JPMorgan Embraces Offshore Yuan as Trading Doubles

Standard Chartered Plc estimates offshore trading of yuan has doubled to at least $6 billion a day, giving investors more confidence to invest in the currency using options, forwards and Dim Sum bonds.

Average daily transactions in Hong Kong surged from $3 billion in the past year, said Charles Feng, Standard Chartered’s regional head for fixed-income trading in the city. Trading in offshore options in the currency swelled to between $300 million and $500 million per day, according to J.P. Morgan Private Bank, which is buying the contracts for its clients. HSBC Holdings Plc says combined yuan deposits and certificates of deposits in the city will rise 43 percent this year to 1 trillion yuan ($161 billion).

Dim Sum bonds have been rallying for a record six consecutive weeks as the central bank announced plans to accelerate the opening up of capital markets to foreigners and allow cross-border yuan loans. The average yield on the securities fell five basis points last week to 3.5 percent, the lowest since October 2011, a Deutsche Bank AG index showed. That compares with an average 2.62 percent for global corporate debt, according to Bank of America Merrill Lynch data.

“Offshore yuan liquidity is unambiguously improving,” said Cliff Tan, East Asian head of global markets research at Bank of Tokyo-Mitsubishi UFJ Ltd. in Hong Kong. “In particular, there is more official sector activity in the first days of the year. This flow is very promising for central banks to get more involved.”

Offshore Premium

The yuan in Hong Kong climbed 0.5 percent this month and touched 6.1735 per dollar on Jan. 11, the highest since trading started in 2010, Bloomberg data show. The offshore rate was 6.1908 as of 11:24 a.m. local time today, a 0.45 percent premium to the spot rate of 6.2187 in Shanghai. Twelve-month non- deliverable forwards gained 0.8 percent in Hong Kong this month.

One-year implied volatility on the offshore yuan, a measure of expected moves in exchange rates used to price options, was 2.4 percent today, down from 4.4 percent a year ago, data compiled by Bloomberg showed. Comparable gauges are 10 percent for the Brazilian real, Russian ruble and India’s rupee.

‘Burgeoning’ Market

The yield on Chinese government Dim Sum bonds due June 2022 was 3.06 percent today, compared with 1.84 percent for 10-year U.S. Treasuries, Bloomberg data show.

“We have been utilizing high carry and low volatility for our clients in the offshore renminbi via its burgeoning options market,” said Erik Wytenus, Hong Kong-based head of foreign exchange and commodities at J.P. Morgan Private Bank in Asia. “This allows for a beneficially asymmetric risk profile for these strategic positions.”

Hong Kong’s Dim Sum bond market is increasingly offering attractive yields as long as buyers are selective, said Adam K. Tejpaul, managing director for the investment business of JPMorgan Chase & Co.’s private bank unit in Asia. The yield on Caterpillar Inc.’s Dim Sum bonds due 2014 was 2.53 percent at the end of last week, compared with 0.58 percent on its similar- maturity dollar debt. The machinery maker is rated A at Standard & Poor’s.

China backed Hong Kong’s status as the major offshore yuan hub in its latest five-year economic plan and is seeking to curb reliance on the use of dollars in international trade and investment. The city “will consolidate and expand the offshore yuan business,” in particular cross-border trade settlement and sales of yuan-denominated securities, Leung Chun-ying, Hong Kong Chief Executive said in a Jan. 16 policy address.

Loan Experiment

Central bank governor Zhou Xiaochuan said on Dec. 31 the country will “deepen” financial reform in 2013. The government may soon announce details for a cross-border yuan loan program in Qianhai, a trial zone near Hong Kong, China Securities Journal reported Jan. 9, citing Wang Jinxia, a spokesperson for the Qianhai management bureau. Hang Seng Bank Ltd., a Hong Kong- based subsidiary of HSBC, will arrange the first yuan loan to Qianhai Co., the lender said Dec. 31.

“The Qianhai trial will accelerate the recycling of the yuan and boost the currency’s liquidity,” said Ken Hu, a Hong Kong-based fund manager at BOCHK Asset Management Ltd, who runs the best-performing Dim Sum bond fund that returned 29 percent in 2012.

RQFII Program

China announced the Renminbi Qualified Foreign Institutional Investors, or RQFII, program in December 2011, which allows offshore yuan to be invested in China’s domestic securities. The available quotas were boosted by 200 billion yuan to a level of 270 billion yuan in November and Guo Shuqing, chairman of the China Securities Regulatory Commission, said in Hong Kong on Jan. 14 that the ceiling can be increased by 10 times more.

Hong Kong residents are subject to a daily conversion limit of 20,000 yuan at the Shanghai rate, while non-residents can buy unlimited amounts of China’s currency at the offshore rate. DBS Group Holdings Ltd. said the limit for people living in the city could hamper the growth of the yuan pool in Hong Kong as more investors channel funds back to China for investment.

“As more offshore yuan centers emerge, it no longer makes sense for Hong Kong to cap locals’ conversion at such a level,” said Nathan Chow, a Hong Kong-based economist at DBS. “Hong Kong needs to ensure a self-sustainable cycle of yuan with increasing repatriation channels for offshore yuan. We expect more Dim Sum bond issuance in 2013 with better liquidity.”

‘Hedging Demand’

Yuan deposits in the city grew 2.9 percent in November to 571 billion yuan, according to Hong Kong Monetary Authority data. That’s the biggest increase since August 2011. Dim Sum bond issuance climbed 16 percent last year to a record 175.8 billion yuan. There has been 18.2 billion yuan in sales this month.

Offshore yuan trading is “primarily driven by hedging demand” from companies, which have replaced currency speculators as the dominant force in the market, according to Standard Chartered’s Feng. “We see this as a positive sign as it paves the way for a more sustainable offshore yuan trading environment,” he said.

China’s economic growth accelerated for the first time in two years as government efforts to revive demand drove a rebound in industrial output, retail sales and the housing market. Gross domestic product rose 7.9 percent in the three months ended Dec. 31, the nation’s statistics bureau said last week. That compared with the 7.8 percent median estimate in a Bloomberg News survey and 7.4 percent in the previous quarter.

Liquidity Operations

The People’s Bank of China said on Jan. 18 it will start short-term liquidity operations as additional tools to manage cash supply, amid efforts by policy makers to liberalize of interest rates. Repurchase agreements and reverse repurchase contracts with a maturity of less than seven days will be the main tools of the so-called SLOs, the central bank said in a statement. It named 12 banks, including Industrial & Commercial Bank of China Ltd. and Bank of China Ltd., as participants in the SLOs, which will supplement regular open-market operations held every Tuesday and Thursday.

The cost of insuring China’s bonds was steady last week. Five-year credit-default swaps protecting the nation’s sovereign notes rose two basis points to 65 in New York, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

“We welcome the growth and deepening of local markets,” said Jamie Stuttard, the London-based head of international bond-portfolio management at Pyramis Global Advisors, a unit of Fidelity Investments, which oversees $1.7 trillion. “The development of the Dim Sum market is important in building a global bond opportunity set which reflects patterns of global economic growth.”

To contact the reporter on this story: Fion Li in Hong Kong at fli59@bloomberg.net

To contact the editor responsible for this story: James Regan at jregan19@bloomberg.net

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