forex

LEAD: China to launch OTC transactions Wed. in interbank forex market

BEIJING, Jan. 3 Kyodo

(EDS: ADDING DETAILS, BACKGROUND)

The People's Bank of China announced Tuesday that China will introduce over-the-counter transactions in the interbank foreign exchange market effective Wednesday.

The Chinese central bank said OTC transactions will henceforth be allowed to be carried out through independent bilateral price inquiry and bilateral settlements based on bilateral credit authorization.

The move follows implementation of reform of the yuan exchange rate regime last July and the introduction of OTC transactions in the interbank yuan forward market last August.

''In order to further develop the foreign exchange market, improve RMB exchange rate regime and enhance the core competitiveness of financial institutions, the People's Bank of China has decided to introduce OTC transactions as of Jan. 4, 2006,'' the bank said.

''Along with the increase in trading volume and in market participants, demand for transactions and risk management has diversified day by day, and the introduction of OTC has become an objective necessity,'' it said.

The bank said automatic price-matching transactions will be maintained after the introduction of OTC transactions, enabling participants in the interbank foreign exchange market to choose between the two modes to conduct spot foreign exchange transactions.

An OTC transaction is based on credit-worthiness of the two parties, with the parties undertaking credit risks on their own, and the transaction takes place only after bilateral credit authorization is conducted.

In an automatic price-matching transaction, by contrast, the China Foreign Exchange Trading System acts as the counter party to all participants and takes credit risks for all of them. Other differences are in price formation and settlement arrangement.

The bank noted that the OTC approach ''is a basic practice in the international foreign exchange market and accounts for most of the trading volume in spot transactions globally.''

''Given the international nature of foreign exchange transactions and market participants' widespread physical presence and diversity, OTC has the advantages of lowering cost and diversifying credit risks,'' it said.

China reformed its foreign exchange management system in 1994, but the bank said it was not realistic then to adopt the OTC approach, given the weak credit basis and regional segregation of foreign exchange markets at that time.

The bank also said that effective Wednesday, it will authorize the China Foreign Exchange Trading System to announce the central parity of the yuan against the U.S. dollar, the euro, the yen and the Hong Kong dollar at 9:15 a.m. on each business day.

That will then be taken as the central rate of the yuan for transactions in the interbank spot foreign exchange market, both for OTC transactions and automatic price-matching transactions as well as transactions effected over the bank counters.

Following the reform of the yuan exchange rate regime on July 21, the yuan is no longer pegged to a single foreign currency and instead its exchange rate is adjusted based on market supply and demand with reference to a basket of currencies.

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