China central bank sets reserve requirements for all FX derivatives
China’s central bank will require reserves to be set aside for purchases of all currency derivatives from October, according to a document seen by Reuters, as Beijing moves to make it more expensive to bet on further depreciation of the yuan.
The move expands the scope of a similar document, seen Tuesday, in which the central bank said it will require banks to hold reserves on behalf of clients’ trading of currency forwards, in a move seen curbing speculation and volatility after the Aug. 11 shock devaluation of the currency.
According to the People’s Bank of China document seen on Wednesday, reserve ratios will be set at 20 percent of the nominal value of forwards and swap contracts, and fixed at 10 percent of the nominal value of principal for options.
“People were thinking about alternatives to circumvent the reserve requirement to bet on yuan depreciation after yesterday’s policy was out. But it’s clear now that it is impossible to do so,” said a Hong Kong-based trader who saw the PBOC document on Wednesday.
The PBOC declined to comment when contacted by Reuters.
CUSHIONING THE IMPACT
Surprised by the global reaction to its currency devaluation, Beijing has gone all out to try to cushion the impact.
The PBOC has set a slew of strong daily trading midpoints for the yuan, increased how frequently it has state banks sell dollars to support the currency and has conducted rare intervention in derivative markets.
Some traders believe such high-frequency intervention in the spot market and the coming requirements in derivative trading mark a step backward for China’s currency reforms.
Another concern is what Beijing’s end-game is, given that efforts to hold up the yuan so far have required it to drain the country’s massive foreign exchange reserves.
If this latest move reduces depreciation pressure, it will also reduce the need for the PBOC to sell foreign currency to buy yuan. But it is not a riskless strategy, as in the past overactive interventions have caused transaction volumes to tank, damaging enthusiasm for holding yuan among international investors.
SQUARING THE CIRCLE
“Repeated intervention to maintain the currency’s stability is at odds with the ‘more flexible exchange rate mechanism’ the central bank announced just three weeks ago,” wrote Chen Long of Gavekal Dragonomics in a research note on Wednesday.
“This contradiction casts doubt over the PBOC’s intentions: whether it is serious about moving to a more flexible currency regime, or whether it has simply re-imposed a de facto peg at a different level against the US dollar.”
The yuan weakened 2.6 percent in August, its worst month on record. This raised concerns a weakening yuan could provoke capital flight even as China’s wider economy stumbles. Offshore markets have been pricing the yuan at a discount to the onshore version.
In late trade on Wednesday, the spread between the onshore yuan and offshore spot widened to about 1,000 pips, the highest level since September 2011, implying foreign investors are pricing in deeper depreciation to come.
Beijing has said it sees no reason for further yuan weakness, with a PBOC official giving Reuters a rare interview in which he defended China’s decision and said it should not be blamed for the global stock rout around the same time.
In a related development, China’s State Administration of Foreign Exchange (SAFE) issued new rules on Wednesday relaxing restrictions on multinational companies’ management of their foreign currency-denominated debt in China, allowing them to pool debt from all their subsidiaries for central management.
Analysts see the moves as also relieving downward pressure on the yuan by encouraging companies to sell off their foreign currency.