Yuan-Tied Structured Product Sales to Rebound Post Currency Blow

Structured products that bet on China’s currency depreciating or trading within a range will become more popular after authorities allowed the yuan to fall the most in two decades last week.

China’s central bank cut its daily reference rate for the yuan by 1.9 percent Aug. 11, triggering its biggest one-day drop since the nation ended its dual-currency system in January 1994. Policy makers are regardless expected to spend $40 billion of foreign-exchange reserves a month to keep the currency from sliding further, a Bloomberg survey showed.

Many investors who held target redemption forwards or notes -- which bet on the currency appreciating and terminate once a cumulative profit has been achieved -- incurred mark-to-market losses when the yuan plunged and received margin calls from their banks. Such securities have been one of the most popular yuan structured notes in Asia this year.

“In the past, it’s been a one-way bet that the yuan will appreciate,” said Mark Liu, the head of global markets at Societe Generale SA’s Taiwan unit. “Going forward, the market will be more diversified with people taking views on depreciation and range trading. It’s healthier.”

The yuan’s most recent devaluation mirrored a similar move by the People’s Bank of China early last year when it allowed for a greater scope of depreciation. That resulted in some $3.5 billion being wiped off the value of offshore yuan structured products, according to Morgan Stanley estimates.

Early Moves

Ahead of last week’s move there were already signs the yuan was under pressure, with other emerging-market currencies also facing a sell off, Liu said.

Some investors had tried to limit their exposure. Swiss-based Leonteq AG last month helped arrange notes that allow investors to convert their yuan to euro at a preferential rate if the exchange rate between the two is less than 7.05, data compiled by Bloomberg show. If not, the notes pay a 1 percent annualized coupon.

“The unexpected devaluation caught a lot of people by surprise and investors in this region have gone through a roller coaster ride in mark-to-market positions,” Eugene Lee, the head of financial products advisory for Asia Pacific at Vontobel Holding AG, said. While most highly leveraged long yuan products are expected to lose money, some investors “are making money depending on how long they’ve had a position on shorting the yuan,” he said.

Immediately post the central bank’s move, investors’ focus has been on the yuan exchange rate rather than structured products, Rocky Cheung, the head of investment product and advisory at DBS Group Holdings Ltd.’s wealth management arm in Hong Kong, said. Clients are still worried about volatility and are cautious about products with tenor, he said.

“Sales of yuan-denominated structured products are likely to fall in the near term while those linked to the yuan rate may not see any significant change,” Cheung said. “The products will be more of a balance between taking an appreciation and depreciation view.”

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