offshore china monthly digest

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OFFSHORE CHINA MONTHLY DIGEST
A Bloomberg Professional Service Offering
CONTENTS
04 MARKET DEVELOPMENTS
12PRIMER
14 FROM BLOOMBERG ANALYSTS
16 NEWS AT BLOOMBERG
17 ON THE RADAR
OFFSHORE CHINA
MONTHLY DIGEST
Welcome to Bloomberg’s August Offshore China Wrap, a monthly digest
that gives you at a glance, news, insights, data and analysis on recent
developments taking place in and around China’s offshore financial markets.
“It’s been no surprise that the slump in the yuan this month has caused
more than just a small ripple across the world’s financial markets.
Despite the fact that yuan is only in the low single digits of global
payments, its clout has grown considerably since the currency’s
‘internationalization’ over a decade ago. So much so, that its inclusion
in the IMF’s Special Drawing Rights currency basket all but seems
inevitable.”
“The PBOC’s decision to allow for more market-based determination of
the yuan is taking us into new territory - one with more volatility but also
of opportunities. And as the yuan moves towards a free float, investors
will have to consider the consequences and risks accordingly. From
structured products through to dim sum bonds, basic assumptions
about the yuan, now a major moving variable, will need to be reassessed and revaluated - and that’s very exciting.”
“As reverberations continue across the world’s currency markets, eyes
will turn back towards China and how it can open its capital markets
in a stable manner. It’s a tricky balance and one that the whole world
should be watching closely.”
Taran Khera,
Bloomberg’s Head of Sales for Hong Kong, Korea and Taiwan.
OFFSHORE CHINA MONTHLY DIGEST 02 // 03
MARKET
DEVELOPMENTS
24/8 CHINA’S YUAN DROP AMID STOCK
SELLOFF AS ECONOMIC CONCERNS MOUNT
hours in Europe or the U.S.,” said Xie Yaxuan, Shenzhenbased chief economist at China Merchants Securities Co.
China’s yuan fell the most in more than a week amid a stock
selloff, breaking a pattern of rallies toward the close of trading
seen since a devaluation two weeks ago.
The International Monetary Fund, which is reviewing
its reserves basket in November and has delayed any
expansion till September 2016, said in a report earlier this
month that CFETS calculates yuan exchange rates four
times a day.
The Shanghai Composite Index of equities plunged 8.5
percent to erase its gains for the year as government
support failed to allay investor concern that a slowdown in
the world’s second-largest economy is worsening. Asian
currencies declined the most in two weeks amid
speculation the current rout may leave the global economy
too weak to withstand a possible rise in U.S. interest rates.
More than $5 trillion has bled out from the value of global
equities since the Aug. 11 yuan devaluation.
China’s currency fell 0.25 percent, the most since
Aug. 12, to end the day at 6.4044 a dollar in Shanghai,
according to China Foreign-Exchange Trade System
prices. It lost 0.1 percent in the last 38 minutes of trading,
in contrast to recent sessions when major Chinese banks
were seen selling dollars to support the yuan.
“The People’s Bank of China didn’t heavily intervene in
the onshore spot market in the last 30 minutes of trading
today,” said Wang Ju, a senior currency strategist at HSBC
Holdings Plc in Hong Kong.
“That is influencing sentiment.”
In Hong Kong, the freely-traded yuan fell 0.8 percent and was
trading at 6.5055 a dollar as of 6:07 p.m. local time.
ECONOMY, OUTFLOWS
A preliminary Purchasing Managers’ Index from Caixin
Media and Markit Economics was 47.1 for August,
indicating a contraction and falling short of the median
estimate of 48.2 in a Bloomberg survey, according to data
on Aug. 21. The opening up of China’s capital account
could spur outflows, Zhang Ming, a researcher at a unit of
the Chinese Academy of Social Sciences, which advises
the government, said at a seminar in Beijing.
The onshore yuan is allowed to trade as much as 2 percent
on either side of the People’s Bank of China reference rate,
which was set at 6.3862 a dollar Monday. CFETS began
publishing a yuan rate five times a day, with the last one on
Monday coming in at 6.3958 as of
4 p.m. A gauge of dollar strength fell for a fourth day.
“The CFETS move makes it more convenient for global
investors to use the yuan as it offers benchmark rates that
they can use as a reference when it’s not regular trading
“The late offshore yuan decline shows traders in Europe are
pessimistic about the yuan, as the stock market continues
to slump and China’s economic slowdown deepens,” said
Kenix Lai, a foreign-exchange analyst at Bank of East Asia
Ltd. in Hong Kong. “The offshore yuan could hit 6.6 and
the onshore rate will likely reach 6.45 in the coming two or
three weeks.”
20/8 IMF BOARD SETS SEPTEMBER 2016 AS EARLIEST YUAN CAN JOIN SDR
The International Monetary Fund pushed back until Sept.
30, 2016, the date that China’s yuan could be included in
its basket of reserve currencies.
The executive board, which represents the IMF’s 188
member nations, voted Aug. 11 to extend the composition
of the fund’s Special Drawing Rights for nine months, the
Washington-based fund said Wednesday in a statement.
IMF staff in July had recommended the extension to
minimize disruption if the board decides to add the yuan to
the basket, which includes the U.S. dollar, euro, yen and
British pound.
“While the board is currently expected to complete the
review in November 2015, staff sees merit in agreeing now
on a limited extension of the current valuation basket,” the
IMF said in a separate report released Wednesday.
The offshore yuan fell as much as 0.4 percent in U.S. hours
following the release of the board’s decision and was down
0.2 percent at 1:38 p.m. in New York.
