China Forex: At the recent 2020 National Work Conference on Foreign Exchange Management，SAFE's General Affairs Department gave a report on its research into improving micro-regulation in the foreign exchange field. Could you give us a brief overview of the framework of micro-regulation?

Sun Tianqi: From the end of 2015 to the beginning of 2017，China's foreign exchange market was buffeted by a number of domestic and international pressures. Over that period we faced large-scale capital outflows，a continued decline in foreign exchange reserves and increased downward pressure on the renminbi. Based on the decisions of the Communist Party's Central Committee and the State Council，foreign exchange administrative departments and other authorities jointly implemented countermeasures and took comprehensive initiatives to avoid intense shocks from the foreign exchange market. In 2017，based on these experiences，SAFE Administrator Pan Gongsheng presented an overall guideline for an integrated management framework of "macro-prudential + micro-regulation" to address cross-border capital flows. The micro-regulation we are talking about now is actually an important part of the integrated management framework. 

We put forward the "three-pillar framework"  of micro-regulation in foreign exchange，basing it on   international experience and tailoring it to the actual circumstances in China. The first pillar is management based on actual needs and the auditing of transactions to ensure authenticity. In this regard the focus has shifted from prior approval to interim and post-transaction supervision. The second pillar is behavioral supervision，which has an objective of maintaining orderly competition in the market and protecting the legitimate rights and interests of consumers. The third pillar，micro-prudential regulation，is designed to protect market entities from excessive exposure to foreign exchange risks and insolvency due to currency mismatch or exchange rate risks. This in turn ultimately prevents the occurrence of systemic risks. At the same time，self-discipline remains an important complementary mechanism.

China Forex: To ensure effective implementation of current management policies what is the primary task of micro-regulation at present? What measures will SAFE take to promote this?

Sun Tianqi: The first objective is to use financial technology to enhance the risk-warning capabilities of off-site supervision. This includes continuing to improve the indicator system for off-site inspections by adapting new features，making better use of data，and adjusting to changes in the foreign exchange market. It also includes expanding data sources to uncover behavior related to abnormal cross-border capital flows in a timely manner. It also requires improved off-site monitoring and analysis as well as facilitating on-site inspections by using modern technologies such as big data，machine learning and artificial intelligence. It also calls for making full use of big data for risk screening by stressing associated account analysis，abnormal transaction analysis，financial statement analysis and public opinion analysis. This will allow us to move forward the threshold of risk prevention and build a solid defense line against foreign exchange business risks. We will focus on strengthening the monitoring and analysis of key institutions and high-risk institutions in the foreign exchange arena，keeping a close eye on their foreign exchange cross-border related economic activities to discover any potential risks in a timely manner.

Second，we will focus on key areas during on-site inspection. This includes covering all major national banks while strengthening inspections for non-bank financial institutions and third-party payment institutions. The focus should be on high-risk businesses，targeting false and deceptive transactions in onshore guarantees for offshore loans as well as on transshipment trades，offshore lending，onshore deposits for offshore loans，domestic and overseas cash in foreign currency，franchise exchange business and other foreign exchange business activities. We are also exploring different approaches in conducting overseas inspections.

Third，we will promote information sharing and regulatory cooperation. Detailed measures will include deepening the cooperation with tax，customs and other departments to give a wider scope to information sharing. This will be aimed at facilitating audits of transaction authenticity for banks. There will be efforts to undertake specific joint investigations as well as evaluations and inspections with other regulators on offshore accounts，non-resident alien accounts and free trade non-resident alien accounts to build a solid foundation for further expansion of opening up of the cross-border account system. There will be stepped up information sharing among all departments by leveraging an "Internet + Regulation" system，notifying relevant departments of pending cases in a timely manner. We will enforce joint punishments against enterprises and their legal representatives or persons in charge in severe cases. We will work with public security and other departments to crack down on illegal private banks and criminal activities. Additionally，we will promote international regulatory cooperation in cross-border finance.

Fourth，we will maintain the stability，consistency and predictability of the micro-regulatory policies and law enforcement standards in the foreign exchange field.

Fifth，we will act in accordance with international practice and implement capital flow management measures where necessary.

China Forex: Could you elaborate on behavioral supervision? What are the main tasks in that area in the days to come?

