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User Manual: RBS 1

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Hong Kong Market Outlook
- Implications of the CNH market
1st ASHK Investment & Risk Management Symposium
19 April 2011
Woon Khien Chia
Head of Local Markets Strategy, Asia
The Royal Bank of Scotland
woonkhien.chia@rbs.com
tel. +65 6518 5169
Duncan Mansfield
Solutions Structurer
The Royal Bank of Scotland
duncan.mansfield@rbs.com
tel. +852 2966 2442
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The CNH roadmap
China’s market liberalisation (2002-2008) – the early days
2003 2004 2005 2006 2007 2008
Dec 03
HK banks
allowed to
take CNY
deposits
Jul 07
CDB issued first
CNY-denominated
bond outside
China
Dec 08
PBOC signed
bilateral currency
swap agreement
with Korea
(CNY180bn). First
of 8 swap lines
Feb 04
HK became a
offshore CNY
clearance
centre
Jan 07
China financial
institutions allowed
to issue CNY bonds
in HK
Jul 05
CNY floated
and revalued
by 2%
against USD
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The CNH roadmap
China’s market liberalisation (2009) – setting goal for CNY internationalisation
2009
Feb 09
Currency
swap
agreement
with Malaysia
(CNY80bn)
Jun 09
Trade settlement
scheme expanded to
allow settlement with
Hong Kong and
ASEAN nations
Jan 09
Currency swap
agreement with
HK
(CNY200bn)
Mar 09
Currency swap
agreements with
Argentina (CNY
70bn), Belarus
(CNY20bn) and
Indonesia (CNY10bn)
Sep 09
China issued its
first CNY
government bond
in HK
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The CNH roadmap
China’s market liberalisation (2010-2011) – the Big Bang
2010
2011
Feb 10
HKMA allowed all
forms of CNY-
related fund
raising as long as
funds do not flow
back to mainland
Jun 10
Trade settlement
scheme expanded
to allow settlement
globally
Jul 10
PBOC and HKMA
signed Supplementary
Memorandum of
Cooperation – paved
way for setup of CNH
interbank market
Aug 10
Foreign central banks
with CNY swap lines,
clearing & settlement
banks for CNY trades
allowed to invest excess
CNY funds in onshore
interbank bond market,
subject to PBOC quota.
Dec 10
Number of onshore
firms eligible for
CNY trade
settlement was
increased from 365
to 67359
Jan 11
PBOC launched pilot
programme to allow
qualified domestic
firms to use CNY for
outward direct
investments.
Oct 10
HKMA took over
CNY clearing bank
role after BOC (HK)
exhausted its
conversion quota
Jun 10
CNY
returned to
appreciation
path, post-
Lehamn
crisis
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Potential of CNY as a world reserve currency
Share of world reserves – China vs. G3 Share of world trade – China vs. US
0%
10%
20%
30%
40%
50%
60%
48 52 56 60 64 68 72 76 80 84 88 92 96 00 04 08
China US Japan Euro Area
0%
2%
4%
6%
8%
10%
12%
14%
16%
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
China US
Source: Bloomberg, RBS
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0
100
200
300
400
500
600
Jul 09 Sep 09 Nov 09 Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11
0
1
2
3
4
5
6
7
8
CNY deposits in HK (% of deposits in HK, RHS) CNY trade settlement (CNY bn, LHS)
CNY trade settlement scheme huge boost to CNH deposit base
Since initiation in Nov 09, banks have cumulatively settled CNY510bn worth of trade
- roughly 80% attributable to China’s imports, 20% from its exports
- Hong Kong and Singapore probably still key countries of import origins
CNY deposits in Hong Kong poised to reach CNY700-800bn by end-2011
Source: Bloomberg, RBS
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New offshore CNY centres – potential competition for HK
Conditions for setting up an offshore
CNY centre
1. Strong trade ties with China
2. CNY swap line from PBOC
3. Central clearing directly with PBOC
4. Domestic currency traded in China’s
onshore interbank market
a. China interbank currently quotes
USD/CNY, EUR/CNY, JPY/CNY,
HKD/CNY, CNY/MYR, USD/SGD
b. PBOC said more foreign
currencies will be allowed to
trade as CNY crosses
Source: IMF, CEIC, RBS
1.9150Jul-10Singapore
0.013.5Jun-10Iceland
0.0720Mar-09Belarus
0.570Mar-09Argentina
1.4100Mar-09Indonesia
2.580Feb-09Malaysia
7.8200Jan-09
Hong
Kong
7.0180Dec-08Korea
% of
China's
total trade
Size of swap
line (CNY bn)
Date of
swap line
agreement
PBOC's CNY swap lines
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Market anomaly 1: FX – CNH spot premium over onshore CNY