“The headline poses a slight disappointment,” said Mike
Moran, head of economic research for the Americas at
Standard Chartered Bank in New York.
The IMF is reviewing a bid by China to have the yuan
included in the SDR. IMF staff are analyzing whether the
yuan qualifies as “freely usable,” a core requirement of
joining the SDR. The executive board has the final say on
whether the currency is added.
Moran said it’s only a matter of time before the yuan wins
the IMF’s endorsement. “As much as some in the market
are worrying, this is the path that China, the IMF and the
Treasury have been advocating and signaling for quite
some time,” he said.
Traders who sold offshore yuan likely overreacted by
misinterpreting the board’s decision as a sign the IMF
doesn’t think the yuan, also called the renminbi, qualifies
for the SDR, said Viraj Patel, a London-based currency
strategist at ING Groep NV.
“Our base case remains that the renminbi will clear the
‘freely usable’ hurdle by the end of the year, and will be
included in the SDR basket,” he said.
China last week shifted to a more market-determined
exchange rate, a move the IMF welcomed as a step toward
a freely floated currency.
18/8 ‘IMPOSSIBLE TRINITY’ ENDS IN CHINA AS
PBOC ALLOWS FREER YUAN
In giving markets a greater say in setting the yuan’s
level, Zhou Xiaochuan is bowing to Nobel-prize winning
economist Robert Mundell’s maxim that a country can’t
maintain independent monetary policy, a fixed-exchange
rate and free capital borders all at the same time.
The policy trilemma, or impossible trinity, is illustrated by
Asia’s experience in the 1990s. When some countries
violated the dictum, their pegged currencies, high interest
rates and open capital borders attracted a flood of foreign
investment that quickly reversed along with their trade
balances, triggering the Asian financial crisis of 1997-98.
The People’s Bank of China’s surprise shift to a more
market-driven exchange rate mechanism a week ago was
largely interpreted as a way to boost exports and improve
chances of winning reserve currency status from the
International Monetary Fund. The policy trilemma suggests
a third motivation: moves to open the capital account and
the desire for more monetary policy flexibility meant a freer
currency was needed.
“The PBOC is shifting priorities,” said Li Jie, head of the
foreign-exchange reserve research center at the Central
University of Finance and Economics in Beijing. “By freeing
the exchange rate, it is focusing on domestic monetary policy
independence and paving the way for freer capital flows.”
PRINTING YUAN
For most of the past decade, that meant printing and selling
yuan and buying dollars to keep a lid on the currency’s
strength, resulting in a foreign exchange hoard of almost
$4 trillion and a broad money supply of 135 trillion yuan
($21 trillion), almost double the U.S.’s level. To offset the
resulting liquidity surge, the central bank would lock away
funds by raising the ratio of deposits that lenders had to
park at the PBOC as reserves.
That all changed over the past year. As yuan appreciation
pressure shifted to depreciation pressure, and as more
capital began moving out, the PBOC found itself on the
defensive: Reserves dropped, it lowered banks’ reserve
ratio requirements and tried to prop up the yuan to
discourage outflows and maintain stability as it pushed for
reserve currency status.
VERBAL SUPPORT
Last Tuesday, the PBOC decided enough was enough,
announcing the biggest devaluation in two decades and
adopting a more market-based methodology to determine
the yuan’s daily fixing rate. Verbal support and assertions
it would step in when there are excessive swings helped
stabilize the yuan by the end of the week, as did reports of
ongoing intervention.
“For the last decade, the central bank’s job was to soak
up excessive liquidity, and in the future, its job will mainly
become providing liquidity,” Huang Yiping, an academic
adviser to the central bank, said in an interview last week.
“It’s possibly an easier job for the central bank.”
Governor Zhou could do with a lighter load. The 67-year-old
central banker, in office since 2002 when Alan Greenspan
was still Federal Reserve chief, is trying to press on with
moves to open the economy while adding monetary
stimulus to keep growth from slowing too fast.
“Exchange rate flexibility means that they can conduct an
independent monetary policy going forward,” said David Dollar,
a senior fellow at the Brookings Institution in Washington who
previously worked for the U.S. Treasury in Beijing. “In the short
run, that probably means monetary stimulus.”
Until last week, here’s how it worked: the PBOC each day
would set a reference rate for the yuan against the U.S.
dollar and limit moves to 2 percent on either side. It also
bought and sold the currency to influence the exchange
rate -- having knock on effects on the liquidity situation
at home.
OFFSHORE CHINA MONTHLY DIGEST 04 // 05
POLICY OPTIONS
China may cut banks’ required reserve ratio amid tightening
liquidity and expectations the yuan will remain weak, the
official China Securities Journal said in a front-page article,
citing unidentified analysts.
Stocks tumbled the most in three weeks as traders
reduced stimulus bets and speculated the government
will pare back efforts to prop up equities. The Shanghai
Composite Index sank 6.2 percent to 3,748.16 at the
close Tuesday.
To offset any further capital outflows, the central bank
could also inject more liquidity into chosen lenders.
Benchmark interest rate cuts can lower borrowing costs,
while a weaker currency should help boost exporters,
who had been loosing competitiveness.
“The central bank is gaining a kind of automatic stabilizer,”
said Zhou Hao, an economist at Commerzbank AG in
Singapore. “It’s in line with the PBOC’s overall goal
of building up a more market-oriented central banking
mechanism.”
A flexible exchange rate will increase room for the central
bank to adjust monetary policy, PBOC Deputy Governor
Yi Gang said at a briefing in Beijing last week. Ma Jun,
chief economist at the central bank, said a more marketoriented pricing mechanism will help avoid excessive
deviations from the equilibrium level and reduce the
chance of sudden fluctuations.
