Foreign exchange: China starts onshore options market

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By:
Hamish Risk
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Must be backed by trade flows; Only option purchases permitted

The trading of onshore renminbi currency options began this month, giving companies with genuine trade flows to China the opportunity to hedge their earnings from swings in currency rates for the first time.

It is the next stage in the development of the renminbi as a fully fledged convertible currency. However, it is still a tentative step, with regulators only permitting companies to buy options, thus preventing speculators from creating leveraged positions in the currency pair. Moreover, companies will only be allowed to sell the options if the specifics of a hedged trade flow change over the life of the option contract, said the State Authority of Foreign Exchange (SAFE), China’s currency regulator.

New rules

It is the first time that the Chinese authorities have allowed a new derivative to trade in the nation’s interbank market since 2007, when currency swaps were approved, and it comes at a time when the China Banking Regulatory Commission is expected to soon publish new regulations on banks’ derivative businesses. When it announced the new rules last month, SAFE said that the renminbi was now sufficiently flexible to merit an onshore options market and that it was the first step in developing an onshore market. The People’s Bank of China has permitted the renminbi to strengthen to Rmb6.5877 to the dollar since scrapping a two-year peg in June last year.

"It’s a great step forward and another rung on the ladder for the development of the onshore market"

Andrew Sharkey, HSBC

"It’s a great step forward and another rung on the ladder for the development of the onshore market," says Andrew Sharkey, Asia-Pacific head of FX and precious metals options trading at HSBC in Hong Kong. "It’s sensible because it shows that the central bank isn’t opening up corporations to unlimited losses." Participants in the options market will need to be Chinese registered entities, while banks providing option prices will need to hold banking licences in China. The onshore market will be the third renminbi options offering, after the CNY NDO market, based on the non-deliverable market, and CNH offshore market, which began trading last year. Therefore, with an already well-established spot and forward curve, there is sufficient background data on historical volatility for market makers to build a series of prices across several maturities.

"We have data on realized volatility, which makes it reasonably straightforward to come up with the implied volatility surface," says Sharkey.

Long term

According to William Johns, Citi’s head of Asian currency options trading in Singapore, limits on the selling of options will mean that the onshore market won’t offer the same breadth of hedging alternatives as does the offshore options market, which was started last year. "In the longer term we would hope to see some of these restrictions removed, but still at this point CNY onshore options will clearly be a huge market for us," he says.

HSBC estimates that the spot onshore market trades between $10 billion and $20 billion a day, and now dwarfs more established currency markets in the region, such as the South Korean won, where on average $12 billion a day trades. As well as Citi and HSBC, both Royal Bank of Scotland and Barclays have said they intend to be market makers in the onshore market; Deutsche Bank declined to comment.