# Presentation: 067408

## China: FX risk management

**China: FX risk management**

**Clyde Wardle**
**Senior Emerging Markets FX Strategist**
**Tel:  212 525 3345**
**clyde.wardle@us.hsbc.com**

## 1.  Outline

**Understanding China and US policy objectives**
**Hedging products available**
**Expected FX movements**
**Recommendations for hedging**
- Appendix
- Reforms over past 12 months
- Allowable exposures to be hedged ‘onshore’
- Rules governing remittances & repatriation
- Requirements for trading domestically

## 2.  China’s policy objectives

**Check fixed-asset investment and loan growth**
**Maintain exports and GDP growth (9.4% expected in 2006)**
**Shift growth driver from investment to consumption**
**Boost rural economy**

## 3.  China perspective: RMB policy a structural and political problem rather than a cyclical one

**An undervalued exchange rate has created excess domestic liquidity**
**This has fuelled over-investment and created inflationary expectations (despite sterilisation)**
**China’s policy options are constrained by underdeveloped financial markets and a complex budgetary process**
**...****meaning that traditional monetary and fiscal options are unusable **
**...****because credit creation is insensitive to interest rates and public spending is decentralised**
**China needs to rebalance growth towards consumption to ensure stable long-term growth and efficient capital allocation**
**The financial infrastructure is not yet robust enough for an open capital account and a fully liberalised FX regime, nor are the politicians ready**
**More two-way flow is needed in the capital account and financial institutions need to learn to manage FX risk**
**There is no ‘magic solution’ here for either Chinese or US concerns**

## 4.  The US’s (policy) objectives

**Diffuse US congressional pressure (via stronger CNY)**
**Schumer-Graham (China Free Trade Act) promised a vote by session-end**
**Grassley-Baucus (US Trade Enhancement Act) has more sympathy from Treasury but sources on the Hill suggest it may never come to a vote**
**Promote intellectual property rights in China**
**Gradual and orderly fix of global imbalances**
**Contain oil prices**
**Enhance strategic cooperation re ‘war on terror’ and Iran / N. Korea**

## 5.  How to fix global imbalances?

**Three-pronged approach**
**US fiscal adjustment (difficult in an election year, may not help CAB sufficiently)**
**European structural adjustment (recent rejection by France of labor market reform highlights difficulties here)**
**Asian (and now commodity country) currency adjustment**
**Therefore Asian FX is the most do-able**
**Oil and other commodity currencies have to adjust too**

## 6.  Domestic ‘onshore’ spot market

**21 July 2005: CNY no longer pegged to USD, but managed with reference to basket of currencies.  **
**Full details of basket not disclosed.  10 Aug 2005 PBOC said USD, EUR, JPY & KRW were main reference currencies in basket.  Other currencies include SGD, MYR, RUB, AUD, THB and CAD.  All are among China’s top 15 trade partners.**
**At market close, PBOC announces rate against the USD for next day.  Intra-day band is +/- 0.3%.  Depending on conditions, economic and financial situation, the PBOC can make adjustments to the band when necessary.**
**Spot FX transactions are settled next day and must be executed in the China Foreign Trading System (CFETS) through a Designated Foreign Exchange Bank (DFEB).  Deals can be auto-matched.**
**Trade related support documents (e.g. contract, invoices, bills of lading, custom claim forms) denominated in foreign currencies or capital documents (FIA issued by MOFTEC or SAFE) are required.**
**Non-USD crosses normally split into two deals: USD/CNY and USD/XXX**

## 7.  Domestic ‘onshore’ forward/swap market

**Forwards launched 15 Aug 05**
**4 currency pairs: USD-CNY, EUR-CNY, JPY-CNY, HKD-CNY (mostly USD-CNY)**
**64 member banks at end-2005**
**Trading hours: 9.30am – 5.30pm**
**Fees/commissions: 0.001%**
**Swaps launched 24 Apr 06**
**Trading mechanism: CFETS-based, member banks quote bid/offer on trading platform, trade direct and take direct counterparty risk (no auto-match on forwards yet)**
**Volumes: est. USD80m per day currently, very slow growth**

## 8.  ‘Offshore’ market

**No spot trading available**
**Non-deliverable forwards (NDFs), options (NDOs) and cross currency swaps**
**Most liquidity vs USD, although other crosses available**
**Trading hours: 24hrs, but least liquidity in NY pm**
**Most liquidity up to 1 year, but prices available to 10 years**
**Tighter pricing (much better liquidity than onshore)**
**No access by domestic entities**

## 9.  Price differences between onshore and offshore 

- Source: HSBC

**Mid-price**

## 10.  Expected FX movements 

**10.  Expected FX movements **

**4.2%**

- Source: HSBC

## 11.  Gradualist policy to continue

- Source: HSBC

## 12.  Long term forecast?

- Source: HSBC

## 13.  Hedging considerations

**Where?**
**Offshore or onshore (accounting, tax, control, regulations, ownership, pricing)**
**What?**
**Medium/Long-term ‘short RMB’ exposures should probably be hedged**
**BoP surplus, undervaluation, global imbalances...**
**Can make an argument for hedging ‘long RMB’ too**
**NPLs, capital a/c liberalisation...**
**Long tenors may be better hedged offshore**
**How?**
**NDFs, Forwards, Options (offshore only), Swaps**

## 14.  Appendix

**Reforms over past 12 months**
**Domestic forwards: allowable exposures**
**Rules governing remittances & repatriation**
**Requirements for trading domestically**

