Thursday, October 11, 2012

New RMB Investment Channel: CNH Currency Futures

CME Group FX. (Chicago Mercantile Exchange) is no doubt a leader of global FX and derivatives marketplace but when it comes to RMB (Chinese Renminbi, also named CNY or Yuan) currency business, Hong Kong Exchanges & Clearing Ltd (SEHK Stock Code: 0388.HK) does have its unique advantages over CME.

Although Hong Kong Stock Exchange (SEHK or called HKEx) is new to FX broker business, SEHK has just introduced the first-ever physically-delivered exchange-traded RMB currency futures contract in the world since September 17, 2012 as a RMB forex hedging and capital risk management tool for investors. This new RMB-denominated derivative product is actually a USD/CNH futures contract, where CNH stands for CNY(HK) which, by definition, is RMB circulated offshore in Hong Kong.

This derivative product needs delivery in USD (U.S. dollars) by sellers but FSV (Final Settlement Value) payment at maturity in CNH by buyers. That said, this future contracts is quoted in CNH per USD but to be settled and margined in CNH, while trading and settlement fees are also charged in CNH. Due to its better transparency and lower counterparty risks, this HKEx new future contracts should be a good supplement to the prevailing USD/CNY NDF (non-deliverable forward), USD/CNY (RMB) contracts for onshore market in mainland China or CNH DF (deliverable forward) products currently offered by CME.

Why CNH?

In fact, CNH has already been used widely in OTC (Over-the-Counter) market trading. As RMB internationalization process has recently been accelerated, market demands for RMB currency-risk hedging has also been increased. A new derivative product, USD against CNH futures contracts, has thus been launched by Hong Kong Stock Exchange (SEHK) since September 17, 2012 to provide investors a new investment channel for hedging RMB forex risk.

Other reasons why investors would consider to get involved in this SEHK CNH-denominated futures investment channel:

(1) Investors do not have to hold any CNH but can still capture investment opportunities for either RMB appreciation or depreciation. This financial derivative instrument should also make it easier for RMB holders to manage RMB exchange-rate related risk exposures. To help you decide if the current FX level of RMB is profitable, Mr China has established our own RMB target for you. Source: 2012 RMB Target;

(2) Investors can even consider to take part in spread trading, because the volatility of this futures contracts is supposed to be small and hence its investment risk is controllable even it is traded on a margin basis with leverage;

(3) Selling USD/CNH futures can obtain unrestricted amounts of CNH, because it is not restricted by the daily exchange limit from Hong Kong banks.

Below is the latest FX chart showing relationship between RMB offshore market (Spot USD/CNH in blue) and onshore market (Spot USD/CNY in red or USD/CNY NDF in green).


Current Spot RMB Offshore vs Onshore Market Trend

The introduction of HKEx (Hong Kong Stock Exchanges) CNH-denominated derivative product can no doubt further accelerate the pace of RMB internationalization. As it helps keeping Hong Kong the biggest offshore RMB liquidity pool outside PRC (People's Republic of China) onshore market, we expect it will also enhance the status of Hong Kong as a preferential offshore RMB centre over other key competitors such as London or Singapore etc.

Actual SEHK CNH Futures Trading Mechanism

For trading any SEHK (Hong Kong Stock Exchanges) USD/CNH futures contract, basic investment expectations are: if you buy a futures contract, you should be expecting a RMB depreciation. Conversely, if you sell a futures contract, you should be expecting a RMB appreciation.

As far as we know, Hong Kong brokers can accept open contract deposits and transaction costs to be settled in Hong Kong dollars (HKD), while unwinding gains or losses to be settled in CNH. For this reason, investors basically can participate in trading of this SEHK derivative product without holding CNH (at least initially).

If any futures contracts is still open at the final settlement day, then it has to be settled in CNH/USD. To avoid forced liquidation or failed settlement for this case, investors normally need to have enough amount of CNH (or USD equivalent) ready in their accounts one business day prior to the last trading day of the expiring contract month.

Since this investment channel is still new to investors, turnover volume seems to be quite low to start with. SEHK traded only a small volume of 415 futures contracts during its first debut day on September 17, 2012, thus representing a total daily turnover volume of USD$41.5 million. The top 3 active-traded quarterly expiries (in descending order) were in December 2012 (trading volume was 82 contracts), June 2013 (trading volume was 80 contracts) as well as March 2013 (trading volume was 72 contracts). Bid-offer spreads or market depth are still limited. It appears that most traders or corporate investors (such as QFII hedge fund managers, asset managers, proprietary traders, banks or other financial institutions) with FX exposure are still sticking to DF (deliverable forward) market currently managed by CME. It can be because DF (deliverable forward) product has no margin requirements, while its contract sizes or tenors can also be tailor-made.

In contrast, standardized future contracts offered by SEHK may not be suitable for corporate investors because there are risks due to the time lag between actual settlement date of exports/imports and standardized expiration date of this FX hedging tool.

Therefore, as new RMB investment channel, we would expect this CNH-denominated futures contracts should be better for retail FX market investors rather than corporate investors.


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