Sun Tianqi: As its name suggests，it is the supervision and management by regulators of the behavior of financial institutions. This mainly includes combating market manipulation and insider trading，conducting anti-fraud efforts，addressing misleading information，and enforcing disclosure requirements. It also includes protecting personal financial information，preventing unfair competition and monopolistic practices as well as ensuring effective consumer dispute resolution in an effort to maintain a fair，just and effective competitive order in the foreign exchange market. There are two major components: supervision of the wholesale market and supervision of the retail sector.

For the wholesale market，our major task currently and for the near future is to improve the behavioral supervision system. On one hand，we shall establish a sound legal system for the wholesale market. We will revise the 1996 edition of the Interim Measures on the Administration of the Inter-bank Foreign Exchange Market and add relevant content to the Regulation of the People's Republic of China on Foreign Exchange Administration. We will make a timely introduction of special guidelines (such as data security guidelines，standardized electronic trading platform and trading center data management，standardized "quantitative" trading of foreign exchange， market information norms and security management guidelines and a code of conduct for sales personnel，etc.) in reference to international practices and the dynamic development of the latest trading products and tools. At the same time，we need to build up the off-site inspection system for the wholesale market，strengthen data collection and statistical monitoring so as to identify and deal with emerging and potential issues as early as possible. In addition，we also need to establish the on-site inspection system for the wholesale market，continue to carry out special inspections on violations of laws and regulations，and keep improving the professional ability of the inspection teams to raise the quality of our inspections of the foreign exchange market.

For the retail sector，protecting the legitimate rights and interests of consumers and investors will be our top priority. The Fourth Plenary Session of the 19th Central Committee of the Communist Party of China has pointed out that we should "adhere to the vision of people-focused development" and ensure that all administrative departments serve the people and are responsible to the people. They must also safeguard the rights and interests of consumers. In foreign exchange，we follow these guidelines through the protection of property rights，as well as the right to know，the right to choose，the right to fair trade，and the rights of consumers and investors to ensure the security of their personal information. Also，we need to maintain a fair and transparent market environment by cracking down on fraud and false and misleading information. First，the Law of the People's Republic of China on the Protection of Consumer Rights and Interests stipulates that consumers have the right to file complaints with relevant administrative departments in the event of a dispute over their rights and interests. Channels for lodging complaints need to be kept open. Additionally，we need to facilitate the dispute resolution mechanisms for market entities and respond to concerns from members of the public in a timely manner. We need to safeguard the rights and interests of overseas consumers and investors and urge financial institutions to improve regulatory compliance in foreign exchange related business activities.

Financial institutions should also set reasonable performance goals，improve incentive mechanisms for tellers and management，and reward employees with an outstanding sales performance while strengthening compliance. These institutions also need to enhance training for front-line staff to improve their professional skills and ensure they can offer objective，accurate and comprehensive responses to clients' questions. Third，consumers and investors need more of an understanding of financial markets and the related risk features，especially in digital finance and foreign exchange. There is a need for helping consumers and investors improve their self-protection capacity against false and misleading statements and fraud. We must guide consumers and investors to closely follow our nation's financial and foreign exchange regulatory policies. We need to encourage financial institutions to cooperate with the People's Bank of China to carry out the objectives of "Financial Literacy Month" (September)，strengthen the promotional efforts on foreign exchange knowledge and risk prevention for consumers and investors. The fourth area is to implement the relevant requirements of the Notice on Further Regulating Financial Marketing and Publicity Activities，to urge foreign exchange business entities to carry out financial market publicity in strict compliance with the law.

Currently，we are focused on implementing existing policies for the micro-behavioral supervision in the foreign exchange field. Regulatory authorities have initiated a number of regulations and banks have introduced internal control measures. The difficulty banks are facing now is in implementing these measures in all business areas.

China Forex: What is the long-term direction of micro-prudential regulation?

Sun Tianqi: In order to guard against insolvencies and maintain a stable financial system，regulatory authorities have developed prudential regulatory policies. The objective is to monitor and evaluate the risk conditions of financial institutions through prudential guidelines coupled with regular on-site inspections which ensure timely warnings and a quick response to related risks. Ultimately，this contributes to financial stability. The following five areas are the main focus of micro-prudential regulation.

