From: smarra@isda.org
To: jennifer@kennedycom.com, tmorita@isda.org, yoshitaka_akamatsu@btm.co.jp, shigeru_asai@sanwabank.co.jp, kbailey2@exchange.ml.com, douglas.bongartz-renaud@nl.abnamro.com, brickell_mark@jpmorgan.com, henning.bruttel@dresdner-bank.com, sebastien.cahen@socgen.com, scarey@isda.org, joshua.cohn@allenovery.com, mcresta@cravath.com, daniel.cunningham@allenovery.com, mcunningham@isda.org, jerry.delmissier@barclayscapital.com, shawn@blackbird.net, evangelisti_joe@jpmorgan.com, francois@us.cibc.com, tim.fredrickson@ubsw.com, gilbert_adam@jpmorgan.com, goldenj@allenovery.com, mark.e.haedicke@enron.com, fwhx9396@mb.infoweb.ne.jp, jhb1@bancosantander.es, yhoribe@isda.org, milphil@gateway.net, skawano@isda.org, hiroyuki_keisho@sanwabank.co.jp, damian.kissane@db.com, kazuhiko_koshikawa@sanwabank.co.jp, robert.mackay@nera.com, markb@cibc.ca, marjorie.b.marker@us.arthurandersen.com, lmarshall@isda.org, donna.matthews@ubsw.com, mengle_david@jpmorgan.com, tom.montag@gs.com, dmoorehead@pattonboggs.com, jonm@crt.com, yasumasa.nishi@ibjbank.co.jp, dennis.oakley@chase.com, losullivan@isda.org, ernest.patrikis@aig.com, rpickel@isda.org, maria.rosario@db.com, arothrock@pattonboggs.com, rryan@isda.org, maurits.schouten@csfb.com, charlessmithson@mindspring.com, ksumme@isda.org, teruo.tanaka@ibjbank.co.jp, steve_targett@nag.national.com.au, h.ronald.weissman@us.arthurandersen.com, dpd@aurora.dti.ne.jp, chi-wing.yuen@aig.com, apapesch@isda.org, nlim@isda.org, kdhulster@isda-eur.org, esebton@isda-eur.org, cirens@isda-eur.org, rmetcalfe@isda-eur.org, mhitchcock@isda-eur.org, kengelen@isda.org, pmartinez@isda.org, steven@kennedycom.com, pwerner@isda-eur.org, azam.mistry@hsbc.com, frederic.janbon@bnpparibas.com, kamin@lehman.com, quentin_hills@hk.ml.com
Date: 2001-05-11 13:02:00+00:00
Subject: ISDA PRESS REPORT - MAY 11, 2001

ISDA PRESS REPORT - MAY 11, 2001

* UK Building Societies To Use Derivatives For Credit Risk - Dow Jones
* Currency swap agreements strengthen Asian co-operation - Financial
Times
* Greenspan Backs Risk-Based Pricing Of Deposit Insurance Provided by
FDIC - BNA
* SEC, CFTC Propose Joint Rules For Trading of New 'Security Futures'
- BNA
* New Rules to Improve Competitiveness Of European Markets,
Commissioner Says - BNA
* Top securities lawyer set to head SEC - Financial Times
* Bush Intends to Nominate Roseboro for Treasury Job - Wall Street
Journal
* Darwinism With Chinese Characteristics - The Asian Wall Street
Journal

UK Building Societies To Use Derivatives For Credit Risk
Dow Jones International News - May 11, 2001

LONDON -(Dow Jones)- The U.K. Treasury said Thursday that it is proposing
legislation to allow building societies to use derivatives to protect
themselves against credit risk.

Building societies are already allowed to use certain types of derivatives
to protect themselves against interest rate risk, currency risk and house
price fluctuations.

But the treasury proposal - agreed by the Building Societies Commission -
will allow the building societies to use derivatives to protect themselves
against credit risks, a treasury spokesman said.

Unlike banks which are allowed to use derivatives to protect themselves
against credit risk, building societies haven't been allowed to do so so far
because of a clause in the 1986 Building Societies Act.

The proposal will be put to parliament and is likely to be approved unless a
member of parliament opposes it, the spokesman said.

