Yuan Bulls and Low Volatility Fuel China Currency Note Sales

Investor confidence in the Chinese currency as volatility in the yuan-dollar exchange rate holds at about the lowest in a decade is fueling sales of structured notes that profit on gains against the greenback.

Barclays Plc, the biggest issuer of the securities this year, sold nine of the 13 notes linked to the exchange rate in July, according to data compiled by Bloomberg. The U.K. bank raised more than $500 million from these notes since April, said Kunal Datta, foreign exchange structurer at the bank in London.

Private banks and wealth management companies in the U.S., Asia and Europe remain bullish on the relative performance of the Chinese currency against the dollar even as the world’s second-largest economy slows. Meanwhile, lower volatility for the currency pair allowed banks to create notes that protect against falls in the yuan more cheaply.

“This has been one of our most popular foreign exchange transactions since the start of the credit crisis as a consequence of investors’ bullish views on the renminbi, record low volatility in the currency and the high volatility in equities this year,"‬said Barclays’s Datta.

Barclays’s notes typically mature in two years or less, offer at least 1.4 times leverage on gains and protect all, or almost all, of an investor’s principal from drops in the Chinese currency. Goldman Sachs Group Inc., Credit Agricole Corporate & Investment Bank and Bank of America Corp. also sold structured notes tied to the exchange rate in July and August, Bloomberg data show.

China Caution

Investors are not necessarily bullish on China’s growth prospects, Datta said. The yuan is among the best-performing emerging market currencies against the dollar, Bloomberg data show, even as the economy grew 7.6 percent in the second quarter, the slowest pace since 2009.

Implied volatility, a measure of exchange-rate swings used to price options, fell to near record lows for one- and two-year maturities in July meaning that the option component of structured notes became cheaper, said Datta. When this is the case, banks can more easily create capital-protected notes that offer investors greater comfort.

One-year implied volatility fell to 2.325 percent on July 20, the lowest level since June 2003, Bloomberg data show. The measure stood at 2.35 today.

A greater focus from China’s policy makers on maintaining exchange-rate stability is one of the key drivers for lower volatility in the yuan-dollar currency pair, said Paul Mackel, head of Asian currency research at HSBC Holdings Plc in Hong Kong.

A decline in China’s foreign-exchange reserves, which dropped by a record $65 billion in the second quarter after the central bank sold dollars, served to cap the top level of the exchange rate and has signaled a lack of desire for a significantly weaker yuan, said Mackel.

Structured notes are securities created by banks, which package debt with derivatives to offer customized bets to investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, currencies and commodities.

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