China’s New FX Regime An Opportunity For RMB Currency Futures Users

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By Julien Martin, Head of FIC Product Development, Hong Kong Exchanges and Clearing Limited (HKEX)
On 30 November 2015, the International Monetary Fund’s (IMF) Executive Board decided to include the Renminbi (RMB) in its Special Drawing Rights (SDR) basket, giving the RMB a 10.92% weighting. The SDR inclusion is essentially an endorsement by the IMF of the RMB internationalisation process. It puts the RMB on par with the likes of the US dollar (USD), Euro (EUR), Japanese Yen (JPY) and British Pound (GBP). The short-term impact is likely to be limited, with a 10-month delay until the new SDR weighting becomes effective on 1 October 2016. Over the longer term, however, the acceptance of the RMB as a reserve currency will trigger asset re-allocation and facilitate foreign capital inflows into China’s capital market. The market estimates that at least US$1 trillion of global reserves will switch into RMB assets following its SDR inclusion1. Moreover, the SDR inclusion will probably push the Chinese government towards further financial reforms, including gradual removal of quota controls on cross-border investment and increasing depth and openness in China’s capital markets.

RMB internationalisation accelerated in 2015
On 11 August 2015, the People’s Bank of China (PBOC) adopted a new daily fixing framework based on the previous day’s closing rate in conjunction with supply/demand factors and movements in other currencies. On 11 December 2015, the PBOC introduced a CNY (onshore RMB) trade-weighted index, CFETS CNY TWI, published by CFETS2 which covers 13 currencies3. The PBOC highlighted the index as an important and more appropriate reference for the market, as it was overly fixated on the bilateral USD/CNY rate. The move was consistent with the PBOC’s stated policy goal of maintaining the RMB exchange rate “basically stable at an adaptive and equilibrium level”. From a macro perspective, with USD on a tightening cycle, the PBOC’s action should help de-link the RMB from a strong USD.
On 4 January 2016, the PBOC extended the onshore RMB, or CNY, market’s trading hours to 11:30 pm in order to allow onshore RMB traded during London business hours under an SDR price fix, and prepare for more international hedging flows.
Liquidity in the offshore RMB (CNH) market continues to develop along with the rapidly growing RMB crossborder trades and offshore deposits. Turnover has nearly quadrupled over the last four years, and the market expects 15-20% YoY growth in the near future, according to a key industry group. Daily spot trading volumes in USD/CNH now stands at over US$25 billion, according the City of London, and a major international bank estimates daily forward and swap trading volumes stand at around US$20 billion. Both are at a comparable size if not bigger than onshore volumes. Over the longer term, demand for CNH will be supported primarily by rising levels of trade (imports and exports) in RMB, cross-border fund flows and CNH asset creation.
RMB’s two-way volatility the new normal With the RMB’s recent two-way movement, the market is beginning to accept RMB volatility as the new normal.
On 4 January 2016, the PBOC surprised the market by setting the daily reference rate for RMB below 6.5 against the USD, the lowest in more than four years. Furthermore, the 332 pips weakening in the CNY fixing on 7 January 2016 was a record single-day decline since the new fixing framework in August 2015, and it represented a five standard-deviation fall in price over the course of the past five years.


Since early November 2015, the spread between the CNH and CNY exchange rates against the USD has seen spikes, reinforced by recent measures limiting offshore entities’ tapping of the onshore repo market and restricting onshore banks’ lending to offshore banks via nostro accounts. On 7 January 2016, the spread climbed to over 2,000 pips, the highest in four years. Such divergence reflects the difference in sentiment towards CNH, which has no restrictions on its use and price range, and the heavily regulated CNY.
In December 2015, Chinese FX reserves declined by a record US$108 billion to US$3.33 trillion, indicating that the currency was supported through government FX purchase operations. To curb arbitrage between offshore and onshore rates, the PBOC recently imposed measures that included a halt on offshore banks’ borrowing from domestic markets through bond repurchases along with a suspension of new applications in a programme that allows domestic investors to buy RMB-denominated assets overseas.
CNH likely to remain volatile
The PBOC has been maintaining a managed floating exchange rate system based on market supply and demand with reference, but no peg, to a basket of currencies. The CFETS CNY TWI had historically tracked closely with the US dollar index (DXY), but began to decouple recently. From 11 December 2015 to 15 January 2016, the DXY was up 1.4% whereas the CNY TWI rate was down 1%. Such decoupling is in line with the PBOC’s intention to de-link the CNY TWI from movements in the USD.
According to the recent remarks by Dr Jun Ma, the Chief Economist of the PBOC, the RMB fixing will be adjusted to reflect China’s economic fundamentals. As RMB becomes more integrated into global FX markets, China’s central bank is expected to gradually introduce more flexibility into its exchange rate regime. Two-way volatility and market-driven pricing are consistent with the PBOC’s commitment to accelerate RMB convertibility and marketisation.
With the CNH-CNY spread, China is unlikely to let a wide spread persist in the longer term because wide spreads would prevent it from meeting SDR requirements. Increased integration and further opening of China’s capital account could narrow the gap and reduce the risk of decoupling.

Risk management and opportunities amid RMB volatility
Ahead of the Lunar New Year holiday on 5 February, HKEX’s RMB Currency Futures volume surged to 6,748 contracts (US$674 million notional), the secondhighest single-day volume ever, and open interest level reached 32,009 contracts (US$3.2 billion notional), an all-time high, and by far the highest open interest level among exchanges offering RMB futures. The number of institutions providing RMB Currency Futures brokerage to end clients has been growing and now stands at 92. Users of the contract include financial institutions, small and medium-size enterprises with cross-border business, and retail investors with RMB exposure.
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