The BSC considers the credit derivatives market to be sufficiently developed
to offer building societies broad and flexible protection.

Credit derivatives will initially be used only by societies which already
have a sophisticated treasury management capability, the treasury said.


Currency swap agreements strengthen Asian co-operation
Financial Times - May 11, 2001
By Edward Luce

Japan yesterday announced that it had concluded bilateral swap agreements
with Thailand, South Korea and Malaysia as part of the region's continued
progress towards strengthened monetary co-operation.

The agreements, which were reached on the first day of the annual conference
of the Asian Development Bank in Honolulu, come a year after the 10 Asian
member countries plus China, Japan and South Korea pledged mutual central
bank support at a meeting in Chiang Mai.

The swap arrangements were designed to provide the former victims of the
1997 Asian financial crisis with firepower to fight off any speculative
attacks on their currencies. Japan said it was also negotiating central bank
swap agreements with the Philippines and China.

But Seichiro Murakami, Japan's deputy finance minister, would not disclose
the nature or the terms of the swaps agreements except to say they were not
based on the defense of any pre-agreed exchange rate levels.

Most of the region's economies have adopted free floating or managed float
currencies after speculative attacks obliterated their exchange rate pegs
with the US dollar in 1997. The bilateral deals provide Korea with Dollars
2bn (Pounds 1.3bn) in possible currency support, Dollars 1bn for Malaysia
and Dollars 3bn for Thailand.

Tun Daim Zainuddin, Malaysia's finance minister, said the agreement, which
comes in addition to the Dollars 1bn pledged in mutual swap support by Asian
countries last November, would help prepare the region for "any
eventualities".

"We will not be caught by surprise this time," said Mr. Daim. "Our
currencies are not at risk now. In fact, in most of the Asian countries, our
reserves have increased."

Mr. Daim also pointed out that the Dollars 1bn in potential support for
Malaysia came in addition to a further Dollars 2.5bn in currency support
that had been pledged by Japan under the "Miyazawa plan", named after
Japan's former finance minister.

Unlike the Miyazawa pledge, which comes free of broader conditions, only 10
per cent of the bilateral swap agreement can be drawn before triggering
control by the International Monetary Fund.

Wednesday's announcements mark a weakening of Japan's drive towards the
creation of an Asian Monetary Fund, vetoed by the US in the late 1990s. In
contrast to Tokyo's original goal of devolving more decisions to Asia, Japan
described the bilateral swap agreements as "complementary" to the broader
financial framework supervised by the International Monetary Fund in
Washington.

The Honolulu agreements, which will be reviewed in three years, form part of
a broader drive by Asian countries to strengthen regional co-operation
following the 1997 crisis. Such efforts, which span deeper trade
liberalisation within Asian and greater political dialogue between Asian and
its east Asian neighbours, have been given further impetus by the damping
effects of the US economic slowdown on the region's high-tech export sector.


Paul O'Neill, US Treasury secretary, told delegates at the opening ceremony
of the ADB annual conference, that, in spite of the region's impressive
recovery since 1997, Asian countries had to accelerate and deepen efforts to
restructure their financial and corporate sectors.

Mr. O'Neill, whose remarks were clearly directed at South Korea, Thailand
and Indonesia, which are still struggling to resolve the overhang of bad
debts from the 1997 crisis, also urged Japan to take steps to boost
aggregate global demand by confronting obstacles to the revival of domestic
demand


Greenspan Backs Risk-Based Pricing Of Deposit Insurance Provided by FDIC
BNA - May 11, 2001

CHICAGO--Federal Reserve Board Chairman Alan Greenspan May 10 called for
more risk-sensitive pricing of deposit insurance provided to banks by the
Federal Deposit Insurance Corporation, saying recent FDIC proposals to move
toward risk-based pricing are "useful."

Greenspan spoke at during the Federal Reserve Bank of Chicago's 37th Annual
Conference on Bank Structure and Competition. Federal Reserve Board Governor
Laurence H. Meyer, who spoke at the conference the same day, said the system
must be adapted to manage the challenges posed by new technologies, new
financial strategies and the globalization of the financial services
industry.

