The new Shanghai Clearing House is working with European central securities depositories Clearstream and Euroclear to bring best practices to China's foreign exchange and over-the-counter (OTC) bond markets.

Launched on November 28, the clearing house has signed memorandums of understanding  with both central securities depositories (CSDs) to help it become the central counterparty in China for currency and OTC transaction clearing and netting. But there is some way to go before they can make the most of the agreements.

Both Deutsche Borse-owned Clearstream and independent firm Euroclear hope the MoUs will act as stepping stones to future links between their systems and Shanghai Clearing House. Such connections would give their members access to the Chinese FX and OTC markets and increase available liquidity in the country.

Meanwhile, Shanghai Clearing House can "leverage the experience from the Euroclear group in Europe and the rest of the world in how to develop, for example, risk management, collateral management and clearing services", says Michel Boving, director of corporate strategy at Euroclear.

As the world's largest CSDs, Clearstream and Euroclear are competing to offer their members the most access to Asia's emerging economies. In the case of Shanghai Clearing House, Clearstream was quick to highlight that it signed its MoU on December 2, whereas Euroclear's was inked on December 8. 

But it's the connections facilitated by the MoUs that really count. "An MoU is like world peace," says Philippe Metoudi, executive board member and relationship manager for Asia-Pacific, the Middle East and Africa at Clearstream. "You cannot be against them, but at the end of the day you need to make something of them."

Clearstream already has a link with the China Government Securities Depository Trust & Clearing (CDC) for US dollar and Hong Kong dollar transactions in China B-shares and an agreement with the China Securities Depository and Clearing Corporation (SD&C). Metoudi says the SD&C has an account with Clearstream and its members can settle on the depository's system.

Euroclear has an existing MoU with CDC, which it signed in 2007. Outside China, it has two memorandums with clearing houses in India and one with the Korea Central Depository (KCD).

However, China's restrictive currency regime and foreign investment regulations prohibit a link to the central securities depository, says Boving. "There are elements the Chinese need to change to make their markets more eligible for entities like Euroclear to create a link," he says. "One big factor is making the currency freely convertible; without that, we won't have an efficient link."

The Shanghai and Shenzhen stock exchanges currently handle FX and OTC clearing themselves, a practice that is known to slow the trading process by the industry.

In China there is no clearing or netting for OTC bond trades, says Boving. "That means there is more operational risk for the market," he adds. "Once the clearing house starts netting, the risk will be reduced for the whole market and allow banks to do more trading activity."

Xu Zhen, chairman and chief executive of Shanghai Clearing House, says: "The creation of Shanghai Clearing House is expected to improve clearing efficiency, reduce costs, provide the necessary technical support for financial product innovation and prevent systemic financial risks within China."

Shanghai Clearing House was created by the China Foreign Exchange Trade System, CDC, China Banknote Printing and Minting and China Gold Coin, all of which hold stakes in the entity. At launch, it had registered capital of Rmb300 million ($43 million).

At the end of November, Clearstream had €10.7 trillion ($15.6 trillion) in assets under custody, up less than 1% month-on-month, but 2% year-on-year. International settlement transactions totalled 2.75 million, down 4.8% month-on-month but up 15% year-on-year.

At the end of October, Euroclear had €19.9 trillion in assets under custody and netted 137.8 million transactions globally. It has links with 11 Asian central depositories, including one with the KDC, which went live in September.