Derivatives industry sober about Asia's potential

SINGAPORE, Mar 16 (Reuters) Economic stars in Asia such as China are all the rage for bankers, but they say moves by regional governments to free up rigid financial markets to allow greater use of derivatives will be a grudging process in the years ahead.

China and India took centre stage at the annual gathering of the International Swaps and Derivatives Association (ISDA) this week as bankers look to future growth for the already booming market for complex financial derivatives.

India is much further advanced than China when it comes to the maturity of its capital and derivative markets, but for similar reasons both countries are expected to move very cautiously.

Among them: wary central bankers, fledgling risk management systems and the need for a stronger legal framework that underpins the over-the-counter derivatives market, where transactions are privately negotiated rather than conducted through an exchange.

The scars of the region's financial crisis in 1997 and 1998 have made officials hesitant to break down restrictions.

''Deregulation will always err on the side of conservatism and incrementalism,'' said Michael Rees, chief executive of wholesale banking at Standard Chartered Bank.

''The potential economic, social and political risks are too great for it to be otherwise. But the other lesson is that too slow could be as bad or worse than too quickly.'' GRIP GRADUALLY LOOSENS China has set up a framework for markets to set the value of the yuan and interest rates since Bejing revalued the currency last July, launching currency forwards just a few weeks after the shift.

Last month regulators approved trade of interest-rate swaps -- the world's most widely used derivative. They have also allowed commercial banks to trade commodity and equity derivatives but keep an eye on all transactions.

As part of the move toward making the yuan more flexible, the People's Bank of China has pinpointed interest rate reform as one of its top priorities for 2006.

Ralph Liu, who gave a keynote speech at the ISDA meeting, helped negotiate the first-ever interest-rate swap last year as chief investment officer at China Everbright Bank, before these swaps were approved for wider use.

''The regulators understand their mission is to connect the domestic banking sector to international standards,'' said Liu, now chief executive at Advanced e-Financial Technologies Inc..

Liu said domestic banks have a lot of catching up to do to gain the expertise needed to trade derivatives as foreign banks gain a bigger foothold. About 40 foreign institutions are listed in China to trade derivatives.

So far China has moved ahead with its own documentation for settling transactions in currency forwards, which differs from the global standard for nearly all OTC derivative contracts -- the ISDA Master Agreement.

''This agreement has caused some concern in the market,'' said Tricia Bowden, managing director and senior counsel at U.S.

investment bank Goldman Sachs.

In China, the derivative trade agreements have to be drawn up for each trade, rather than using a master agreement that can apply across instruments, from foreign exchange to interest rates.

The applicable law for the agreements is Chinese, rather than the global standard of New York or British law.

ISDA officials have met regularly with Chinese authorities to talk about these issues.

INDIA In India, the trading of foreign exchange derivatives and instruments like interest-rate swaps has taken flight after a series of deregulations. In 1999, laws were amended to classify derivatives as securities, and a 30-year ban on trading forwards was lifted.

But markets for other products, such as credit derivatives, still seem distant in India as much more work is required in developing how investors assess the default risk of borrowers, keeping regulators cool, bankers at the meeting said.

Attendees at the ISDA meeting also noted news reports in India suggesting the country's central bank was considering capping the total notional amount of interest-rate swaps a bank can hold on its books.

''Regulators in Asia know derivatives are here to stay, but they just want to make sure the local banks can risk manage it,'' said Jacqueline Low, Citigroup's legal counsel for emerging market sales and trading in the Asia-Pacific region.

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