Though Greenspan said federal regulation of the financial services industry
has provided an admirable degree of stability to banks and investors, he
said these benefits come at a significant cost and reform is needed. He
called for financial industry supervisory policies that promote the type of
market discipline that existed prior to the erection of current safety net
structures, which evolved in the wake of the Great Depression. In addition,
he reminded large institutions engaged in risky practices and their
investors that the safety net cannot and will not insulate them from every
type of financial crisis.

Market-based reforms would better protect investors, reduce costs to the
economy, and allocate risk more equitably, the Fed chairman said. "While
valuing the benefits of stability that the safety net confers, we
nonetheless need to recognize that the benefits are not without costs,"
Greenspan said

"In this context," Greenspan added, "reform of the safety net must remain on
the agenda. I believe this means being very cautious about purposefully or
inadvertently extending the scope and reach of the safety net. It also means
supervisory reform to create, as best we can, inducements to bank behavior
similar to those that would exist with no safety net. And, it means, I
think, that there be a presumption that uninsured claimants are at risk."

It appears "politically infeasible" to eliminate government subsidies of
deposit insurance altogether, but "more risk-sensitive pricing is
nonetheless helpful, and prudential regulation has already begun to move in
the right direction to reduce the safety net subsidy," Greenspan said.

The so-called financial safety net, as currently configured, is comprised of
banking regulation, deposit insurance, the Fed's discount window, and access
to Fedwire and daylight overdrafts, he said. He said these structures
provide depository institutions and market players with a degree of safety,
liquidity and solvency never before seen in economic history.

At the same time, this structure comes at a cost to the economy. Among other
things, Greenspan pointed to distortions in the price signals used to
allocate resources, inducements for institutions to take excessive risks and
relatively high degrees of government supervision as a strategy for limiting
moral hazard.

FDIC Proposal 'Useful.'

To avoid these distortions, Greenspan suggested reforms aimed at pricing and
managing the safety net in a manner aimed at simulating what the markets
alone might do. Toward this end, he called for fairer pricing mechanisms
with respect to FDIC insurance premiums. Greenspan did not discuss specific
components of the recently released FDIC reform proposal, but he described
it as "useful" and commented that the plan moves the agency toward better
pricing to safety net access.

On April 5, the FDIC proposed a system under which all institutions would
pay risk-based premiums based on indexed coverage levels and a merger of the
bank and savings association insurance funds (67 DER A-40, 4/6/01). The
House Financial Services Committee will broach the controversial subject of
how best to reform the deposit insurance system in a hearing scheduled for
May 16.

Greenspan also called for regulatory structures aimed at making capital
requirements sensitive to each bank's particular risk profile and exposure.
He said supervision and examination policies are moving in this direction
and are evident in the new Basel Capital Accord.

Finally, Greenspan called for greater market discipline--a factor that
preserved the banking system prior to the development of the safety net.

"The real pre-safety-net discipline was from the market and we need to adopt
policies that promote private counterparty supervision as the first line of
defense for a safe and sound banking system," he said.

Disclosure Key, Greenspan Says

To promote this concept, Greenspan called for wider disclosure by financial
institutions so counterparties can better evaluate risk. While banks are
already subjected to significant degrees of disclosure, Greenspan said the
quantity and quality of the data is often uneven. He suggested that, "all
entities could, should, and may soon be required to disclose more and better
data."

But Greenspan stressed that market discipline will never be achieved unless
uninsured private counterparties understand that they will not be protected
by the safety net. He suggested too many players live under the false
assumption that they will always be made whole under a, "de facto
too-big-to-fail policy."

"Let me remind you that the ten largest U.S. banking organizations fund only
about one-fourth of their worldwide banking assets with insured deposits,"
Greenspan said. "Let me also remind you that the least-cost resolution
exception [contained in the Federal Deposit Insurance Corporation
Improvement Act] does not require that all uninsured creditors be made
whole, but rather only that they be made no worse off than they would have
been if the bank were liquidated. The potential for greater market
discipline at large institutions is substantial."

Greenspan said he could conceive of "rare situations" when the FDIC or other
governmental resources would temporarily be used to sustain failing
institutions pending managed liquidation, but that "indefinitely propping up
insolvent intermediaries is the road to stagnation and substantial resource
misallocation, as recent history attests."

