1. Progress of Interest Rate Liberalisation

In November 2013, the 3rd Plenary Session of the Chinese Communist Party’s 18th Central Committee adopted the Decisions on Major Issues Concerning Comprehensively Deepening Reforms which provides that interest liberalisation is to be accelerated in order to have a government bond yield curve that reflects the market demand and supply. This high level statement signals Chinese top authority’s commitment to promote interest rate liberalisation and the strategic importance of interest rate liberalisation in building China’s overall financial market system.

  • Looking back on the past 20 years, interest rate liberalisation has been constantly progressing since the very concept was initially proposed in 1993 in the Decisions of the Central Committee of the Communist Party of China on Some Issues Concerning the Establishment of the Socialist Market Economy and the Decisions of the State Council on Reforming the Financial System:

Click here to view image.

  • As the above diagram illustrates, all lending rates in China have been deregulated as of today, which makes the removal of the control over the deposit rates the final step towards overall interest rate liberalisation in China.
  1. Deciphering the Latest Regulation

The Interim Measures promulgated by PBOC took effect on 9 December 2013. On the same date, the China Foreign Exchange Trade System released the Trading Rules on Issuing the Interbank CDs (hereinafter the “Trading Rules”) providing more detailed operating rules for the Interim Measures.

  • What is An Interbank CD

According to the Interim Measures and the Trading Rules, Interbank CDs are book-entry certificates of time deposit issued by deposit-taking financial institutions on the interbank market, which by nature is a money market instrument.

  • Transaction Parties
  1. Issuers

According to the Interim Measures, the issuers of Interbank CDs shall be the depository financial institutions, including policy banks, commercial banks, rural cooperative financial institutions and other financial institutions approved by PBOC. Currently ten banks have pilot issuance qualification of Interbank CDs, which include Industrial and Commercial Bank of China, Agriculture Bank of China, Bank of China, Construction Bank of China, Bank of Communication, China Merchants Bank, China CITIC Bank, China Industrial Bank, Shanghai Pudong Development Bank, and China Development Bank.

  1. Investors

Article 4 of the Interim Measures stipulates that the parties permitted to invest in and trade the Interbank CDs shall be members of the national interbank lending market, fund management companies, and fund products. The Trading Rules further clarify that such parties include policy banks, commercial banks, county-level rural credit cooperatives, first-tier branches authorised by Chinese funded commercial banks (excluding city commercial banks, rural commercial banks and rural cooperative banks), foreign bank branches, group finance companies, trust companies, financial asset management companies, financial leasing companies, auto finance companies, securities companies, insurance companies, insurance asset management companies, fund management companies, fund companies’ asset management business for specific clients, commercial banks’ asset management business, securities companies’ securities asset management business, insurance products, trust products and etc. However, the scope of investors for each issuance of Interbank CDs may be set by the issuer through the issuing system.

  • Issuance Method and Procedure
  1. Issuance method

The Interim Measures stipulate that the Interbank CDs shall be issued on the national interbank market in electronical form, either through public offering or via private placement.

  1. Public Offering

Issuance through public offering includes issue by tender and issue by quotation. Publically offered Interbank CDs may be freely traded and repurchased.

Issue by tender refers to a method of issuing the Interbank CDs whereby the issuer issues a request for tender and investors participate in the tendering, upon which the issuing price (or the coupon rate, basic interest margin) and volumes of successful tenderers shall be determined by the issuer in accordance with the calculation made by the issuing system. Issue by tender includes both price tender and volume tender. Currently price tender shall be conducted in the form of uniform price tender. Issue by quotation refers to a method of issuing the Interbank CDs whereby the transaction is concluded in accordance with terms and conditions pre-determined by the issuer before the issuance when the investors accept the quotation.

  1. Private Placement

Private Placement refers to sale of Interbank CDs to specific investors in accordance with the terms and conditions mutually agreed between the issuer and the investors. Privately placed Interbank CDs can only be traded among initial investors.

  1. Issuance Process

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  • Issuance Interest Rate and Price

Article 8 of the Interim Measures provides that the interest rate and price of the Interbank CDs shall be determined by the market forces. In principle, the tenor of fixed-rate Interbank CDs shall be no longer than 1 year, which may be 1 month, 3 months, 6 months, 9 months or 1 year, and the rate of interest shall be set by reference to the SHIBOR of comparable tenor. In principle, the floating-rate CDs shall have a tenor of more than 1 year, which may be 1 year, 2 years or 3 years, with applicable SHIBOR used as the benchmark for the floating rate.

  • Management of Issuance

The issuance of Interbank CDs shall be subject to a filing of issuing volume on yearly basis and a control over the outstanding volume.

