It has been a tough year for Taiwan's derivatives market with several rounds of regulatory tightening from the Financial Supervisory Commission and a breakdown in relations between banks and clients after investors suffered huge losses in renminbi-linked target redemption forwards, or Tarfs. In an unwinding and deleveraging environment, CTBC Bank developed the capability to warehouse 94% of derivatives products, including forex, rates and commodities in-house.
Jack Wang, head of treasury sales at the bank, says in-house risk warehousing enables the banks to be better prepared to deal with difficult times of tight liquidity such as last August when the RMB was devalued 1.9% overnight versus the dollar, and the start of this year when many clients unwound their Tarf positions.
"With an in-house risk management model, we can hedge ourselves ahead if we expect the renminbi to devalue and foresee clients to unwind their positions. We will monitor the greeks closely and allocate limits to traders accordingly. If we understand how much delta our positions translate to, then we will know how much to sell or buy beforehand. But if we use a back-to-back hedging model, we will be in a passive position where we can only rely on our counterparties," he says.
He adds that warehousing risks in-house, especially with renminbi-related derivatives, is challenging. "The main challenge is that the movement of the renminbi spot price can cause bigger movement in its swap points, compared with other G10 currencies. Also, renminbi is now a more volatile currency than before. Managing risks in-house is a long and painful process, but it is a valuable lesson for us to learn to manage our book."
Another example of the bank's risk warehousing capabilities has been a 30-year callable swap. The swap bank business used to be monopolised by global banks and CTBC was the first local bank to break though the market. A local bank issued a 30-year callable Formosa bond denominated in US dollars and to hedge its long-term fixed rate payments, it entered into an interest rate swap with CTBC.
"The first challenge of this trade is to find an investor who is willing to invest in a long-term bond. With the call feature, the duration will be about 10 to 14 years; it is unusual in Taiwan market," says Wang.
However, he says the bank has found local insurance companies to invest in the bonds. The regulator allowed local insurance companies to invest in Formosa bonds and account for them as their local investment, rather than using up their foreign investment quotas.
"The second challenge is to monitor and calculate the risk exposures we have and make the decision of whether to call the bonds before each call date. Because we are able to warehouse the risk in-house, we can hedge ourselves ahead of each call date, rather than passively waiting for our counterparty's decision of whether to call," he says.
In May, CTBC became one of six offshore banks to trade forex products including spots, forwards, options, interest rate swaps and cross-currency swaps in China's interbank bond market.
Wang says access to the interbank bond market means the bank has more bargaining power in the onshore market. "Before, we could trade with the designated local clearing bank and we had to accept whatever price they offered. Now, we can trade directly with various counterparties in the interbank bond market, so we will have more options and more bargaining power in the onshore market. It will benefit our derivatives business in the future."
According to Wang, US dollar/renminbi spots and same-day products have seen most demands from his clients. So far, the bank hasn't seen huge demands of forex derivatives from onshore clients but Wang says in the future, the bank will use its Shanghai branch, rather than the CFETS channel to trade forex derivatives.
As its continuing effort to expand in China, CTBC opened its Xiamen branch in August, making it the third Chinese onshore branch. The bank hopes to target small and medium-sized enterprises (SMEs) in China. "We probably can't compete with the big four Chinese local banks but we want to tap the Chinese SMEs with foreign currency needs. From there, we wish to extend our services to them in regions where we have expertise, such as South Asia, Japan and the United States," says Wang.
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