Meyer Seconds Reform Call

Meyer, in his speech, also argued for a more risk-based regulatory
structure. Meyer acknowledged the FDIC's April 5 proposal for reform but
would not comment on it. Meyer complimented the agency on its diligence, but
said the board would withhold judgment on the plan until it has had a chance
to fully review it.

"There seems to be a widespread feeling, which I share, that additional, or
at least improved, efforts toward limiting moral hazard, enhancing market
discipline and lowering taxpayer liabilities should and can be made," Meyer
said. "Our world is a rapidly changing place with technological change,
financial engineering, globalization and deregulation combining to alter the
realities we all face. As a result, all of us must be willing to adapt old
policies and adopt new one if the circumstances require."

Meyer noted that, unfortunately, existing risk-based capital standards are
becoming divorced from the realities of modern risk management for a growing
number of financial institutions. As such, he said the 1998 Basel Accord's
capital ratios have become a less reliable tool for determining the capital
strength of a particular firm. Meyer said the new Basel Capital Accord
creates standards that will reflect the true risks being taken by the most
financially sophisticated and complex banks. He called on bankers to provide
public comments on the proposal to the Basel Committee on Banking
Supervision by the end of May.

"[I]t is of the highest priority that, for the most financially
sophisticated and complex banks, we make the capital standards more
reflective of the risks that they are, in fact, taking," Meyer said.


FDIC's Murton Speaks

Arthur J. Murton, director of the FDIC's division of insurance, also spoke
at the conference. He said that in developing the reform plan, the FDIC
hoped to make significant improvements in the safety net while acknowledging
political realities.

"We hoped it would represent an intersection of sound economic and financial
principles on the one hand and political realities on the other," Murton
said during the same panel discussion with Meyer. "Our goal was to offer a
framework that, with further discussion and modification, could generate a
consensus around these issues and could make its way through the legislative
process. We might have come up with a different approach if we had started
from scratch. Instead, we recognized that passing banking legislation
without a banking crisis requires consensus."

Murton said the plan calls for a merger of the Bank Insurance Fund and the
Savings Association Insurance Fund and the elimination of current
restrictions on charging risk-based premiums. In addition, the plan calls
for indexation of insurance coverage levels to reflect inflationary changes
and a shift from the current 1.25 percent Designated Reserve Ratio to a
target level between certain ranges. The plan also suggests the development,
for the first time, of a rebate system when certain triggers are achieved.


SEC, CFTC Propose Joint Rules For Trading of New 'Security Futures'
BNA - May 11, 2001

The Commodity Futures Trading Commission and the Securities and Exchange
Commission announced May 10 that they have proposed joint rules to implement
new statutory provisions relating to security futures products.

"Security futures" are single stock futures and futures on narrow-based
stock indices--given new life by last year's sweeping Commodity Exchange Act
reform legislation after a nearly 20-year ban.

In related matters, the SEC May 8 proposed rules and a new registration form
for designated contract markets and derivative transaction execution
facilities to use to register as national securities exchanges to trade the
new instruments (Release No. 34-44279, 5/8/01).

Joint Regulation

Under the law, security futures are "securities" under the federal
securities laws, but may be traded on either futures or securities
exchanges. The CFMA also established a framework for the joint regulation of
security futures products by the CFTC and SEC, the agencies noted. However,
they added, futures contracts on broad-based indexes remain under the
exclusive jurisdiction of the CFTC.

Accordingly, the SEC and CFTC related, they proposed joint rules regarding
the distinction between broad-based and narrow-based security indexes.
According to the regulators, the CFMA defines the criteria for an index to
be considered "narrow-based," including, among other factors, the market
capitalization of each security in the index and the dollar value of that
security's average daily trading volume. The statute also requires the two
agencies jointly to specify the methods that must be used to determine these
values.

In their release, the SEC and CFTC said the proposed rules "are designed to
fulfill that statutory mandate, as well as to address other issues that
arise in the application of the definition of narrow-based security index."
They noted that trading in security futures products may begin Aug. 21,
provided certain regulatory requirements are met.

