When Beijing announced the 2.1 per cent revaluation of the renminbi late on July 21, traders at Deutsche Bank in Singapore had to rejig their plans for the evening to set-up the hedge against forex exposure.
“It was chaotic because everyone had already left the office,” says Mirza Baig, currency strategist at Deutsche. “Traders had to rush back to their desks to look at their exposure, particularly in terms of short positions.”
Currency traders were focusing on the market for renminbi non-deliverable forwards – offshore derivatives that are mainly traded by big international banks in Singapore.
NDFs are widely used by hedge funds betting on the value of currencies that are not fully convertible. However, Beijing policymakers have not publicly expressed any interest in the informational value of the market, despite the paucity of other credible indicators for the Chinese currency. Nor does the NDF market receive much attention in the Chinese press, which focuses on trading in the central bank-dominated domestic foreign exchange market.
Forwards are over-the-counter agreements in which assets are traded at current prices for delivery after a specified period, normally ranging from one month to one year. Renminbi forwards are “non-deliverable”, because they are settled in US dollars.
One official at the People’s Bank of China, the country’s central bank, dismisses suggestions that NDF prices might play a role in the renminbi’s new rate-setting regime, which is formally known as a managed float based on “market supply and demand with reference to a basket of currencies”. “NDFs are not a currency . . . they are just a kind of contract, so they are not in our basket,” the official says. “It’s not in this basket, so it will certainly not be considered [in setting the exchange rate].”
Still, with an average daily trading volume of about US$500m, the renminbi NDF market is more than just a playground for a few trigger-happy hedge funds. For example, big international companies with operations in mainland China tend to use NDFs to hedge their foreign currency exposure.
One Hong Kong-based treasurer at a big international group says US companies are particularly keen to avoid currency translation effects on their balance sheets. “They tend to have very conservative internal accounting policies,” he adds. “They are saying: ‘we understand that the renminbi is a one-way bet at the moment, but we don’t care’.”
International companies might also want to use NDF contracts because they are sourcing from Chinese suppliers and because some of their costs are denominated in renminbi.
Mr Baig at Deutsche believes some companies will be keen to “lock in” bullish market expectations. One-year NDF contracts suggest the renminbi will rise by about 5 per cent from its revalued level. “Hedging gives them certainty for their profit forecasts for the next 12 months,” he adds.
Others, however, remain sceptical. “Often, the expectations in the NDF market are quite exaggerated, compared with what companies [on the ground] think,” says Stephen Green, senior economist at Standard Chartered Bank. “There is no point in using this market for hedging if you think it is out of line.”International fund managers who are investing in China’s domestic capital markets account for a small part of the renminbi NDF market, according to Deutsche Bank. While some managers have to follow strict internal hedging policies, others leave their positions unhedged. “We are not planning to use it,” says Shifeng Ke, a director at Edinburgh-based Martin Currie. “If the currency appreciates, the value of the fund’s assets will increase.”
Supporters of the NDF market include big international banks such as Deutsche Bank, Citigroup and HSBC, which derive attractive trading revenues from their hedge fund clients.
Typically, investors use the on-shore spot market as a reference point for their offshore bets. Under a one-year NDF contract, the difference between the present spot value and the value in 12 months’ time is paid to the winning party in dollars. The renminbi cannot be taken out of the country.
NDFs are popular among investors who are trying to exploit the differences, or “relative value”, between two assets. “If you think the Japanese yen is lagging behind a renminbi appreciation, you will buy yen and sell renminbi in the NDF market,” explains Mr Baig.
Yet, while renminbi NDFs are widely traded, they have a poor track record in predicting future currency values. According to economists at the Monetary Authority of Singapore, the city-state’s central bank, forward markets failed to show their worth during the 1997-1998 Asian financial crisis.
One Tokyo-based currency trader at a US investment bank believes the renminbi NDF market is not representative, because of the limited number of participants. “A lot of the big banks are expressing their views on the renminbi by investing indirectly through, say,dollar-yen trades,” he adds.
By Florian Gimbel and Mure Dickie
Source: FT via Yahoo News
Photo credit: kern.justin via VisualHunt.com / CC BY-NC-ND
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