Letting market forces decide the exchange rate has
“untied the hands of the PBOC somewhat so that it
can focus more on domestic economic activities when
making monetary policy,” said Liu Li-Gang, head of
Greater China economics at Australia & New Zealand
Banking Group Ltd. in Hong Kong. “It will help align
China’s monetary policy objectives.”
17/8 MORGAN STANLEY’S FRAGILE FIVE SWELLS
TO TROUBLED 10 IN SELLOFF
Forget the “Fragile Five.” These days, strategists at Morgan
Stanley are worried about what could be called the
“Troubled Ten.”
That’s how many nations they say are particularly at risk since
China devalued the yuan. While the analysts haven’t used
the term themselves, it’s as good a description as any for the
currencies — from the Brazilian real to Peru’s sol and South
Korea’s won — which have trading ties making them susceptible
to a slowdown in the world’s second-biggest economy.
“It’s all about vulnerability,” said Hans Redeker, the Londonbased global head of foreign-exchange strategy at Morgan
Stanley. “Major victims of the policy change this time are
currencies of countries with high export exposure and
export competitiveness with China.”
Morgan Stanley was right about the Fragile Five. Those
currencies include four of the developing world’s eight
worst performers since the phrase was coined in 2013.
The real, together with Turkey’s lira, South Africa’s rand,
the Indian rupee and Indonesian rupiah, have suffered as
rising global interest rates make it more difficult for the
countries to finance their current-account deficits.
NO GROWTH
For Redeker, the biggest challenge now is a lack of global
growth. While central banks in Japan, Europe and the U.S.
have rolled out record stimulus, the world’s economy will
expand at the slowest pace since 2009 this year, according
to International Monetary Fund forecasts.
That “lukewarm” recovery means China won’t be able
to rely on exports to drive expansion, said the strategist,
whose firm was the second-highest ranked forecaster of
the dollar versus the yuan, according to data compiled by
Bloomberg for the four quarters ended June 30. In turn,
the slower growth will also put China’s trading partners in
the crosshairs.
There’s some overlap between the Fragile Five and the
new at-risk list, with the rand and real to be found in
both. Also vulnerable to China’s slowdown are the Thai
baht, the Singapore and Taiwan dollars, the Chilean and
Colombian pesos, Russia’s ruble and the won and the
sol, according to Redeker.
China is the top export destination for most of the countries
on the troubled 10 list, data compiled by Bloomberg show.
The nation accounted for 37 percent of South Africa’s
exports and 30 percent of South Korea’s in 2014.
Investors were jolted last week as China implemented
the biggest depreciation of the yuan since 1994, raising
concern that authorities plan to use a lower exchange rate
to shore up the weakest growth in more two decades.
Even with the yuan roiling markets, investors still see the
Federal Reserve sticking to its plan to raise interest rates
for the first time in nine years, threatening to lure capital
away from emerging markets. Futures contracts show
traders see a 75 percent chance the U.S. central bank
will move by year-end.
It will take a sizable fiscal package to boost China’s
economy and reverse the selloff in emerging markets,
according to Redeker — and it’s not clear that will be
forthcoming.
“The biggest concern is that we are not going to turn
the corner and the economic performance in China will
continue to disappoint,” he said. “Investors will watch
China data closely and trade the yuan accordingly.”
13/8 SO HOW ARE ALL THOSE YUAN STRUCTURED
PRODUCTS DOING?
Hi, Mr. Chief Financial Officer of Generic China Corp. This
is John Doe from sales at Solidly Second-Tier Bank. How
are you? Listen, I think I have something that might interest
you. Ever heard of a Target Redemption Forward? No? Let
me explain. It’s a structured product, kind of like a series
of exotic options that pay a monthly income as long as the
GLOBAL REPERCUSSIONS
The move rippled through global markets, weakening the
currencies of the Asian countries that compete with China
for exports and sending developing-nation stocks into a bear
market. A Bloomberg index tracking major emerging-market
currencies, already under pressure from slowing growth and
a slump in commodity prices, fell 0.9 percent last week to a
record low.
“The move by China has introduced further concerns on
foreign-exchange valuations in emerging markets,”said Chris
Chapman, a London-based fixed-income trader at Manulife
Asset Management, which oversees $302 billion. “We
have reduced our EM positions over time as the risk-reward
profiles have changed, and will continue to monitor.”
spot yuan exchange rate remains above the strike price.
Now, I hate to mention this, but I want to be up front with
you, because you know I value your business. The risk here
is that if the yuan falls below a certain level—say, 6.2 against
the dollar—the option gets knocked out and you have to
pay out double the amount. I personally don’t see that
happening any time soon. I mean, with USD/CNH trading
in this kind of range, we’re talking practically no-risk money.
You’re in? Great!
It’s worth wondering now, days after the People’s Bank
of China sprang a surprise devaluation of the yuan on
markets, just how all those FX Target Redemption Forwards
(Tarfs) are doing. With Tarfs predicated on the USD/CNH
rate moving within a predictable range, this week’s events
are unlikely to produce good news for companies, like
Generic China, that snapped up the products and still have
contracts outstanding.
Last year, when the offshore yuan moved above 6.2 against
the U.S. dollar, there were already rumblings of losses on
the circa $150 billion worth of Tarfs that were estimated to
remain. Geoffrey Kendrick, head of Asian currency and rate
strategy at Morgan Stanley, wrote in March that more than
$3.5 billion had been wiped off the value of these structured
products at an offshore yuan exchange rate of 6.2.