  1. The issuer shall, before the issuance of the first Interbank CD of each year, file its issuance plan of the year with PBOC.
  2. Each year the issuer shall, before the issuance of the first batch of Interbank CDs, register the volume of the year with the National Interbank Funding Center and the registered volume shall be consistent with the annual issuing plan filed with PBOC.
  3. The volume of each issuance of Interbank CDs by the issuer shall not exceed the issuer’s available volume of that particular year.
  4. The issuer may determine the amount and tenor for each issuance, provided that the minimum amount shall be no less than 50 million. The issuer shall not arbitrarily change the redemption date.
  • Trading Mechanism and Trading Rules

Pursuant to the Interim Measures and Trading Rules, a market making system is adopted for the trading of Interbank CDs with the role of market makers assumed by core members of a self-regulatory panel which is tasked for the determination of market interest rates. PBOC may alter the scope of market makers with the development and changes of the Interbank CD market. Market makers shall provide continuous buy-side and sell-side quotes of the Interbank CDs through the trading system of the National Interbank Funding Center and conclude trading with other market participants in accordance with the relevant quotes.

Interbank CDs may be traded on the interbank market after the completion of registration through sale, purchase and repurchase, or other transactions approved by PBOC. Interbank CDs issued via private placement can only be transferred amongst initial investors and cannot be pledged or mortgaged for repurchase. Trading of Interbank CDs shall be concluded through the trading system of the National Interbank Funding Center which offers features such as quotation enquiry, execution by clicking, and request for quotation (RFQ).

  • Information Disclosure

Sufficient and prompt disclosure of relevant information to the market is a key principle of the Interim Measures and Trading Rules in respect of the issuance of Interbank CDs. The main disclosure requirements are set out below in detail:

  1. The issuer is obligated to disclose its annual issuance plan to the market before annual issuance and promptly re -disclose its annual issuance plan, if such plan is updated because of any subsequent material changes.
  2. The issuer is obligated to promptly make public announcement on www.chinamoney.com.cn if there occurs any material change in the issuer’s status or financial conditions, and report the same to PBOC.
  3. The issuer is obligated to make pre-issuance disclosure, which in the case of public offering, involves disclosure of terms and conditions of issuance to all investors for at least one business day and in the case of private placement, involves notification to the National Interbank Funding Center of the issuance intention at least one business day before the issuance.
  4. The issuer is obligated to make post issuance disclosure of the issuance result and promptly disclose any material event that affects the issuer’s ability to repay its debt, which occurs after the issuance.
  1. Comparison of Similar Interbank Business

There are interbank instruments that are similar to the Interbank CDs, for example, Interbank Deposits and Interbank Lending. These three types of interbank instruments are similar in that they are all channels between banking financial institutions whereby funds flow from those who have funds to those who are in need of funds and the funds so financed are repaid on maturity with interests. The key differences of these instruments are as follows:

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  1.  Implications
  • Firstly, the interest rates of Interbank CDs are the only deposit interest rates that are determined by market forces, which could be used as a useful reference for the liberalisation of deposit interest rates, paving ways for the overall interest rate liberalisation.
  • Secondly, the interest rates of Interbank CDs may be taken as a reference for the lending interest rates. In the future, lending rates may well be set as a margin over the interest rates of Interbank CDs. Furthermore, the interest rates of Interbank CDs are also helpful in evaluating the reasonableness of the LPR pricing mechanism and whether there exists any malignant competition in the pricing for the lending interest rate.
  • Thirdly, Interbank CDs may enhance the benchmark effect and validity of SHIBOR. As the most important part of the construction and development of market benchmark interest rate, SHIBOR has generated positive impact, since it was established and put int o operation  under the Rules for Managing Interbank Bond Market Maker promulgated by PBOC in 2007. The reality is while less-than-1-year SHIBOR (inclusive) is reliable 1-year-above SHIBOR is less so due to a lack of effective references which in turn is  due to inactiveness of such secondary market transactions of comparable tenor, e.g. repurchase and inter-bank loan. With Interbank CDs making references to SHIBOR the credibility, benchmark effect and validity of the 1-year-above SHIBOR could be greatly improved.
  • Fourthly, Interbank CDs provide banks with a debt instrument which is more stable than time deposits. The challenge brought about to banks by the interest rate liberalisation is the continuous loss of deposits. In fact, even the stability of time deposits is significantly compromised since such deposits could also be withdrawn prior to the maturity, whereas the Interbank CD issuers do not have the obligation to redeem the Interbank CDs before the maturity date, which makes Interbank CDs a more stable debt instrument compared with time deposits, and will be helpful in reducing the debt pressures which may be brought by the interest rate liberalisation.
  • Fifthly, Interbank CDs promote interest liberalisation on the liability side. The path to overall interest liberalisation may be as follows: introduction of deposit insurance mechanism→liberalisation of large amount transferable fixed-term CD interest rates→raising upper limit for deposit interest rates→abolishing upper limit for deposit interest rates, which marks the consummation of overall liberalization of loan market.