How to clear cross-currency swaps is a conundrum that the world’s largest clearing houses have tried and failed to solve for some time, and it’s a problem that is especially acute for the nascent renminbi cross-currency swaps market because of the questions of credit quality surrounding many Chinese corporates.
The Stock Exchange of Hong Kong’s launch of renminbi cross-currency swaps has garnered it this year’s Asia Risk Clearing House of the Year award, and HSBC played a key role by clearing the first trade.
It is a product that Justin Chan, HSBC’s co-head of global markets, says is not only a new edge for the SEHK, but also for Hong Kong’s status as the global offshore renminbi centre, since it will deepen the pool of renminbi liquidity in the territory.
“One of the challenges we are faced with by renminbi-related products is the settlement risk, particularly for long-dated trades. So when the SEHK launched renminbi cross-currency swaps clearing, we were keen to be involved. The exchange approached us to be one of the counterparties because they know we are a major player in the market,” says Chan.
The SEHK is the first and – so far – only clearing house in the world that offers this service.
“It is of particular value to Chinese banks, which generally don’t have good credit quality, especially for long-dated transactions, meaning they often can’t find enough counterparties to satisfy their requirements. The launch of cross-currency swaps clearing will help them bridge the market, as they can be more active in laying off their own risk,” says Chan.
An additional benefit of central clearing is that it swerves the need for credit support annexes, which Chinese banks are generally reluctant to enter into, and which can in any case be problematic because of major doubts about the enforceability of netting mechanisms in the event of a default.
“To have all these renminbi cross-currency swaps trades centrally cleared removes a large amount of uncertainty with regard to counterparty risk, so it is really a no-brainer to participate in this market,” says Chan.
Chan concedes that volumes so far have not been great, with daily notional values of $100 million the norm. One reason is that the main source of demand for this product comes from Chinese corporates that are raising finance in dollars and switching back into renminbi – a sector that has been sluggish throughout 2017.
The second reason for the low volumes is the daily cap the SEHK has in place to ensure it can manage its settlement risk. This cap currently stands at around $90 million per bank, per day, and Chan says they have had to turn counterparties down because of a lack of capacity on the SEHK (although the SEHK is understood to be looking at whether this limit can be further increased).
“We are in discussions with SEHK over whether they are comfortable with increasing this cap, as currently it is a hindrance for the renminbi cross-currency swaps clearing market development,” says Chan.
A surge in deal-making across Asia saw an upswing in deal-contingent foreign exchange hedge transactions, where the bank provides the customer with a forex hedge that, if the underlying deal isn’t completed, isn’t used. The timing was perfect for HSBC’s Hong Kong business, which had previously made a decision to focus on this type of business, resulting in volumes of these kinds of structures increasing by between three and four times during 2016 and 2017.
Selene Chong, head of global forex and commodities in Asia, said that because the bank had previously decided to allocate both human and financial capital, it was well placed to capitalise on this year’s upswing in mergers and acquisitions. She says this also requires co-operation between disparate parts of the bank that are involved in this type of deal.
“The pick-up we have seen in the contingent mergers and acquisitions hedging business has been driven by several factors – one of which is our deliberate focus on this part of the business. And for that to happen, a few things had to come together,” says Chong. “This is an area where we work closely with our investment banking partners, who follow closely the underlying transactions. The ultimate outcome was a very happy client – they gave us the largest share in this transaction, and this should hopefully lead to further opportunities.”
Chong gives the example of a major deal for a global client involving a local asset that would have required it to sell euros in the event of completion. Because of the 2016 US election, there was concern over potential forex volatility, which proved to be apposite, given that the deal did not complete until early 2017 – by which time, the currency moves over the election would have led to a significant loss.
“There was appetite internally for this risk, and, because we understood the deal and the risks it contained, we were able to come to the client with sharp pricing.