China’s largest companies have spent the past couple of months reassessing their options after years of eschewing hedging of overseas debt in favour of taking advantage of renminbi appreciation.
They can hardly afford not to. Bloomberg estimates that the 2.8% fall in the yuan cost Chinese firms an extra $14 billion on their overseas liabilities in August alone and says the mismatch is most evident among developers, whose FX assets cover less than 25% of foreign liabilities.
However, this had led to issues around affordability. Standard & Poor’s Ratings Services credit analyst Christopher Lee reckons the cost of hedging via forwards or swaps has risen as high as 3%.
| High-yield issuers have switched to raising funds in the RMB bond market instead of the offshore USD market this year|
S&P Ratings Services
The cost of a hedging contract has risen to a high point for both one-week and three-month maturity, observes Peter Wong, founding chairman of the International Association of CFOs and Corporate Treasurers (China) and convenor of the Hong Kong Association of Corporate Treasurers (HKACT).
“Another reason for this increase is the recognition that the future strength of the renminbi may not be sustainable as it has already appreciated close to 40% since 2005 when China began its foreign-exchange reform and economic growth has entered into a period of new normal,” adds Wong.
Eric Sim, managing director, corporate solutions at UBS Investment Bank, notes that the USD/CNH spot price is around 2.7% weaker than before the devaluation and that call options on USD/CNH and entering into forward contracts has become less popular.
While noting that regulatory changes have added between 150 and 300 pips depending on the market maker’s USD funding cost, CG Zhou, head of financial institutions sales, China, at Standard Chartered, says market volatility makes it difficult to pin down specific cost changes.
Chen Ying, vice-president in charge of corporate finance at steelmaker Baosteel, has said his company will make more use of spot, forwards and financial derivatives as part of an increased focus on FX risk management. Use of non-deliverable forwards is understood to be in decline since the daily trading band was widened.
Lee at S&P explains that a large number of corporates have issued RMB bonds in the domestic bond market since the beginning of 2015, adding: “High-yield issuers have switched to raising funds in the RMB bond market instead of the offshore USD market this year.”
However, HKACT’s Wong says it is difficult to determine precisely to what extent Chinese companies are borrowing in yuan instead of dollars or using derivatives to reduce their FX risk.
“Until recently, there was approximately 150 basis point difference between the risk-free rates in China and the US, but that gap has narrowed as the People’s Bank of China has reduced banks’ required reserve ratio and renminbi onshore interest rates,” he continues.
“State-owned enterprises with an average cost of funding of 5% can now raise onshore bond funding at less than 4% for three-years maturity.”
Chinese companies with assets and liabilities in RMB will prefer to borrow in the Chinese currency, while those companies with USD income or receivables might continue to finance in USD as a natural hedge, adds Andrew Fung, executive director and head of global banking and markets at Hang Seng Bank.
“Based on our experience, Chinese companies have shown a preference to borrow in RMB since the Chinese central bank devalued the currency,” says Zhou. “Yet we think that they will still borrow in USD if they have more USD investments/assets.
“In other words, Chinese companies will be more concerned about asset/liability currency risk-management going forward. We have seen more Chinese companies coming into the market to hedge their USD liability after the devaluation.”
|The future of the RMB:|
Singapore-based independent treasury consultant David Blair suggests some Chinese corporates have been borrowing in USD to take advantage of strong investor demand and observes that limited access to hedging instruments and a long period of currency stability means most Chinese corporates do not have experience with FX hedging, having instead added a mark-up on export prices to reflect currency risk.
This has translated into increasing demand for FX risk-management training, adds Sim.
“Typically, clients want guidance on risk quantification, optimal hedge ratios, hedging products and strategies and best practice,” he says. “A major part of our offering is training to help clients understand the implications of different hedging strategies, including using USD assets to offset the FX translation risk in USD debt.”
Chinese companies prefer to use vanilla products to hedge their currency risk, but Fung reckons demand for more sophisticated and bespoke hedging solutions will grow in the next two to three years.
“With RMB internationalization and relaxation of cross-border trade, Chinese companies have become more sophisticated and familiar with different hedging products,” he concludes.