction business systems or other related facilities in the manner required by the Derivatives Measures (if the Institution fails to establish these systems it must also cease all derivative transaction activities); has failed to assign specific professional staff to handle its derivative transactions as required by the CIRC (if the company fails to assign such staff, it must also cease all derivative transactions); and terminates its derivative transactions or has rescinded its authorization for an asset management company to execute derivative transactions on its behalf.

Finally, Chinese Insurance Institutions must provide the CIRC with the following regular reports: by the 10th day of each month, a report on the total derivatives risk exposure and the risk-hedging conditions; a quarterly auditing report for the prior quarter within the first 30 days of each quarter; an annual derivative transaction report that includes the Institution’s general derivative transaction risks, the effectiveness of its hedging activities, and its regulatory compliance work within 60 days of the new fiscal year beginning; reports on any conduct that does not comply with CIRC regulations; reports on any large derivatives risks undertaken, or any abnormal derivatives conditions that involve the Institution; and any other regular reports that the CIRC deems are necessary to supervise derivative transaction activities