China’s New FX Regime An Opportunity For RMB Currency Futures Users

By Julien Martin, Head of FIC Product Development, Hong Kong Exchanges and Clearing Limited (HKEX)
On 30 November 2015, the International Monetary Fund’s (IMF) Executive Board decided to include the Renminbi (RMB) in its Special Drawing Rights (SDR) basket, giving the RMB a 10.92% weighting. The SDR inclusion is essentially an endorsement by the IMF of the RMB internationalisation process. It puts the RMB on par with the likes of the US dollar (USD), Euro (EUR), Japanese Yen (JPY) and British Pound (GBP). The short-term impact is likely to be limited, with a 10-month delay until the new SDR weighting becomes effective on 1 October 2016. Over the longer term, however, the acceptance of the RMB as a reserve currency will trigger asset re-allocation and facilitate foreign capital inflows into China’s capital market. The market estimates that at least US$1 trillion of global reserves will switch into RMB assets following its SDR inclusion¹. Moreover, the SDR inclusion will probably push the Chinese government towards further financial reforms, including gradual removal of quota controls on cross-border investment and increasing depth and openness in China’s capital markets.

RMB internationalisation accelerated in 2015
On 11 August 2015, the People’s Bank of China (PBOC) adopted a new daily fixing framework based on the previous day’s closing rate in conjunction with supply/demand factors and movements in other currencies. On 11 December 2015, the PBOC introduced a CNY (onshore RMB) trade-weighted index, CFETS CNY TWI, published by CFETS² which covers 13 currencies³. The PBOC highlighted the index as an important and more appropriate reference for the market, as it was overly fixated on the bilateral USD/CNY rate. The move was consistent with the PBOC’s stated policy goal of maintaining the RMB exchange rate “basically stable at an adaptive and equilibrium level”. From a macro perspective, with USD on a tightening cycle, the PBOC’s action should help de-link the RMB from a strong USD.
On 4 January 2016, the PBOC extended the onshore RMB, or CNY, market’s trading hours to 11:30 pm in order to allow onshore RMB traded during London business hours under an SDR price fix, and prepare for more international hedging flows.
Liquidity in the offshore RMB (CNH) market continues to develop along with the rapidly growing RMB crossborder trades and offshore deposits. Turnover has nearly quadrupled over the last four years, and the market expects 15-20% YoY growth in the near future, according to a key industry group. Daily spot trading volumes in USD/CNH now stands at over US$25 billion, according the City of London, and a major international bank estimates daily forward and swap trading volumes stand at around US$20 billion. Both are at a comparable size if not bigger than onshore volumes. Over the longer term, demand for CNH will be supported primarily by rising levels of trade (imports and exports) in RMB, cross-border fund flows and CNH asset creation.
RMB’s two-way volatility the new normal With the RMB’s recent two-way movement, the market is beginning to accept RMB volatility as the new normal.
On 4 January 2016, the PBOC surprised the market by setting the daily reference rate for RMB below 6.5 against the USD, the lowest in more than four years. Furthermore, the 332 pips weakening in the CNY fixing on 7 January 2016 was a record single-day decline since the new fixing framework in August 2015, and it represented a five standard-deviation fall in price over the course of the past five years.