After considering any comments, the agencies said, they expect to adopt
final rules prior to Aug. 21.


New Rules to Improve Competitiveness Of European Markets, Commissioner Says
BNA - May 11, 2001

Key legislation needed to make European financial markets more competitive
with U.S. markets is expected to be introduced by early 2002, Frits
Bolkestein, a Dutch member of the 20-person European Commission, said May
10.

In a speech at the American Enterprise Institute, Bolkestein reaffirmed the
European Union's commitment to requiring all E.U.-based companies to use the
International Accounting Standards (IAS) practices in their record keeping
in order to enhance transparency and provide higher quality financial
information to investors across the world.

"The use of one global accounting language will greatly benefit European
companies. It will help them compete on equal terms for global capital,"
Bolkestein said. He added that the legislation would require companies to
begin preparing their consolidated accounts using IAS by 2005.

Bolkestein also said he is hopeful that the U.S. Securities and Exchange
Commission will begin to accept financial statements prepared by firms in
the European Union without requiring them to be reconciled with the
generally accepted accounting principles (GAAP) standard used in the United
States.

A major reason that changes are needed in the European Union's financial
regulations is because of the "unprecedented volume of mergers and
acquisitions" between American and European firms.

Another reason is that the European Union has established a goal of becoming
"the most competitive and dynamic knowledge-based economy in the world,
capable of sustainable growth with more and better jobs, and greater social
cohesion," Bolkestein said.

Since 1990, Bolkestein said the European community has added 900,000 jobs
and has seen improved competition and productivity add 1.5 percent to gross
domestic product growth because of measures taken to create a single market
for financial services.

If the European Union is successful at restructuring its financial system by
2005, Bolkestein said he sees other benefits to include a lower cost of
capital for all companies, a deeper and more vibrant venture capital market,
lower costs of purchasing financial products, and higher returns on pensions
and investment funds.

To realize those benefits, Bolkestein said the European Commission would
like to see an integrated securities market in place by 2003, replacing the
individual domestic securities markets of the European Union's 15 member
states.

"Mergers and alliances between existing exchanges are already breaking down
barriers, pooling liquidity, reducing clearing costs, decreasing volatility,
and increasing transparency," Bolkestein said. He added that Europe is also
seeing "a marked increase in the number of on-line brokerage accounts, which
further contributes to efficiency and transparency," but also creates a
greater need for changes in the way the European Union regulates its
financial sector.


Top securities lawyer set to head SEC
Financial Times - May 11, 2001
By John Labate

President George W. Bush yesterday named securities lawyer Harvey L. Pitt to
head the US Securities and Exchange Commission after one of the
administration's longest searches yet to fill a key post.

If approved by the Senate, Mr. Pitt would replace Arthur Levitt, who stepped
down as chairman in February after more than eight years. Mr. Bush is
expected to send a formal nomination to the senate soon but no date for a
confirmation hearing has been set.

Mr. Pitt, a partner at New York-based law firm Fried, Frank, Harris, Shriver
& Jacobson, is widely regarded as one of the country's leading experts on
securities law and one of its toughest litigators.

His long list of clients has included Ivan Boesky, for whom in 1986 he
negotiated a $100m settlement with SEC officials on insider trading charges.
Other clients include LLoyd's of London, the New York Stock Exchange, and
all "big five" accounting firms.

The move would return Mr. Pitt, 56, to the SEC, where he worked for a decade
after law school and where, at age 30, he served as its youngest ever,
general counsel. He has remained at Fried, Frank, Harris since leaving the
SEC in 1978. The planned nomination comes as the SEC faces a number of
difficult issues, including decisions on the structure of securities trading
as more markets, inside and outside the US, seek to become publicly traded
companies.

"We're heading into a period of globalisation that will call for change,"
said Richard Phillips, former SEC assistant general counsel and partner at
the law firm Kirkpatrick & Lockhart. "It won't be for congress to take the
lead but a chairman with vision, and Harvey could be that kind of chairman."

The decision to nominate Mr. Pitt was welcomed by Senator Phil Gramm, the
Republican
Chairman of the Senate banking committee, which oversees the SEC. "I look
forward to working with him and anticipate prompt consideration of his
nomination by the banking committee," he said.