OFFSHORE CHINA MONTHLY DIGEST 06 // 07
He estimated at the time that losses could mount to as
much as $7.5 billion if the yuan went to 6.38 against the
U.S. dollar. It shot through that level this week.
Goldman Sachs analysts estimated in a note out on
Thursday that some $40 billion worth of Tarfs are
outstanding. Amazingly enough the products seem to have
been sold relatively recently. “Due to a stable spot over the
last few month, older Tarfs issued in early part of this year
would have likely [knocked out]. Therefore, the desk thinks
that most of the remaining TARFs will have been issued
recently,” the analysts said. So some very awkward clientsales phone calls are probably happening right now.
While losses on these types of structured products are
unlikely to endear John Doe to his buy-side clients, they
pose a potential problem for his bank employer, too. As
Josh Giersch points out in a gloriously geeky post, losses
on Tarfs don’t necessarily mean boom time for the banks
that ostensibly took the other side of the trades. Just
because clients such as Generic China effectively sold
volatility of USD/CNH, doesn’t mean that Solidly Second
Tier is short the same thing.
The problem comes from the way such banks have
sought to offset, or hedge, the risk of the trades. Many of
these products were already knocked out or restructured
following last year’s turmoil, but we’re still betting that
plenty of Tarf-related phone calls are being made this week
as a sudden burst of FX volatility spurs delta hedging
desks at banks to play an unenviable game of hot-potato
risk transfer.
Hi, John? It’s Howard from trading. I just got off the phone
with risk, and we need to talk about this Tarf situation.
I know, I’ve been watching USD/CNH too. So listen,
when we did the trade, we hedged with a bunch of vanilla
swaps that roughly matched the expected length of the Tarf
contract. But with everything that’s happened and USD/
CNH outside the range, and all our clients losing money,
expected maturity on Tarfs is extending at exactly the same
time those vanilla swaps are turning ATM. We need to buy
gamma. You don’t know what gamma is? No wonder you’re
in sales. Let me put this into oversimplified English in case
anyone ever publishes a transcript of this completely fictional
call on the Internet. If we’re long gamma, that means we’ll be
able to handle movements in the USD/CNH. If we’re short
gamma, which we are right now, all these currency swings
are really bad news. What do you mean buying gamma
sounds just like what everyone is trying to do right now?
Put someone else on the *BLEEP* phone!
13/8 WHY CHINA DEVALUED THE YUAN
To some, it’s the renminbi or People’s Currency. To others,
it’s the yuan, the kuai or the redback.
Whatever you choose to call it, China’s currency this week
roiled global markets after the central bank’s sudden move
to devalue it. The decision sparked fears of a new currency
war and even drew the ire of Republican presidential
candidate Donald Trump.
So what happened?
On Tuesday, the People’s Bank of China, the central
bank, made a significant shift in how it manages the yuan
by allowing markets to play a bigger role in valuing the
currency. It now sets the yuan’s daily fixing to the U.S.
dollar based on the currency’s closing level the previous
day. Before the change, the PBOC wasn’t overly influenced
by daily market moves, and sometimes pushed the currency
OFFSHORE CHINA MONTHLY DIGEST 08 // 09
in the opposite direction.
Still, the visible hand of the state isn’t going to disappear
completely. The currency can only trade 2 percent above or
below the fixing level.
By keeping a tight grip on the currency, the mechanism
helped protect China during times of market turmoil like the
Asia financial crisis and global financial crisis.
So why change now?
The motivation for the shift is a source of debate among
economists.
Outwardly at least, the move has been explained as a
key reform that allows the market to steer the currency’s
value. Central to this is a bid to have the yuan accepted by
the International Monetary Fund into its basket of reserve
currencies, placing the yuan on par with the dollar, euro,
yen and British pound, and boosting China’s global stature.
Letting the market steer the yuan is the kind of move that
should please critics who accuse China of controlling its
currency to help exporters at the cost of other nations. The
IMF has welcomed the change, though it added it will wait
to see how the new mechanism is implemented. The yuan
hadn’t budged much since March as China’s policy makers
wanted stability as part of the IMF push.
By coincidence or not, the devaluation came days after
data showing a big fall in exports. A mix of interest-rate cuts
and fiscal stimulus to spur growth has struggled to gain
traction. So, by weakening the currency, the thinking is that
shipments will get a jump start and rev up the economy.
Another reason cited by some is a fall in China’s currency
reserves, which have slumped $315 billion in the year to
July to $3.65 trillion, as the central bank kept the exchange
rate stable.
Whatever the reason, a weaker currency won’t solve
everything; the fall in exports is at least partly due to weak
demand in key markets like Europe, for example. The yuan’s
weakness won’t
11/8 CHINA RATTLES MARKETS WITH
YUAN DEVALUATION
China devalued the yuan in a move that rippled through
global markets, as policy makers stepped up efforts to
support exporters and boost the role of market pricing in
Asia’s largest economy.
The central bank cut its daily reference rate by 1.9 percent,
triggering the yuan’s biggest one-day drop since China
ended a dual-currency system in January 1994. The
People’s Bank of China called the change a one-time
adjustment and said its fixing will become more aligned
with supply and demand.
The announcement suggests policy makers are now
placing a greater emphasis on efforts to combat the
deepest economic slowdown since 1990 and reduce
the government’s grip on the financial system. Authorities
had been propping up the yuan to deter capital outflows,
protect foreign-currency borrowers and make a case for
official reserve status at the International Monetary Fund.