First is to strengthen information sharing among different regulators on the regulatory and monitoring indicators over currency mismatch and exchange rate risks. SAFE shall establish mechanisms for regulatory cooperation and data sharing with other regulatory authorities. The idea is to exchange relevant data on regulatory indicators related to the international balance of payments; foreign investments in the domestic bond market，stock market and derivative market; and track currency mismatches and exchange rate risks at commercial banks. Other areas include monitoring indicators (such as liquidity) as well as any punishments imposed as a result of inspections. There is also a need for timely communication with other regulators on other issues found in the foreign exchange market.

Second，it is important to work in a transparent fashion with relevant departments to promote micro-prudential regulatory requirements in foreign exchange based on practical conditions in our country. It is also necessary to conduct research on how to implement the requirements，as proposed in Basel III，so that we can raise the risk weightings and corresponding capital of insufficiently hedged foreign exchange loans to 1.5 times and ensure successful implementation as scheduled by January 1，2022. We also need to promote research on how to employ additional discounts on renminbi mortgages or guarantees for foreign exchange mortgage loans and guaranteed foreign exchange loans to enhance capital requirements.

We need to pay more attention to the exchange rate and foreign currency interest rate risks of overseas bonds issued by domestic enterprises. We need to guide banks to conduct a comprehensive assessment of possible currency mismatches，exchange rate risk，commodity price volatility risk and related hedging status of renminbi/foreign currency borrowers and import-dependent customers of non-export sectors. These factors need to be reflected in risk pricing. We also need to study how to restrict implicit guarantees of the government for cross-border debts of market players and avoid risk from issuing non-hedged foreign debt to non-export sectors in order to reduce moral hazard.

Third，we need to strengthen our warning capacity for risks from enterprises and groups that are active in cross-border trade，investment and other financial activities. This requires the heightened use of currency mismatch and exchange rate risk monitoring systems. There is a need for a monitoring indicator system (non-rigid regulatory indicator) and a corresponding risk warning mechanism for their foreign exchange exposure，the matching of foreign exchange loans，overseas bond issuances and foreign exchange income，the hedging of currency mismatches and exchange rate risks as well as cross-border contingent liabilities. We need to work with authorities to encourage enterprises to improve the quality of their reports and data so that their risks can be assessed in a more comprehensive and accurate way.

Meanwhile，we must pay attention to the regulatory indicator requirements for currency mismatches of non-financial enterprises. For example，Indonesia has adopted prudential principles for non-banking companies holding foreign currency and foreign debts. For exchange rate risk hedging，the hedging ratio of net foreign exchange liabilities due within 6 months shall not be lower than 25%，and as of 2017，all hedging transactions must be handled directly with local banks in Indonesia. For the minimum liquidity ratio，the hedging ratio on foreign currency liabilities due within three months from the end of the quarter shall not be less than 70%. Indonesia also requires a credit rating of at least BB- for enterprises holding foreign currency and foreign debts.

Fourth，we need to guide enterprises towards the financial management concept that "risk is a neutral factor," helping them to correctly understand the relationship between "hedging losses" and actual losses and the connection between hedging costs and normal expenditures. We should support the participation of qualified domestic companies in domestic and foreign derivatives trading as long as they meet requirements for legal compliance，risk control and sustainable business practices. Meanwhile，we should work on prohibiting companies from engaging in complex derivatives trades that exceed their level of expertise. This requires strengthened communication across regulatory departments to guide state-owned enterprises and other market entities in improving their hedging ratio and enhancing risk prevention efforts.

Fifth，it is important to remember that market access is one of the important components of micro-regulation in the foreign exchange arena. The rapid development of financial technology has not only spurred innovation in financial services but has also increased opportunities for cross-border violations of laws and regulations. These areas include cross-border investments in stocks，bonds and foreign exchange as well as insurance products. Regulatory authorities need to conduct close inspection and heavily penalize violators，including those who make illegal cross-border financial advertisements.

In the future we will continue to improve the micro-regulatory framework for foreign exchange as directed by Administrator Pan Gongsheng. Regulators at all levels need to work together to maintain an orderly foreign exchange market. China needs to demonstrate increased vigilance to ensure that its regulations are followed. Over the decade following the sub-prime crisis，European and US banks were fined a total of around US$350 billion. China should draw lessons from the experience of the developed countries，establish and improve its regulatory framework for foreign exchange and cross-border financial services. It also needs to clarify relevant rules and regulations and increase punishments for violators of its laws and regulations.