Mr. Pitt is known as a tireless worker, who employs three secretaries to
work round the clock for him.

"Some people are going to have to run quicker and run longer to keep up with
him, but the vast majority of people here are delighted with the choice,"
said one SEC staff member.

Mr. Pitt will be closely watched in the coming months for his views on
several controversial rules passed in the final year of Mr. Levitt's term.
Among them are those on overseeing consulting services by accounting firms
and a new disclosure rule, Regulation Fair Disclosure, fiercely opposed by
securities firms.

The administration encountered unexpected difficulty in filling the top SEC
job. Several leading candidates withdrew from the process or turned down
offers.

Mr. Bush still has to fill forthcoming vacancies among the SEC's
commissioners. He named Laura Unger, a corn- -missioner, as acting SEC
chairman soon after Arthur Levitt stepped down.


Bush Intends to Nominate Roseboro for Treasury Job
The Wall Street Journal - May 10, 2001

WASHINGTON -- President Bush announced his intent to nominate Brian C.
Roseboro, of New York financial-services giant American International Group
Inc., to be assistant Treasury secretary for financial markets.

The job involves making and implementing policy on capital markets and
federal-debt management. Mr. Roseboro is deputy director of market-risk
management for AIG.

Mr. Roseboro earlier worked at financial-services firm SBC Warburg Dillon
Reed, from 1993 to 1996, and at First National Bank of Chicago, from 1990 to
1993, the White House said. From 1983 to 1986, he held several positions at
the Federal Reserve Bank of New York, including chief dealer for
foreign-exchange trading.

Election records show Mr. Roseboro didn't contribute to Mr. Bush's
presidential campaign, although AIG's political action committee contributed
$5,000 to it, and also gave $5,000 to his GOP rival, Arizona Sen. John
McCain. AIG Chairman Maurice "Hank" Greenberg raised at least $100,000 for
Mr. Bush in the insurance and financial-services industries.


Darwinism With Chinese Characteristics
The Asian Wall Street Journal - May 11, 2001
By Pu Yonghao

The expansion of China's capital markets is central to the government's plan
to finance long-term economic growth. While observers have focused primarily
on efforts to reform and broaden the equity markets, two other developments
are important to meet the objective: a mature debt market and a wider
variety of derivative products.

About 1,100 companies are listed on China's domestic stock exchanges in
Shanghai and Shenzhen. About 90% are state-owned enterprises and some 62% of
the total issued shares are state held. The two bourses combined had a
market capitalization of $580 billion at end of 2000, though some
two-thirds, about $360 billion, of A shares (which can be purchased only by
Chinese investors) are in state hands.

Chinese companies generally turn to banks for funding. By the end of 2000,
bank lending was $1,200 billion, equivalent to 112% of China's gross
domestic product. In the wake of the 1997 Asian financial crisis, the
government realized that a dependence on bank lending leaves both the
corporate and banking sectors vulnerable to crises. That is why it has
decided to expand the capital markets to finance long-term growth. If all
goes well, the market cap of the two boards together is likely to double to
$1.2 trillion by 2005 and play a leading role in the country's evolution
into a market economy.

The reasons for this kind of growth are numerous. First, China's economy
should grow at an annual average rate of 7.5% between 2001-05, bringing
total GDP to about $1.6 trillion (based on an inflation of 2%). The
country's high savings rate of 40% (currently $809 billion) should provide
ample capital to facilitate the expansion.

Second, the government is pushing forward with the reform of SOEs.
Privatization, the reduction state holdings and expansion of the private
sector will increase the market-capitalization-to-GDP ratio. Listing SOEs
will deepen the restructuring program and usher in good corporate
governance.

Moreover, the government's fiscal resources are limited. Revenues comprise
only 14% of GDP and social-welfare costs are rising. The growth of the stock
markets is likely to help expand China's private sector and bolster
employment at a time when many SOEs are downsizing their labor forces.

The stock markets will also become an important vehicle for channeling
long-term investment, and thus help increase the efficient allocation of
capital and improve returns on infrastructure projects. And finally, foreign
investors and investment banks are expected to play an active role in the
domestic markets after China's accession to the World Trade Organization.