## 15.  Reforms over past 12 months

**18 May 05**. CFETS enhanced. The system will host trading in 8 more currency pairs, USD/JPY, EUR/USD, USD/HKD, USD/CHF, AUD/USD, USD/CAD, GBP/USD and EUR/JPY, in addition to the 4 currencies previously traded (USD/CNY, JPY/CNY, HKD/CNY, EUR/CNY)
**11 July 05.** China raised QFII quota (mainly for equity markets) by USD6b to USD10b for 2005
**21 July 05.** **China revalues USD/CNY by 2.1% and introduces a new FX regime. Puts a daily trading limit of 1.5% on currencies other than the U.S. dollar that are traded against the yuan **
**2 Aug 05.**  PBOC expand eligibility for CNY forward licenses. SAFE lifted cap of FX amount that Chinese companies can retain to 50%.  Limitation for personal FX purchase expanded to USD8k.
**10 Aug 05.** PBOC allows non-financial firms into the spot FX market China indicates that USD, EUR, JPY, KRW are the main reference currencies in the basket
**23 Sep 05.** Broadens the band for CNY/non-dollar currencies to +/- 3%. Designated FX banks are allowed to quota a rate 1% above the parity rate for USD/CNY. No ceilings for non-dollar currencies
**27 Sep 05. Another 24 banks allowed to trade onshore CNY forwards **

## 16.  Reforms over past 12 months...cont.

**25 Nov 05.**  PBOC conducts its first currency swap with the domestic commercial banks
**28 Nov 05.**   SAFE announces 1) introduction of a bilateral trading platform in addition to the existing centralized (matching) trading platform, and **2) introduce a market maker mechanism for the inter-bank RMB spot market. **
**19 Dec 05.** PBOC allows all inter-bank market traders to invest in domestic corporate bonds
**1 Jan 06.** Bilateral trading on the inter-bank market takes effect
**4 Jan 06.**  Change in the way USD/CNY central parity is set. Instead of being based on closing prices for the previous day, now formed by a weighted average of participant prices  PBOC will set the daily central parity USD/CNY rate at 0115 GMT
**9 Feb 06. Introduces yuan interest rate swaps** Central bank establishes a mechanism that allows it to periodically adjusts its rediscount rate, which has been fixed at 3.24 percent since March 2004.
**11 April 06.** Businesses that import and export goods worth at least USD1bn a year given the green light to trade foreign currencies in the inter-bank market.

## 17.  Reforms over past 12 months...cont.

**12 April 06. **State Council gives the green light for insurers to invest some of their CNY1.6t (USD200bn) of capital abroad. Forms part of the Qualified Domestic Institutional Investor program
**14 Apr 06. Allows citizens and companies to make a much greater range of investments overseas.** Changes took effect on May 1
- 		- Chinese citizens are allowed to buy up to USD20000k worth of FX a year and they can buy 	more if there is a real need such as overseas education
- 		- Banks are allowed to manage funds for their customers and invest part of the renminbi fund in 	overseas fixed income markets
- 		- Chinese  insurance companies can invest part of their renminbi income in overseas fixed 	income assets
- 		- Local fund management companies are allowed to pool onshore foreign currency deposits 	and invest overseas including in equities
- 		- The cap on the amount of FX earnings Chinese exporters can retain is increased from 50 	percent to 80 percent.
- 		- Restrictions on foreign currency purchase for service imports are reduced

## 18.  Domestic forward/swap market - business range

**Bank buying FCY / selling CNY**
**Current account**
**Trade related**
- 1. T/T
- 2. Export DC
- 3. Export collection
**Non-trade related**
**Capital account**
**1. Direct investment (registered)**
**2. Capital injection (registered)**
**3. Foreign currency income of overseas listed company (registered)**
**4.Other foreign currency income approved by SAFE**

## 19.  Domestic forward/swap market - business range (continued)

**Bank selling FCY / buying CNY**
**Current account**
**Trade related**
- 1. T/T
- 2. Import DC
- 3. Import collection
**Non-trade related**
**Capital account**
**1. Repayment of FCY working capital loan **
**2. External debt (registered)**
**3. Foreign currency expenses of direct overseas investment (registered)**
**4. Other foreign currency expenses approved by SAFE**

## 20.  Remittance & repatriation

**Dividends**
**Profit after tax can also be repatriated outside China as dividends without SAFE approval as long as supporting documentation is provided to remitting bank.  In practice, dividends can only be repatriated following the presentation of the following documents to the remitting bank:**
- Audited financials which show a profit has been made
- A tax receipt showing that profit tax has been paid
- An investment verification report by a PRC-registered auditor certifying that capital is fully paid up
- A board resolution on the amount of the dividends to be paid
- A letter from the FIE instructing the bank to remit the funds abroad
**Repatriation of royalty fee is allowed subject to documents including royalty agreement, sales invoices and tax certificate.**
**Repayment and repatriation of principal and interest are capital account items and subject to prior SAFE approval.**

## 21.  Remittance & repatriation (continued)

**A & B shares**
**A-shares (denominated in CNY) are open to QFII who have obtained approval from PBOC, SAFE and CSRC.  Repatriation of principal and proceeds derived from A-share investments is subject to strict controls.**
**Sales proceeds and income from B shares (denominated in USD and HKD) invested by foreign investors can be repatriated.**
**All PRC-registered enterprises are required to obtain tax-clearance documents from local tax authorities in order to remit non-trading-type payments to overseas entities in excess of USD1,000.**

## 22.  Onshore forwards: customer requirements

**At least one bank account opened with HSBC**
**Sign ISDA or IFEMA or accept the facility letter which contains relative paragraphs **
**Accept and sign facility letter regarding the FX line**
**Provide Board Resolution and signature specimens of authorized persons**

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