spot…
From peak of 2.5%, CNH spot premium over onshore CNY spot has narrowed to 0.05%
Source: Bloomberg, RBS
6.45
6.50
6.55
6.60
6.65
6.70
6.75
6.80
6.85
23 Aug 10 23 Sep 10 23 Oct 10 23 Nov 10 23 Dec 10 23 Jan 11 23 Feb 11 23 Mar 11
-300
-100
100
300
500
700
900
1100
1300
1500
1700
Spread (pips, RHS) CNY spot CNH spot
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… leading to divergence in FX forward curves
FX forward markets – onshore, CNH and NDF USD/CNY 1y forward – onshore vs. NDF
Source: Bloomberg, RBS
6.2
6.4
6.6
6.8
7.0
7.2
7.4
7.6
7.8
8.0
06 07 08 09 10 11
1y USD/CNY onshore 1y USD/CNY NDF 1y USD/CNH
6.35
6.37
6.39
6.41
6.43
6.45
6.47
6.49
6.51
6.53
6.55
Spot 1m 3m 6m 12m
Tenors
USD/CNY
Onshore CNY CNH Offshore NDF
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Markets anomaly 2: interest rates – CNH yield curve differ in
both levels and directions from onshore swap curve…
CNH interest rate term structure vs. offshore ND-CCS, onshore IRS and CCS
Source: Bloomberg, RBS
-3
-2
-1
0
1
2
3
4
1y 2y 3y 4y 5y
CNH-CCS ND CCS
Onshore CNY CCS Onshore IRS
-4
-3
-2
-1
0
1
2
3
4
Jan
10
Mar
10
May
10
Jul
10
Sep
10
Nov
10
Jan
11
Mar
11
1y onshore CCS 1y ND-CCS 1y onshore IRS
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… which led to huge premium of CNH bond issues over
onshore issues, including Chinese government issues
Sovereign benchmark curve set by China MOF CNH issues vs. onshore benchmark curve
Source: Bloomberg, RBS
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
CNH government benchmark Onshore government benchmark
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The next phase – adding asset classes, expanding
geographical coverage
Mini QFII Scheme
China’s domestic securities houses and fund managers to directly tap into overseas
investors to invest in onshore China bonds and equities
CNY-denominated equity listing in HK
Listing CNY-denominated equities offshore; investors can exchange for CNY via liquidity
facility, with profits/ losses to be converted back into HKD
Inward foreign direct investment settlement
Allowing foreign firms to bring offshore CNY funds into China for direct investments
More offshore CNY centres
The 4 pre-requisites
a. strong trade flows with China
b. access to PBOC’s CNY swap line
c. CNY central clearing directly with PBOC
d. trading of offshore centre’s domestic currency in China interbank market
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Implications of CNH on HKD
On HKD’s dollar peg
- A re-peg is not de-peg
- CNH increased chances of HKD re-
pegging to CNY…
- … conditional on CNY becoming fully
convertible (~ 5 years’ time)
- Asset substitution – USD deposit base in
HK being eroded, not HKD deposit base
- Meanwhile, Hong Kong’ strong
fundamentals allow dollar peg
On HKD interest rates
-
USD rates remain anchor for HKD rates
until HKD re-pegs
- Re-peg pressure will come from CNH
rates, not onshore CNY rates
- Fortunately, CNH rates are also anchored
by USD rates…
- … as long as China maintain border
control between CNH and onshore CNY
- Bigger uncertainty is in USD rates – when
will Fed starts hiking? when will it unwind
QE?
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History of HKD dollar peg
7.60
7.65
7.70
7.75
7.80
7.85
7.90
7.95
99 00 01 02 03 04 05 06 07 08 09 10 11
6.4
6.6
6.8
7.0
7.2
7.4
7.6
7.8
8.0
8.2
8.4
USD/HKD spot USD/HKD 1 yr Upper CU Lower CU USD/CNY(RHS)
Source: Bloomberg, RBS
USD/HKD forwards have not priced in resumption of CNY appreciation plus growth of CNH
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“Asset substitution” underway
CNH deposits are eroding USD deposits, not HKD deposits
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
HKD USD CNY Other fcy
HKD trn
0
10
20
30
40
50
60
70
80
90
100
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
HKD USD CNY Other fcy
% share
Source: Bloomberg, RBS
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HKD FX forward vs. CNH forward – implying sustained HKD
depreciation vs. CNY
USD/HKD vs. CNH, onshore CNY, offshore CNY NDF HKD/CNH vs. HKD/CNY, HKD/CNY NDF
6.4
6.4
6.5
6.5
6.6
6.6
O/N 1W 2W 1M 2M 3M 6M 9M 1Y
7.735
7.740
7.745
7.750
7.755
7.760
7.765
7.770
7.775
7.780
CNH CNY onshore CNY NDF HKD (RHS)
0.820
0.825
0.830
0.835
0.840
0.845
O/N 1W 2W 1M 2M 3M 6M 9M 1Y
HKDCNH HKDCNY HKDCNY NDF
