Chinese corporates step up FX hedging after reopening

Exporters eye hedges as RMB strengthens, but negative forward points are a turn-off for some

Chinese corporates are looking to take a more proactive approach to foreign exchange hedging following the country’s reopening and the unwinding of its zero-Covid policy.

According to data from China’s State Administration of Foreign Exchange (Safe), FX forwards sales to onshore companies totalled $54 billion in February – a 44% increase since October. Kevin Zhang, head of FX onshore China trading at Standard Chartered Bank, says it has seen an estimated 10–15% increase in client hedging demand compared with last year.

Some dealers say much of this activity is coming from Chinese exporters, who receive dollars and then need to convert them back into renminbi.

“Exporters have natural cashflow hedging needs as the USD is still the main currency in cross-border trades,” says a macro sales head at a European bank in Hong Kong. 

This is backed up by Safe data, which shows there was a net $28 billion bias in corporate FX forwards sales towards corporates selling dollars and buying renminbi at the end of February – the highest net balance in the past two years.

Companies that have increased a cap on trading FX derivatives include electronic car maker BYD and lithium compound producer Gangfeng Lithium, according to Shenzhen Stock Exchange filings.

At the same time, however, Safe data shows the hedging ratio using forwards from local corporates has nearly halved from 24.6% a year ago to 12.9% at the end of February.

Michelle Xu, Greater China head of risk management solutions at Deutsche Bank, attributes the growth in dollar-receivable hedging demand to the end of China’s zero-Covid policies and the reopening of supply chains for exporters.

Over this period, the onshore renminbi (CNY) has strengthened, with the spot rate rising from 7.3 at the beginning of November 2022 to 6.88 as of March 29. But there have been significant changes to the interest rate differentials between the two countries.

 

Chinese rates were higher than those in the US, but that has flipped since the Federal Reserve embarked on its path of rate hikes. As of March 27, one-year Libor was 4.81%, while the closest Chinese equivalent, the one-year loan prime rate, stood at 3.65%.

Interest rate differentials determine the premium or discount applied to the spot exchange rate when pricing a forwards contract. Before the Fed’s first rate hike in March 2022, when the dollar was weaker, 12-month forward points on US dollar/offshore renminbi were 1,193, according to Bloomberg – meaning a corporate selling CNH and buying dollars for future delivery would receive a worse rate than spot.

Now the situation is reversed – as the Federal Reserve continues to raise rates and China’s central bank keeps benchmark lending rates unchanged, forward points had fallen to -1,595 by March 29, making it much more attractive for corporates to hedge with forwards contracts.

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As a result, say some senior FX traders in Asia, the prospect of locking in weaker FX rates than spot has caused some exporters to sit on the sidelines.

“Looking at the USD/CNY one-year points now, they are pricing an outright one-year forward much cheaper than spot, which makes it a very interesting dynamic. if I were an exporter, I have no reason to hedge anything or increase my hedging ratios. If I’m an importer, I will say, okay, even after providing for this … I think it still works out well,” says a senior FX executive at one large US dealer.

Standard Chartered’s Zhang also says exporters might look at the forwards rates and choose to sit it out. “Because the forwards price is lower than spot, exporters might choose to hold their USD for longer and sell when they need it rather than hedge it in advance. So, it generally makes exporters sell less forwards,” says Zhang.

Higher costs

The rise in hedging activity has come despite onshore corporates having to pay more to use FX derivatives due to the return of the People’s Bank of China’s deposit requirements in September last year.

The ruling required banks to put up a zero-interest, US dollar-denominated deposit representing 20% of the notional value of all new FX forwards and swaps that are selling onshore renminbi for a year. These costs would then be passed on to buyers of these derivatives, resulting in an extra 800 basis points of costs in some cases.

Forwards sales took a hit in the following months, and according to Safe data, client-facing FX sales dropped by two-thirds in October to $37.4 billion, compared with $55.7 billion a year earlier. Sales picked up marginally in the following two months but still fell short of 2021 levels.

Zhang says some corporates tried to lock in their forwards hedges before the deposit requirement was introduced, while others sought to trade in the offshore renminbi market.

He says forwards remain the most popular choice for corporates seeking to hedge their FX exposures, though demand to hedge via options is growing. Safe data shows there were $33.8 billion of options notional trades done with Chinese corporates in February, an increase from $27.8 billion in January.