China bans pricing in offshore NDF market

The State Administration of Foreign Exchange (Safe) issued orders on Thursday last week, suspending onshore banks from transacting in offshore US dollar/renminbi NDFs. The move stops a common practice among onshore banks that had been matching onshore forward US dollar demand by buying US dollars through NDFs.

"The attraction of this was that it was not booked as a net-open position and could allow for onshore/offshore arbitrage," said Claudio Piron, Asia foreign exchange strategist at JP Morgan in Singapore.

Some analysts believe that the order was partially introduced to punish onshore bank speculation. The statement prompted speculation that onshore banks would have to unwind existing long US dollar positions, said Piron. This caused NDF outright to trade as low as 7.6355, from the previous day close of 7.6545.

"We would take the alternative view that the move was designed to move offshore renminbi trading onshore," said Piron. He said that it would be in line with the People's Bank of China's (PBoC) comments on October 17 that the central bank aimed to improve liquidity and onshore foreign exchange trading, as well as develop an onshore futures market.

Ashley Davies, forex strategist at UBS in Singapore, agreed the order would help to develop the nascent local derivatives market by channelling trading activities onshore. The local forwards market has been largely playing second fiddle to the NDF market since its launch about a year ago, he said.

"We think the move is intended to smooth out the distortion in the NDF and local markets by drawing the local arbitrage bids away from the NDF market and shorts from the onshore markets," said Davies.

Davies said this will push the offshore swaps to the left, resulting in the NDF market pricing in a higher rate of appreciation in the renminbi than the current 3.5–3.7% pace priced into the 1–12 month NDFs. "This would then make speculative short US dollar/renminbi spot positioning more expensive to fund and less enticing," said Davies.

He added: "Perhaps, equally importantly, this move to ostensibly stamp out speculative positioning in the spot market could be a harbinger of a move to allow the renminbi to pick up its pace of appreciation."

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