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