“The one-off devaluation of the fix and allowing more
market-based determination takes us into a new currency
regime,” said Khoon Goh, a Singapore-based strategist at
Australia & New Zealand Banking Group Ltd. “It looks like
this is the end of the fixing as we know it.”
The yuan dropped 1.8 percent to close at 6.3231 per dollar
in Shanghai. It slid 2.6 percent to 6.3790 in Hong Kong’s
offshore trading, the biggest discount to the onshore spot
rate since 2011. The central bank allows the Shanghai rate
to diverge a maximum 2 percent from its daily fixing, which
was set at 6.2298.
GLOBAL IMPACT
China’s devaluation jolted global markets, with the currencies
of South Korea, Australia and Singapore falling at least 1
percent amid bets other countries will seek weaker exchange
rates to keep exports competitive. Shares of Chinese
airlines sank on concern dollar debt costs will rise, while
commodities retreated amid speculation yuan weakness
will erode the buying power of Chinese consumers. U.S.
Treasuries gained on growing demand for dollar assets.
“Today’s sudden policy move is a
reaction to a significant weakening
of China’s export numbers in July
and rising deflation risk”
Exchange-rate intervention contributed to a $300 billion
slide in China’s foreign-exchange reserves over the last
four quarters. It also made the yuan the best performer in
emerging markets, a factor behind last month’s 8.3 percent
slide in exports.
The yuan’s real effective exchange rate -- a measure
that’s adjusted for inflation and trade with other nations
-- climbed 13 percent over the last four quarters and was
the highest among 32 major currencies tracked by Bank for
International Settlements indexes.
MARKET FORCES
Effective immediately, market-makers who submit prices
for the PBOC’s reference rate will have to consider the
previous day’s closing spot rate,
foreign-exchange demand and supply, as well as changes
in major currency rates, the central bank said in a
statement. Previous guidelines made no mention of those
criteria.
“The new fixing will be quoted based on the previous day’s
closing, which is a real market level,” said Becky Liu, a
Hong Kong-based senior strategist at Standard Chartered
Plc. “The band will become the real band. This is a big
step, and bolder than we expected.”
Tuesday’s devaluation was a one-off adjustment and
shouldn’t be interpreted as a sign that the yuan will enter
a depreciation trend, PBOC chief economist Ma Jun was
cited as saying in a Caixin report. The central bank said it will
stabilize market expectations and ensure the new referencerate mechanism will take effect “in an orderly manner.”
CAPITAL FLOWS
China has to balance the need to boost exports against the
risk of capital outflows, Tom Orlik, chief Asia economist at
Bloomberg Intelligence, wrote in a note. He estimates that
a 1 percent depreciation in the real effective exchange rate
boosts export growth by 1 percentage point with a lag of
three months. At the same time, a 1 percent drop against
the dollar triggers about $40 billion in outflows.
“The risk is that depreciation triggers capital flight, dealing
a blow to the stability of China’s financial system,” Orlik
said. China’s leaders may be calculating that they can
manage those risks with their $3.69 trillion of foreign
currency reserves, he said.
The PBOC said Tuesday that a strong yuan puts pressure
on exports and cited a high effective exchange rate as
a factor behind the devaluation. July’s export slump was
deeper than economists predicted, while the nation’s
index of producer prices declined 5.4 percent, the most
since 2009.
DEFLATION RISK
“Today’s sudden policy move is a reaction to a significant
weakening of China’s export numbers in July and rising
deflation risk,” said Liu Li-Gang, the chief Greater China
economist at ANZ in Hong Kong.
While the devaluation will help support growth, Liu is
predicting that the PBOC will lower lenders’ reserve
requirements in August and cut benchmark interest rates
this quarter for the fifth time in a year.
IMF requirements that reserve currencies must be freely
usable may have also played a role in the PBOC’s move,
according to Commerzbank AG. The fund has said in
recent months that the yuan needs to be more flexible.
“The yuan exchange rate will be more market-oriented
going forward,” Zhou Hao, an economist at Commerzbank
in Singapore, wrote in a report. “Volatility of both the
onshore and offshore rates will pick up significantly.”
The yuan’s one-month implied volatility, a measure of
swings used to price options, surged 4.8 percentage
points, the most since 2004, to 6.01 percent. The gauge
had fallen to a one-year low of 0.99 percent on July 24.
CURRENCY WAR
China’s move has raised the risk of a “currency war”
as export rivals seek a weaker exchange rate to stay
competitive, according to Stephen Roach, a senior fellow
at Yale University and former non-executive chairman for
Morgan Stanley in Asia.
“It’s hard to believe this will be a one-off adjustment,”
Roach said. “In a weak global economy, it will take a lot
more than a 1.9 percent devaluation to jump-start sagging
Chinese exports. That raises the distinct possibility of a
new and increasingly destabilizing skirmish in the everwidening global currency war.The race to the bottom just
became a good deal more treacherous.”
OFFSHORE CHINA MONTHLY DIGEST 10 // 11
PRIMER
8%
To fuel a slowing economy and back rising political
ambitions, China is promoting the use of the yuan
throughout the world, a slow-moving process known as
internationalization. It’s one of the biggest changes since
the creation of the euro, a beckoning bonanza for bankers
and traders — as well as a threat to China’s stability.
