China Orders Banks to Hold Reserves for Currency Forwards

Updated on
  • 20% of forwards sales to be held for a year with no interest
  • Move makes it more expensive to bet on yuan weakness

China’s central bank added to measures designed to shore up the yuan, making it more costly for traders of forwards contracts to bet on swings in the currency.

The People’s Bank of China will impose a reserve requirement on financial institutions trading in foreign-exchange forwards for clients, according to six people familiar with the matter. The change, which takes effect on Oct. 15, will mandate a deposit of 20 percent of sales to be held at zero interest for a year, said the people, who asked not to be identified because they aren’t authorized to speak on the issue.

“It’s a move to ease the reduction in foreign-exchange reserves,” said Tommy Ong, managing director for treasury and markets at DBS Bank Hong Kong Ltd. “It’s also meant to discourage speculation and ensures the yuan’s rates are reflecting genuine demand and supply. That includes cross-border yuan investment into fixed assets.”

The PBOC has intervened to prop up the yuan since the country’s Aug. 11 devaluation, a policy that eats into its $3.65 trillion of foreign-exchange reserves. The stockpile will drop by an estimated $40 billion a month partly because of the support, according to a Bloomberg survey conducted in August. Premier Li Keqiang signaled support for the currency, saying late last week that there was no basis for further declines.

Market Size

“The new move aims to curb speculative onshore positions as it makes the cost of buying dollars higher,” said Becky Liu, a rates strategist at Standard Chartered Plc in Hong Kong. "It will also remove lots of speculative trades that aim at short-term gains as the reserves have a minimum lock-up period of one year."

The value of yuan forward transactions was $51.1 billion in July, according to the State Administration of Foreign Exchange, compared with $698 billion in the spot market. The yuan, which fell 2.6 percent in August in the biggest monthly decline since 1994, rose 0.1 percent to 6.3698 a dollar as of 2:27 p.m. in Shanghai. The freely traded currency in Hong Kong was at 6.4110, after a 3.5 percent drop last month.

The onshore currency’s one-month implied volatility, which measures expected swings and is used by some traders to price options, jumped 427 basis points to 5.78 percent in August, the biggest monthly advance since 2005. It fell 19 basis points on Tuesday to 5.59 percent.

IMF Bid

The new reserve requirement comes as China pushes to add the yuan to the International Monetary Fund’s reserve-currency basket in a review later this year. The IMF has said China should reduce intervention except at times of excessive volatility and allow a more market-oriented exchange rate.

“The PBOC move is probably made to reduce the gap between onshore and offshore yuan rates, reduce volatility in the short-run and reduce the cost to intervene in the onshore market,” said Irene Cheung, a currency strategist at Australia & New Zealand Banking Group Ltd. in Singapore. “But in the medium to long term, the yuan’s volatility and exchange-rate depends on fundamentals.”

Opening Up

China has accelerated the opening up of its financial markets this year with moves such as allowing foreign banks to trade in its interbank bond market, and inviting some offshore yuan clearing lenders to apply to trade onshore swaps and forwards. The PBOC didn’t immediately reply to a fax seeking comment on the reserve requirement for yuan forwards.

"The new reserve requirement for forwards discourages speculation against the yuan," said DBS’ Ong. "I don’t see it having any major implications for IMF inclusion, as long as it doesn’t disrupt any major progress made so far."

— With assistance by Tian Chen, Wenwen Zhang, Ran Li, and Fion Li

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