China yesterday began yuan swaps trading on the interbank foreign exchange market against the US dollar, euro, yen, British pound and Hong Kong dollar, the central bank announced on its website.

The new move will enrich the interbank foreign exchange market and satisfy domestic firms' demand for more products to hedge against currency risks, the People's Bank of China said.

A currency swap is an exchange through a lender by two borrowers with opposing currency needs.

Forwards and swaps are the only two products in China's yuan derivatives market, and yuan swaps trading is conducted only between financial institutions and companies.

Banks that are qualified to trade yuan forwards in the interbank market will be allowed to engage in swaps trading after they register with the State Administration of Foreign Exchange, according to the statement.

Chinese companies need more derivatives products to help guard against exchange-rate risk.

"This is a belated move, as it will enrich the structure of China's capital market and expand the available instruments," said Yan Qifa, an economist with the Export-Import Bank of China.

As the number of market players increases, the swaps trading will play a better role in discovering the prices of the currencies, Yan said. "And this provides an alternative for enterprises to reduce financing costs."

The interest rates used as references for yuan swaps should be from the benchmark market rate announced by China's interbank lending market or the central bank's benchmark lending and borrowing rates, according to the new rules.

China needs to allow more players, such as the non-financial institutions, into the market in the future to further improve the market structure, Yan suggested.

(China Daily August 21, 2007)