RMB hedging gains momentum

2014-11-21 10:39 China Daily Web Editor: Qin Dexing

Currency volatility prompts traders, manufacturers to seek alternatives

Rising volatility and the higher global use of renminbi have led to a sharp increase in hedging activities by traders and manufacturers, bankers in Hong Kong said.

Hedging is a process whereby traders make additional investments to reduce risks from adverse price movements in an asset.

"More and more people are now feeling the need to hedge the yuan. Demand is rising steadily," said Donald Lam, head of commercial banking at Hang Seng Bank Ltd in Hong Kong.

"The Chinese currency ended its long-standing, one-way movement earlier this year. It has now become harder to predict its movements. As a result, people with renminbi receivables are looking to hedge against depreciation, whereas those with payables are worried about appreciation. The hedging market is robust," Lam told China Daily.

Traders are also feeling the need to hedge the Chinese currency due to its volatility.

"If the yuan rises or declines by more than 1 percent over a short period, or makes several hundred basis points difference, people tend to be sensitive and actively seek ways to protect themselves from exposure to exchange risks," Lam said.

After rising against the US dollar for almost three-and-a-half years, the yuan has slipped by 3 percent in about two months since January this year. The People's Bank of China, the central bank, widened the currency's daily trading band on March 17 - from 1 percent to 2 percent. It then extended the loss for another 50 basis points to 6.2598 yuan per dollar on May 1, hitting an 18-month low.

Frances Cheung, head of Asian rates strategy at Credit Agricole Corporate & Investment Bank in Hong Kong, said: "Exporters and manufacturers are driving the hedging demand as they need to pay production and labor costs in the yuan and receive payments in US dollar. For these traders, hedging is a necessary tool to maintain revenue and to ensure that the currency volatility does not affect overall returns."

"One can sell US dollar forwards to lock up the exchange rate," she said.

The hedging ratio - the share of assets protected via hedge compared with the entire position - depends on the company's internal strategies and views on the market, Cheung said. "If the view is for a stable foreign exchange market, the company may want to hedge less."

"Even though volatility is higher, we are still confident in the yuan and expect it to pick up in the long term. Our target price is 6 yuan per US dollar," Cheung said.

On the other hand, importers who mainly source raw materials to the mainland also hedge renminbi to protect themselves from depreciation. For them, a concern that is bigger than the hedging cost is the dollar liquidity.

"In Asia, dollar liquidity is tight from time to time. For people with dollar payables, deliverable forwards is the all-in-one solution," Cheung said. "The liquidity issue is one of the reasons why China is promoting more trade settlements in the yuan - it's not just a matter of exchange rate, but dependency on the US dollar."

A rising number of foreign exporters are willing to settle in the yuan when trading with Chinese firms. Some of them are accumulating yuan for direct investment back to the mainland or to buy offshore renminbi assets. Others are attracted by a better price offered in the yuan.

According to a report published by the Society for Worldwide Interbank Financial Telecommunication, the renminbi is now the seventh largest payment currency in the world in value terms, six positions above the ranking it achieved in January 2013. It also accounts for about 1.57 percent of the global money traffic.

By August this year, Europe accounted for 10 percent of global yuan payments, in value terms, driven by growth in the United Kingdom, France, Germany and Luxembourg. Since July 2013, direct payments in the yuan between Europe, the Chinese mainland and Hong Kong increased by 105 percent, "showing a considerable uptrend in renminbi usage", the SWIFT report said.

For most of these European hubs, the Chinese mainland is the main renminbi trading partner. There seems to be a noticeable shift in business for some countries like Luxembourg, however, with an increasing share of truly offshore flows, the report pointed out.

Yet another interesting aspect is the increased flexibility for derivatives trading on the Chinese mainland, said Credit Agricole's Cheung. "From August, lenders in the mainland can now buy and sell options for clients, thereby offering more yuan hedging options."

"The move is helping mainland companies to move to a gradually relaxed market environment, no matter if it is due to interest rates or exchange rates. The mainland authorities are introducing various financial instruments and policies so that Chinese enterprises can be better prepared for a more open and volatile market," Cheung said.

The State Administration of Foreign Exchange said in late June that, based on the principles of European options, banks can conduct option trade, including portfolios that consist of two or more put and call options. Restrictions on swaps and forwards were also relaxed.

Even so, Hang Seng Bank's Lam emphasized that Hong Kong, the first and foremost offshore renminbi center, still holds the advantage in serving the currency's hedging demand.

"Hong Kong has enough renminbi liquidity. Banks in other offshore centers often tend to borrow from the interbank market in Hong Kong. A lot of big deals are actually settled here," he said. "Besides, fierce competition between banks leads to more favorable prices for hedging. It's always attractive to the mainland, especially the inland-based business, not to mention the quality of services."