China surprised global markets on August 11, 2015
with its first major devaluation of the yuan since 1994. It
pledged to give market forces a bigger role in determining
the exchange rate, which is managed through a daily
government-set fixing to the U.S dollar. It can trade 2
percent above or below that level each day inside China,
with an offshore rate that tracks closely. While the
government attracted criticism for many years for using the
arrangement to limit gains and aid exporters, the situation
has changed. The weaker economy is putting downward
pressure on the currency at a time when the U.S. dollar
is strengthening. China is changing policy as it’s trying to
convince the International Monetary Fund to include the
yuan in the basket of reserve currencies it holds for central
banks known as Special Drawing Rights. Analysts estimate
the approval could trigger a $1 trillion switch into Chinese
assets. Mainland officials have slowly eased restrictions
on the currency, but there’s still a long way to go: China
accounts for more than 10 percent of world trade, yet only
about 2 percent of global payments are made in yuan.
Private investors — both Chinese and non-Chinese — can
legally move their money in and out of the mainland only
through approved programs and in limited amounts.
Source: bloomberg, pricing via china foreign exchange trade system
THE BACKGROUND
THE ARGUMENT
China has been reluctant to open its doors throughout
history; a scornful 1793 letter from the emperor to King
George III dismisses all requests to ease restrictions on
British traders. The economy was closed to non-socialist
countries under Mao Zedong for 30 years and then China
started liberalizing at its own pace, an approach the
late leader Deng Xiaoping called “crossing the river by
feeling the stones.” In 1994, it set a fixed rate for the yuan
against the U.S. dollar, a peg that endured for a decade.
After China joined the World Trade Organization in 2001,
selected foreign institutional investors were permitted to
buy yuan-denominated stocks in limited amounts. The
yuan’s peg was dropped in 2005 and then unofficially
slapped back on in 2008 to insulate China from the
global financial crisis. In 2010, China’s economy overtook
Japan as the world’s second-largest and yuan use took
off. There’s no specific timetable for further reform; some
China-watchers expect the yuan to be fully convertible by
2020. More than a dozen countries are vying to become
yuan trading hubs and have signed emergency swap
agreements. China is also leading the charge to create the
first new international development bank in decades.
The yuan’s advance into global markets demonstrates
President Xi Jinping’s ambition to challenge the hegemony
of the dollar and a global economic order dominated by
the U.S. and Europe. China has an incentive to pick up the
pace of reform ahead of the IMF review. The U.S., which
has scolded China on and off for decades for keeping the
yuan weak to boost exports, says it hasn’t done enough
to dismantle controls. A more widely used currency would
raise China’s influence in setting prices of commodities
from oil to iron ore and give individuals and companies on
the mainland more choice with their savings. As the yuan
makes the long march to convertibility, China becomes
vulnerable to swings in the currency and money flows that
could aggravate its economic slowdown.
OFFSHORE CHINA MONTHLY DIGEST 12 // 13
FROM
BLOOMBERG
ANALYSTS
Tim Craighead (Research Director): Companies in
China and around the world surely heard the shot fired
by the PBOC, as the yuan weakened a record 1.9%
in one day vs. the dollar. A true yuan inflection, from
sustained strength to gradual weakness, would impact
revenue, costs, margins and competitive positions across
industries and regions.
The most obvious upshots of a weakening yuan are
improving competitive positions for Chinese exporters
and harder times for international firms trying to sell into
the mainland.
Bloomberg Intelligence 12 Aug 2015: Trade-Weighted Yuan Long & Strong
PBOC’S YUAN SHIFT BELONGS IN THE
CONTEXT OF STEADY 10-YEAR CLIMB
The PBOC’s policy change on the yuan needs to be
viewed in a long-term context. On one hand, weakening the
yuan by 1.9% is the largest one-off adjustment on record.
More importantly, it may also mark a clear shift in stance
from years of promoting yuan strength. Yet yuan movements
tend to be gradual and long-term in nature. The 52% gain
in the trade-weighted yuan since 2005 is significant, yet it
took place over 10 years. Other factors have driven shortterm cycles and will likely do so in the future.
WEAKER YUAN STOKES COMPETITION, LOWERS COSTS FOR GLOBAL FIRMS
Companies around the world may have to shift their global strategies if the PBOC’s yuan reset starts a new trajectory.
Even if weakening is gradual, China’s manufacturing and growing services capability would be more competitive.
Currency translations on exports to China, a major source of revenue for sellers of everything from tech to autos, fried
chicken to handbags, would be reduced. While the costs of imports from the mainland would be cheaper, growth in
outbound Chinese travel may be slowed.
Bloomberg Intelligence 12 Aug 2015: Global Firms With Notable China Sales
YUAN SHIFT MAY STIMULATE SOME EXPORTERS IN CHINA, VEX IMPORTERS
A sustained weakening in the yuan would have both positive and negative implications for companies in China. It could
make Chinese exporters more competitive and/or boost their translated revenue, reversing a trend that has been in place
with few exceptions since 2005. For companies that import into China, costs could go up. For those with dollar debt,
servicing will be more expensive. These effects will take time to play out, especially with the trade-weighted yuan now still
up about 10% vs. the 3Q 2014 average.
Bloomberg Intelligence 12 Aug 2015: China Firms with Big International Sales
OFFSHORE CHINA MONTHLY DIGEST 14 // 15
NEWS AT
BLOOMBERG
Bloomberg hosted a seminar in Sydney on July 15 to discuss how investors in Australia can better position
themselves for a changing China. More than 70 executives attended the seminar and we polled them to see
what they thought about the potential of the RMB.
Q. WHEN IS THE RMB LIKELY TO BECOME FREE FLOATING?
5 years
Over 10 years
2-3 years
Within one year
Q. WHICH OF THE FOLLOWING WOULD HAVE THE
BIGGEST IMPACT ON YOUR INTEREST IN USING RMB?
RMB being seen as safe haven currency...
