Wrong Yuan Bet Sees Derivative Defaults Rising for Taiwan Banks

  • Lenders' clients haven't honored $60 million of notes' losses
  • Fitch warned that losses could run higher than $2 billion

Taiwanese bank clients who bought leveraged structured products that bet on a rising Chinese yuan are struggling to honor losses on their positions after the currency sunk.

Investors failed to honor losses on almost NT$2 billion ($59.5 million) of yuan target-redemption forwards and discrete knock-outs, derivatives that cease to exist after certain profit or exchange rate conditions are met, as of mid-January, Austin Chan, director-general of the Financial Supervisory Commission’s banking bureau, said in a Taipei media briefing Tuesday. Fitch Ratings said in December that a large drop in the yuan could see around $2 billion of losses on such notes.

The weaker yuan, which has declined 6 percent since a surprise August devaluation, is heightening risks for Taiwanese banks as Chinese market volatility roils markets across the globe. Most of the target-redemption-forward contracts were sold when the exchange rate ranged from 6.35 to 6.5 yuan per U.S. dollar and will mature in the first half of this year, said Fitch. Banks’ current losses may not yet be realized, as some are providing loans to clients to avoid that scenario, Chan said.

Most of the TRFs sold in the past two years in Taiwan had exchange rate levels between 6.5 and 6.7 yuan, known as knock-in points, where clients start losing money, over which banks conduct margin calls, Morgan Stanley analysts wrote in a research note dated Jan. 6. The yuan traded at 6.58 at 11:22 a.m. in Hong Kong.

The island’s watchdog has been increasing scrutiny and tightening rules on complex, high-risk derivatives, including imposing margin requirements and limiting such business for some banks.

Nine banks, including Cathay United Bank Co., Citibank Taiwan Ltd. and Standard Chartered Bank, were fined for poor internal risk control on yuan derivatives, the regulator said in a statement yesterday. The outstanding notional amount of TRFs and discrete knock-outs was NT$110 billion at the end of last year, according to FSC data.

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