As China faces sputtering economic growth and renewed concerns of high leverage in the banking system, the People’s Bank of China has undertaken measures to curb outflows in order to defend the currency as well as its exchange reserves.
The stabilisation of the renminbi was of utmost importance to the PBoC, which is eager to avoid the same turmoil that befell the markets following the currency’s devaluation in mid-2015. Since July this year, banks and financial institutions in China have had to report to the central government on every single foreign exchange transaction worth 5 million yuan ($750,000) or more. China’s State Administration of Foreign Exchange (Safe) also now vets any ongoing direct investment projects in which Chinese investors need to transfer more than 50 million yuan out of the country.
However, behind the flashy headlines involving the country’s biggest conglomerates, there are thousands of mid-tier and small Chinese corporations that still require funding for their domestic operations.
To this end, BNP Paribas has been at the forefront of providing RMB solutions for its customers. The bank has emerged as one of the largest providers of RMB quanto investment products, which eliminate currency exposure by giving investors access to overseas assets but allowing them to settle in the home currency. Over the past 12 months, the French bank has traded more than 500 billion yuan notional in this kind of structure.
“BNP Paribas met our expectations based on our assessment of counterparties considering product diversity, pricing capabilities and services. The strength of its local network was a particular highlight, so we were more than happy to take up quanto swaps with them,” says a senior product manager of a local commercial bank based in Guangzhou.
BNPP’s most popular product in this space was the DXY Digital, an RMB-structured quanto investment linked to the DXY index, which is a measure of the strength of the US dollar relative to a basket of six major foreign currencies.
The product enables clients to proxy-hedge renminbi depreciation against the dollar, whilst still satisfying local regulations that prohibit any investment products directly linked to the US dollar/renminbi exchange rate.
At the same time, investors can enjoy a potential higher yield of 5% per year if the DXY index exceeds a predetermined threshold at maturity. The product has a three-month tenor and trades with a notional of 100 million yuan.
“It was the right product at the right time. We were very happy to capture the market opportunity with this particular investment,” says an investment manager for one of China’s largest multinational banks.
Chen Bing, chief executive of BNP Paribas China, says: “We are proud of this product for a number of reasons. Firstly, it allows offshore exposure with no outflow investment. Secondly, we anticipated the growing demand for this type of product and provided a seamless and timely solution for onshore investors. Thirdly, we overcame significant challenges by leveraging our integrated onshore and offshore platform to serve our clients.”
Managing the currency risk inherent in the DXY Digital product is difficult, since the basket of six underlyings against the renminbi translates into 21 currency correlation risks in BNP Paribas’s trading book. Bing says that, because of the difficulty in managing the risk inherent in the product, very few other banks have been able to structure similar solutions.
“Even managing a currency basket of two or three underlyings is quite challenging for a lot of banks, but at BNP Paribas we have experience in being able to manage this correlation risk in multiple currencies,” says Henry Wong, BNP Paribas’s head of forex structuring for global markets in Asia. “Furthermore, for this kind of risk it is important to have a robust risk recycling platform. Without such a platform, it would be very difficult to manage these currency pairs and to get comfortable with the product.”
In addition to its robust risk management framework and pricing platform, the bank is able to flexibly generate tailor-made payoffs for its clients according to their preferred offshore indices – not only for the DXY but also for other currency, interest rate, equity and commodity underlyings.
The size of the transactions completed by BNP Paribas over the past 12 months underlines the market opportunities that were capitalised upon, says the group’s head of global markets for Greater China, CG Lai.
“The domestic Chinese financial markets and onshore derivatives products are still not that well developed. This is why investors are keen to link with the offshore ones, where you can use onshore deposits to fund against offshore exposure, whether this be through currency, commodities, rates, equities or any asset classes that we are in,” he says.
Another trend in China this year has been an increased pick-up in demand among investors for alternative funding solutions. This has been a consequence of rising onshore borrowing costs – linked to an increase in the rate that the central bank charges on short-term loans – and the tightening in loan quotas as part of the PBoC’s attempts to prevent loan growth spiralling out of control.
“It became much more expensive and difficult to borrow RMB directly from local banks this year. To cater to daily operational needs, we opted to borrow foreign debt offshore, but we also needed a solution that offers significant cost savings,” says an assistant vice-president of a major Chinese steel products manufacturer.
BNPP’s RMB funding solutions directly address the problems faced by Chinese companies. One of its main offerings is a synthetic loan that bundles US dollar foreign debt with an onshore cross-currency swap between the US dollar and the renminbi.
The structure falls outside the scope of the PBoC’s loan quota restriction as it involves foreign debt borrowing. It also helps satisfy the aims of the Chinese authorities, who are keen to encourage foreign money into the country in order to help stabilise capital flows and prop up reserves.
By leveraging on its strong onshore and offshore platforms, BNP is able to provide these synthetic loans at attractive rates. In one of the products, the client financing cost over the loan’s tenor comes to 3.97% per annum, which translates to significant savings when compared to the PBoC’s one-year benchmark rate of 4.35%.
“By taking up the synthetic structure, the client can source funding from an alternative channel while paying rates that are well below the PBoC benchmark. We have facilities, in both China and overseas, for onshore companies to raise foreign debt and then swap it onshore, which also requires financing line facilities onshore. What we do is not just cost-effective, but in many cases it’s the best and most efficient way to help companies continue growing in China,” says Wong.
BNP Paribas has also had a number of successes onshore in terms of regulatory permissions that have been granted.
In July, BNP Paribas was one of a handful of foreign banks named as market-maker for the newly launched Bond Connect scheme, which links Hong Kong’s fixed-income market with that of the mainland.
Also in July, the Hong Kong branch of the bank became a member of the China Foreign Exchange Trade System (CFETS), which enables it to provide both onshore CNY and offshore CNH forex hedging products to offshore clients engaged in Bond Connect, as well as the commercial import and export trade.
In January this year, BNP Paribas was extended the non-financial corporate bond underwriting licence by the National Association of Financial Institutional Investors to underwrite various types of debt instruments for non-financial corporates in the China interbank bond market. BNP Paribas is one of only a few foreign banks to have achieved this qualification.
Going forward, Chen says that regulatory changes will continue to influence market demand for renminbi solutions. He believes the stabilisation of capital flows bodes well for the currency and will lead to a more resilient renminbi over the long run.
“BNP Paribas will remain as the RMB business leader through anticipating market development in a timely way and continuing investments in our on and offshore RMB platform. We’re convinced that RMB internationalisation will continue, but will evolve through different phases. As always, BNP Paribas is well-positioned to embrace the regulatory and market changes with our clients, as well as developing innovative RMB solutions to best serve clients’ needs in investment, financing, hedging, asset management, and custodian services,” says Chen.
The week on Risk.net, September 8-14, 2018Receive this by email