Appreciation of RMB
Increase business with China
Volatility of RMB
ON THE
RADAR
Launch of the Shenzhen-Hong Kong
Stock Connect
Hong Kong stocks rallied the most in three weeks on
speculation authorities are getting closer to announcing
a start date for the Shenzhen exchange link.
Foreign investors have purchased about 136 billion yuan
($22 billion) of the 300 billion yuan aggregate quota of
mainland equities available through the Shanghai link.
Chinese traders have bought about 90 billion yuan of Hong
Kong shares.
The Hang Seng Index jumped as much as 2.4 percent
before paring gains to 2 percent at the close.
China and Hong Kong begin
cross-border sales of funds
Hong Kong Exchanges & Clearing Ltd. climbed 5 percent
even as the bourse said it has no plans to unveil the
program today. Haitong International Securities Group Ltd.
advanced 6.3 percent.
Money managers and banks are still waiting for
regulators to approve sales of funds under the mutual
recognition plan between Hong Kong and China a month
“There are some market talks that the Hong Kong Stock
Exchange will announce details on the Shenzhen connect
this weekend, with the starting date being in September,”
said Yen Chiu, a Hong Kong-based trader at Shenwan
Hongyuan Group. “The rally seems to be speculationdriven for now.”
The Shenzhen link, modeled after its six-month-old
counterpart in Shanghai, will help solidify Hong Kong’s
role as a gateway to Chinese markets and give foreign
investors greater access to non-state companies in the
world’s second-largest economy. HKEx Chairman Chow
Chung Kong said last month the bourse is preparing for the
Shenzhen program to begin in the second half of 2015.
The exchange has no arrangements to announce
the Shenzhen connect today, said Lorraine Chan,
aspokeswoman at HKEx. A call to the media department
of the Shenzhen Stock Exchange went unanswered.
LINK BUYING
HKEx shares extended their gain this year to 69 percent.
Volumes via the Shanghai link helped boost the bourse’s
first-quarter profit by 34 percent from a year earlier as
average daily turnover for equities climbed 17 percent, the
company said this week.
after its start date, according to people with knowledge of
the matter.
The China Securities Regulatory Commission hadn’t
officially started processing applications from Hong Kong
fund houses as of July 31 as it focused on stabilizing the
stock market, the people said, asking not to be identified
because the information is private. While Hong Kong’s
Securities and Futures Commission has given its first round
of feedback, no funds have been approved for distribution
in the city, according to the people.
The delay flags fallout from China’s stock rout that wiped
out as much as $4 trillion and prompted support measures.
While mutual recognition offers a new channel for foreign
firms in China amid tight capital controls, concerns have
mounted after policymakers banned major shareholders
from cutting stakes in listed companies and curbed short
selling.
“The month of July for investors, especially the mainland
side, has been pretty dramatic,” said Khiem Do, Hong
Kong-based head of multi-asset strategy at Baring Asset
Management Ltd., which oversees about $41 billion. “It has
been quite a volatile or even violent month so it will take a
little bit of time for things to settle down before they look at
these new initiatives.”
The SFC declined to comment.
Hutchison Whampoa Ltd., controlled by Hong Kong
billionaire Li Ka-shing, gained 4.3 percent, its biggest
increase in four months. CK Hutchison Holdings Ltd. rose
4.1 percent, while China Mobile Ltd. climbed 3.6 percent.
The Shenzhen Composite Index fell 0.5 percent at the
close, paring an earlier loss of as much as 1.9 percent.
Technology, consumer and health-care companies
comprise almost half of the index, while state-backed banks
and industrial conglomerates dominate Shanghai’s bourse.
OFFSHORE CHINA MONTHLY DIGEST 16 // 17
CIFM Asset Management Ltd. and Zeal Asset
Management Ltd. said they applied in July to sell
funds on the mainland, while Hang Seng Investment
“What they’ve done goes beyond what I had expected,”
Wolf, whose firm oversees about $380 billion, said in a
phone interview on Thursday. “Recent reforms were meant
to create a more professional and more mature market.
Intervention definitely does undermine that view. It may be
harder in the future to attract more offshore capital.”
Value Partners Group Ltd. and Bank of East Asia Ltd.
are among Hong Kong-based companies that have also
applied, according to one of the people. Value Partners
declined to comment, while Bank of East Asia didn’t
immediately respond to e-mailed questions.
Foreigners are already pulling out of Shanghai’s stock
market. Even amid the biggest rally since 2009 on
Thursday, they sold shares through the city’s exchange
link with Hong Kong, extending a record four-day outflow,
according to data compiled by Bloomberg. The Shanghai
Composite rose 4.5 percent at the close on Friday.
APPLICATIONS SUBMITTED
Management Ltd. said in a statement it has submitted for
registration to the CSRC.
JPMorgan Asset Management has also applied and a
formal start is likely to be in the fourth quarter or year-end at
the soonest, according to Executive Director Lilian Leung.
Since the cross-border plan kicked off on July 1, 25 funds
have applied, with 14 from the mainland and 11 from
overseas, SFC’s Chief Executive Officer Ashley Alder said
last month.
The absence of approved funds a month after the launch is
normal because CSRC has six months to review, according
to Sally Wong, the chief executive officer at Hong Kong
Investment Funds Association.
Mainland funds are also waiting to sell in Hong Kong.
Shenzhen-based Invesco Great Wall Fund Management
Co., a joint venture between companies including Great
Wall Securities Co. and Invesco Ltd., applied in July to the
SFC, according to general manager Richard Chow.
