This year, the Renminbi (RMB) has taken center stage on global currency markets as Beijing keeps up the pace of reform to internationalize its currency.
The move in March by the People’s Bank of China (PBOC) to double the RMB’s daily trading band from 1 percent to 2 percent has coincided with a new era of exchange rate volatility. This year, the long running trend of RMB appreciation has reversed course with it losing 3.4 percent against the dollar since its January high.
At the same time, interest in the RMB has exploded due to its widening use in global markets and a proliferation of offshore currency derivative products. Added into the melting pot is the degree to which the RMB has become a highly popular carry-trade, at a time that markets are still digesting the implications of Fed tapering.
Last year, the RMB entered the list of top 10 most traded currencies for the first time, according to the latest triennial foreign exchange (FX) market survey by the Bank for International Settlements (BIS). This made the RMB the ninth most actively traded currency with a share of 2.2 percent in global FX volumes after volumes trebled from $34 billion (U.S.) per day in April 2010 to $120 billion (U.S.).
Other signs suggest RMB trading momentum is continuing. In February this year, Thompson Reuters reported that the CNH has become the second largest traded FX currency on its relationship trading platform.
To get a better understanding of the rise of China’s currency policy and the growth of RMB derivatives, we sat down with Malcolm Baker, senior director of FX and interest rates products at CME Group, in Singapore.
There has been a lot of speculation about the RMB’s recent weakness. Is this a sign that Beijing is accelerating its move to a market determined exchange rate?
It is widely believed the recent depreciation in the RMB can be attributed to intervention by the PBOC, designed to shake out an excessive build-up of speculative currency bets. This was effectively to pre-warn the market to expect volatility in the exchange rate.
Although the PBOC has also widened the RMB trading band, we do not see it as a change in policy, in the sense of allowing the market to set the exchange rate. The fact that China’s forex reserves expanded to over $4 trillion in the first quarter of 2014, confirms there was intervention by the PBOC to weaken the RMB.
There seems to have been a lot of confusion in the market over PBOC’s policy. How do you see it?
It is healthy for the central bank to make a clear path for the market and manage expectations. They are basically saying the RMB can go down as well as up. The international RMB market is effectively a new market with fledgling parties – transparency and clarity are very helpful. In some ways, the PBOC action is no different from the Federal Reserve saying, “This is what we are doing.” You also have to remember, as the RMB moves to being more widely traded on international markets, it is unchartered territory for the PBOC. It is likely finding markets are complicated – but I think it is doing a terrific job.
Why have we seen such an upswing in interest in RMB?
The growth in RMB trading is the product of a number of factors that have boosted confidence and liquidity. As well as encouraging RMB use for trade settlement and the build-up of RMB deposits overseas, new initiatives such as the Shanghai Free Trade Zone and the Hong Kong/ Shanghai investment “through-train” collectively keep momentum going.
I would say the direction of currency liberalization is clear and there is confidence in the underlying policy. There remains uncertainty on the exact timing of full capital account opening, although it is now being talked in terms of just 3-4 years.
The recent volatility in the RMB also coincides with the one-year anniversary of the introduction of the CME Group’s CNH (Offshore RMB) FX contract. How would you describe its growth?
Since April 2013, we have seen a huge increase in the volumes of our USD/CNH FX contract. To date, it has had over $1.4 billion (U.S.) notionally traded and has been our third fastest growing product, amongst all the FX contracts we have launched. It is clear CNH is no longer an emerging market currency as its trades globally.
While 85 percent – 90 percent of transactions are from Hong Kong, we are seeing participants from Brazil, Canada, Europe and North America. The fact we have a 23-hour trading window and global distribution via Globex are contributing to this. It is also clear CNH is not just day trades but a significant amount of longer-term trades being put on.
There has been speculation that an unwinding of RMB carry trades could add to pressure on the currency. Can you comment if this is a big issue or is it overblown?
In our view, the movement in the exchange rate is largely being orchestrated by the PBOC. Since last April, shortly before the Fed announced tapering, there has been an explosion in the CNH market. The RMB appeared to be favored as it was immune to the turmoil that affected emerging market currencies. What I would say is the CNH market may have grown too fast too quickly and recent PBOC measures may be taking some of the heat out of it.
RMB debt markets have also expanded considerably. Are you seeing more interest now in hedging positions, given recent directional change in RMB?
One consequence of the recent unexpected weakness in the RMB is that a variety of parties now realize they need to hedge CNH currency exposure. So there is a growing interest to find the most efficient way – be it swaps, options or futures.
As noted in a recent CME Group research report (‘Growth of RMB Brings Changes to FX Markets’) since February we have seen a divergence in the onshore and offshore spread. What’s driving this and how significant is it?
Typically, different parties, doing trades for different reasons, are trading the CNH and CNY contracts. I would not read too much into this.
The paper also mentions that non-deliverable forwards are losing popularity to exchange-traded contracts. Could you explain why this is so?
The OTC market has been losing popularity because there is a preference for trading in transparent, open exchange-based markets. Here, traders also get the advantage of having multiple counterparties, volatility and liquidity.
In terms of the CNH market, pricing is still determined by the PBOC through its daily setting of the onshore CNY spot rate. However, the CNH market is important in terms of indicating what is leading in terms of trading interest.
Hong Kong, Singapore, Taiwan and London are all now offshore RMB markets. How are these markets developing?
What many people fail to realize is how quickly the CNH market has grown, partly because most of that growth has been concentrated in Asia. Traditionally London dominated global FX trade but with CNH, Hong Kong has stolen a march. Recently, Singapore became the number one RMB offshore clearing center after Hong Kong, pushing London into third place, according to the latest data by SWIFT. I think this has surprised people and many still don’t realize quite how big the market is.
We are also seeing demand from Europe for CNH products. Just last month on April 27th, CME Europe – CME Group’s London-based, FCA-supervised derivatives exchange was launched starting with 30 FX futures products and a suite of commodities contracts, including CNH contracts. This is a tremendous addition to our global offering by bridging a gap in the European marketplace to provide seamless, trading connectivity.
Can you talk about the prospects for launching USD/CNH options. What are the underlying drivers?
I think there is a demand from market participants to find the most efficient way to trade with a liquid and active market. As the underlying cash market grows, we anticipate the proliferation of derivative hedging products for clients to manage their RMB risk. In particular, CNH options have grown in liquidity and popularity as a risk management tool. CNH option liquidity is estimated around US$3-5 billion by local market traders though patchiness in liquidity exists. CME Group is currently assessing launching USD/CNH options on futures for 2014.