2016 has barely begun, but so much has happened already in the financial markets. Many friends are distraught at the decline in the value of the Renminbi (RMB) in the last week. They have asked me how they can hedge this currency risk, especially as many people had put their savings in RMB in anticipation of the currency appreciating.
The RMB had appreciated for a long time – for almost two decades it was seen as pretty much a one-way bet until only a year or two ago, and I blogged about this at the time, arguing that the RMB rate will be more susceptible to market forces. Today, with the RMB being included in the International Monetary Fund’s Special Drawing Rights (SDR) basket of currencies, we are seeing that two-way volatility is the new norm, and investors need to wear their seatbelts and prepare to manage the exchange rate risk.
This new era of volatility in the RMB brings opportunities to Hong Kong, which is the largest offshore centre for the Chinese currency. When the RMB appreciates, Hong Kong can provide strong RMB-denominated assets to investors who are interested in holding them, and when the currency depreciates, we can provide a variety of debt products because a weakening currency is in borrowers’ favour. In fact, a number of companies have recently been reducing their borrowing in US dollars and raising RMB loans, a very sensible market reaction as the RMB depreciates.
With price fluctuations in the offshore market more intense than in the onshore market these days, there is a greater need for exchange rate risk management in the offshore market compared to the onshore market. The contrast also shows that the breadth and depth of the offshore market for RMB-denominated products needs to be strengthened. A strong offshore market for RMB products is especially important at times like this, when a small change of Mainland policy often leads to extreme volatility in the offshore value of the RMB.
With this market demand and our unique advantages, we can develop RMB exchange rate and interest rate products which will not only help the RMB further internationalise and gain influence, but also build out the RMB ecosystem in Hong Kong.
We took our first step in 2012 with the launch of the RMB currency futures contracts to meet market demand for a tool to manage the RMB’s currency risk. We’re thrilled the product has already become the most actively-traded on-exchange RMB futures contract in the world. Because of the recent volatility in the RMB, the contracts hit a record open interest level of 29,352 contracts on 11 January, and turnover hit 6,425 contracts with a notional value of US$643 million on 7 January, the second highest ever.
What’s the outlook going forward? First, the People’s Bank of China (PBOC) has been very clear about its determination to promote market-oriented reform of the RMB exchange rate. It has relaxed controls in recent years, and also widened the trading band, which introduced greater volatility.
Second, more and more countries are holding RMB as the currency internationalises, meaning its exposure to supply and demand of these economies is increasing. With the inclusion in the SDR, central banks around the world are actually required to gradually increase their RMB asset allocation, which will bring further market forces to the determination of the value of the RMB.
These are steps taken by the PBOC as it has undertaken market-oriented exchange rate reforms. It has repeatedly stressed that the RMB is no longer pegged only to the US dollar, but rather a basket of currencies. On 11 December, the China Foreign Exchange Trade System released, for the first time, a new exchange rate index based on the RMB’s value against 13 trade-weighted currencies. The PBOC’s intention is clear: as an emerging market currency that is internationalising quickly, the PBOC wants the RMB to continue to be relatively stable against the basket of currencies, but has no direct ties to a single currency. That means while the RMB exchange rate will be stable overall, the RMB-USD exchange rate may be volatile, which requires proper risk management.
To help investors meet the new challenges, HKEX intends to roll out a suite of new products to hedge RMB-related risks, including currency-pair products against multiple currencies and precious metals products denominated in dual-currencies. On Friday, we will also host a forum for Hong Kong futures brokers to explain how to manage RMB exchange rate risk in this new era.
This is all a good start, but more will be done. We’ll stay focused to better serve the needs of investors and strengthen the position of Hong Kong as a major RMB pricing centre.
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