HSBC Jintrust Fund Management Co., HuaAn Fund
Management Co. and China Universal Asset Management
Co. also applied last month, they said. Bank of
Communications Schroder Fund Management Co. and
Bank of China Investment Management Co. are each
awaiting approval.
Inclusion of China’s mainland stocks
to MSCI’s benchmark indexes
It’s hard for Alex Wolf to believe that the Chinese
officials he met four months ago are the same ones
running the world’s second-largest stock market today.
When Wolf, an emerging market economist at Standard
Life Investments, sat down with the nation’s securities
regulators in Edinburgh in March, they had a clear
message: China is enacting the free-market reforms
needed to lure foreign investors and gain entry into
MSCI Inc.’s global indexes.
Now, after a week of unprecedented government
intervention to prop up the stock market, it’s clear to
Wolf that reform has taken a back seat to easing the
pain from a rout that many analysts say was inevitable.
He’s among international investors at Aberdeen Asset
Management and Clough Capital Partners who say market
meddling threatens to further delay MSCI inclusion after
the index provider decided to leave China’s domestic
shares out of its equity gauges in June.
LOBBYING POWER
Phone calls and emails to MSCI officials in London and
New York weren’t answered. Fennie Wong, an official in
Hong Kong for FTSE, another index provider, couldn’t give
comments immediately.
“What has happened in the stock market gives opponents
a reason to lobby against the inclusion as it’s not market
driven,” said Nicholas Yeo, the Hong Kong-based head of
Chinese equities at Aberdeen. “They will become more
powerful.”
As China’s record-breaking equity boom turned into a bust
over the past month, authorities responded with a series
of measures aimed at stopping the rout. They suspended
initial public offerings, restricted bearish bets via stockindex futures and banned major shareholders from selling
shares. In one of the most extreme efforts to stop an
avalanche of sell orders, local exchanges allowed more
than 1,400 companies to halt trading in their shares.
FOREIGN ACCESS
“We may see a delay in MSCI inclusion,” Eric Brock, a
Boston-based money manager at Clough Capital Partners,
which oversees about $4.4 billion and met with China
Securities Regulatory Commission officials in March, said
by e-mail. “Though that depends on how quickly these
measures serve to re-open the locked markets, where many
shares are suspended or not trading.”
Chinese authorities had been pushing for an MSCI
endorsement -- sending a delegation of regulators to
Europe and the U.S. in March to make the case for
inclusion -- as President Xi Jinping’s government sought to
elevate the status of mainland markets on the world stage
and make the yuan a more international currency.
MSCI said in June that it will work with Chinese
regulators to establish policies that resolve the “remaining
accessibility issues.” Those include giving investors
quotas commensurate with the size of their assets under
management, improvements in liquidity and further
clarification of share-ownership rules.
NO CHOICE
CHINA PUSHES FOR SDR STATUS
“By intervening in the market, they are creating more
uncertainty,” said Jorge Mariscal, the emerging-markets
chief investment officer at UBS Wealth Management in
New York, which oversees $1 trillion in invested assets.
“Some of the MSCI concerns are surfacing.”
The International Monetary Fund welcomed China’s move
The possible addition of mainland equities to MSCI gauges
has been a divisive issue among fund managers. Even as
the Shanghai Composite Index rallied 152 percent in the
year through June 12, foreigners had been cautious about
entering a market where individual investors account for
80 percent of trading. The benchmark index is down 28
percent from its peak.
MSCI’s main consideration is whether foreign investors can
freely access yuan-denominated
to devalue the yuan and said it doesn’t directly impact the
country’s push to win reserve currency status.
The comments by the IMF came as China cut the value
of the yuan for a second day after surprising markets on
Tuesday when it lowered the yuan’s value by the most in
two decades. The central bank said the move would allow
the market to play a greater hand in setting the currency’s
value. Economists said the decision was also likely taken to
boost exports.
The People’s Bank of China on Wednesday set the yuan’s
reference rate at 6.3306 per dollar, 1.6 percent lower than
Tuesday’s level.
A shares, said Shanquan Li, a senior portfolio manager at
Oppenheimerfunds Inc. On that front, there are signs of
improvement. China opened the Shanghai exchange link in
November and has plans to replicate the program for the
nation’s smaller bourse in Shenzhen this year.
“The new mechanism for determining the central parity of
the Renminbi announced by the PBC appears a welcome
step as it should allow market forces to have a greater role
in determining the exchange rate,” the IMF said in a release.
“The exact impact will depend on how the new mechanism
is implemented in practice.”
“The latest market interventions won’t play a big part in
MSCI’s consideration,” Li said by phone Thursday from
New York. “Chinese policy makers intervened in the market
because they don’t have a choice at this point.”
On China’s push for the yuan to be included in the IMF’s
basket of reserve currencies, known as the Special
Drawing Rights or SDR, the Washington-based fund said
the devaluation won’t directly impact its decision.
For Macquarie Asset Management’s Sam Le Cornu, extreme
volatility in Chinese shares is one of the biggest turnoffs for
global investors. Price swings in the Shanghai Composite
approached the highest levels since 1996 this week.
“Regarding the ongoing review of the IMF’s SDR basket,
the announced change has no direct implications for the
criteria used in determining the composition of the basket,”
the IMF said. “Nevertheless, a more market-determined
“I’d say the volatility is the key hurdle to the inclusion,” said
Le Cornu, who oversees about $3 billion in Asian equities
in Hong Kong. “We have no A share exposure.”
exchange rate would facilitate SDR operations in case
the Renminbi were included in the currency basket
going forward.”
OFFSHORE CHINA MONTHLY DIGEST 18 // 19
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