But this picture of thriving capital markets will be incomplete without the
speedy evolution of debt trading and derivative instruments. The development
of a debt market is important because bank savings remain China's primary
investment vehicle, despite a 20% tax on deposit interest income and
historically low interest rates. Bonds generally offer relatively high
returns with low risk and fill the gap between high-return, high-risk
equities and low-return yet safe bank deposits.

Moreover, social security funds need to hold bonds to balance their
portfolios. A mature debt market diversifies the financing channels of
enterprises, enabling them to gain capital leverage. Debt pricing is more
sensitive to interest rates, spurring more efficient capital pricing and
thus allocation.

A mature debt market can also help finance the state's budget deficit and
provide capital for long-term construction projects. Government bonds enable
effective monetary policy through open-market operations. The use of bonds
to control the base money supply reduces the reliance on a credit plan for
implementing macro-economic objectives. The government's ability to conduct
open-market operations can help it control the impact of external capital
inflows.

The Chinese government appears to be drafting debt-market regulations that
will allow the listing of more corporate bonds, firms to use the proceeds as
they see fit and new debt products. But many other issues need to be
addressed before the debt market can take off.

First, an environment of commercial trust and a system for contract
enforcement and liquidation must be established. Second, a comprehensive and
reliable credit-rating system is needed. Some mainland Chinese rating
agencies are pressured to make positive evaluations. When rating agencies
are reliable, investors can better gauge whether a company will repay.

Third, a benchmark rate and yield curve must be established. Currently, the
benchmark coupon-rate on debt is a one-year deposit rate of 2.25%, but this
is not entirely appropriate. The coupon rate is 3.07%, for example, on a
five-year treasury bond, 2.87% for a three-year treasury bond, and capped on
the former at 4%. This provides little scope for corporates to price new
issues attractively. The average yield of listed-corporate debts is already
4.5%, or 5.1% for maturity of more than five years.

Moreover, debt markets need to merge. At present, trading occurs at
exchanges or between banks. Since trading volume is small and liquidity low,
prices face distortion. The trading volume of enterprise bonds, for example,
is just 1% of treasury bonds.

Finally, there is need for a wider range of debt products (for example,
floating-rate bonds as opposed to simply fixed-rate debt instruments). As it
stands now, there only about 10 types of corporate debts. Most are
zero-coupon bonds, one is floating.

The development of derivative products would provide another important
impetus to growth of the capital markets. Mainlanders have few financial
products to choose from -- just 1,100-plus listed stocks and a handful of
corporate bonds and closed-end funds. China does have some futures
exchanges, but trading is limited to a few commodities like soybeans, wheat
and copper.

The trading of derivatives would enhance economic efficiency. First, they
enable investors and underwriters to hedge their positions and "lock in"
profits. Second, derivatives temper stock-price volatility by reducing the
concentration of money in one market. Once an index derivative market is
established, variance between two markets can prompt arbitrage
opportunities. Derivatives also enable better risk management, attracting
more capital to the stock markets, especially risk-sensitive pension,
insurance and offshore funds.

However, the value of mature capital markets goes beyond capitalization.
Full fledged, they can force enterprises to compete for funds, weeding out
the weak from the strong. Last month, the China Securities Regulatory
Commission delisted washing-machine maker Narcissus from the Shanghai Stock
Exchange after the company racked up four consecutive years of losses. The
rules for stripping companies of their listing had been murky, but the CSRC
assertively clarified them in February, saying firms posting three or more
years of losses would be given just six months to make a profit or face
delisting. Narcissus soon came back with a turnaround plan, but the Shanghai
exchange rejected it, claiming the proposal was unworkable. That's just one
example of an array of reforms regulators are pressing ahead with to bring
China's capital markets in line with the survival-of-the-fittest ethos that
characterizes their more mature counterparts elsewhere.

Mr. Pu is senior economist at Nomura International in Hong Kong.




Scott Marra
Administrator for Policy & Media Relations
ISDA
600 Fifth Avenue
Rockefeller Center - 27th floor
New York, NY 10020
Phone: (212) 332-2578
Fax: (212) 332-1212
Email: smarra@isda.org