Source: Bloomberg, RBS
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HKD interest rates vs. CNH rates – anomaly between interbank
deposit rates and implied swap offer rates
Interbank rates – hibor vs. CN-hibor, Libor Rates implied from FX forward curves
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
O/N 1W 2W 1M 2M 3M 6M 9M 1Y
CNH USD HKD
-3.5
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
O/N 1M 2M 3M 6M 9M 1Y
CNH CNY onshore CNY NDF HKD USD Libor
Source: Bloomberg, RBS
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HKD rates – front-end lower, curve to steepen vs USD
EFN vs. IRS EFN vs. UST
0
1
2
3
4
5
6
7
02 03 04 05 06 07 08 09 10 11
EFN 2y IRS 2y EFN 10y IRS 10y
0
1
2
3
4
5
6
7
02 03 04 05 06 07 08 09 10 11
EFN 2y UST 2y EFN 10y UST 10y
Source: Bloomberg, RBS
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The CNH Market
Types of CNH products
CNY, CNH and CNY NDF compared
CNH market liquidity
Examples of CNH FX investment products
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Overview
• CNH market – developing and does not offer the liquidity many need to
hedge their risks
• Onshore CNY – generally not open to Hong Kong investors and
involves CNY/CNH basis risk
• CNY NDF/NDS – better liquidity than CNH but also involves basis risk
Some structured investment products are available for participants
to reduce or increase exposure to CNH/HKD and/or provide better
yields than CNH money markets
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Snapshot of CNH-denominated product availability
Hong Kong CNH bond market continues to build YesBonds
Fully funded structures so far Not all
Structured
products
Illiquid YesFX options
CDs launched; structured notes and deposits in early
development stage
Yes for CDs
CDs/structured
notes
Interbank trading relatively thin amid CNH ‘pooling’ in small
number of institutions
YesMoney market
IlliquidYesCCS
There are now CNY DF, CNY NDF and CNH DF curves YesForward
USD 500mn interbank volumes YesSpot
Remarks AvailabilityCNH product
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CNH vs. onshore CNY and offshore CNY NDF
NDF: Out to 1y
NDS: Liquid out to 5 years,
some liquidity out to 10
years
Deep Spot and forward to 3
months, modest liquidity at
1 year
Deep Spot and forward to 1yLiquidity
None
Trade documents for
transfers into/out of China
Trade documents, or
PBOC/SAFE approvals for
capital account transactions
Documentation needed
2 business days ahead of
maturity
No fixingNo fixingFixing
Forwards and OptionsSpot, Forwards and OptionsSpot, Forwards and OptionsProducts available
Allowed purposes
How is it settled
Remittance into China
Remittance outside
China
Freely convertible
Who is allowed to
buy/sell
Location
Current and capital account
with supporting documentation
Delivery
n.a.
No
No
Only companies in China
(with supporting documents)
China onshore
CNY
Trade purposes into China
alone, otherwise restrictions
Delivery
Yes, for trade purposes
n.a.
Yes
Everyone outside China
Abroad,
(Hong Kong for clearing)
CNH
n.a.
Cash settled in USD
n.a.
n.a.
n.a.
Everyone outside China
Abroad
CNY NDF
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Market liquidity
Offshore CNH Deliverable
Offshore CNY Non Deliverable (settled in USD)
Onshore CNY Deliverable
Up to 10y
Up to 1y
-
Liquid out to 5y
Up to 1y
Liquid out to 1y -18
months
-
Tenor
50-100 pipsUSD 10mmUSD 250mm
USDCNH FX Forwards &
Swaps
10-20 pipsUSD 5mmUSD 400-500mmUSDCNH FX Spot
USD 3-4 bn 30-50 pipsUSD 10-20mm
USDCNY Non Deliverable
Forward (NDF)
20-30 bppaUSD 10-20mmUSD 20-50mm
USDCNY Non Deliverable
Cross Currency Swap
(NDS or NDCCS)
10-20 pipsUSD 10-15mmUSD 10 bnUSDCNY FX Spot
50-100 pipsUSD 10-15mmUSD 6 bn
USDCNY FX Forwards &
Swaps
50-100bpCNH 5mmIlliquid
Fixed Income Sovereign
Bonds
Bid to Offer
Volume per
Transaction
Daily Average
Volume
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USD dual currency investment linked to CNH
Indicative Terms & Conditions
USD Principal : USD 10 million (equivalent to CNH Principal = CNH 65.2 million)
USD/CNH Spot Reference : 6.5200
Tenor : 3 Months
Strike : 6.5200
Redemption Conditions
- if USD/CNH Spot at expiry is above Strike, Investor receives CNH Principal with 2.0% p.a. interest
- If USD/CNH Spot at expiry is at or below Strike, Investor receives USD Principal with 2.0% p.a. interest
Rationale and Benefits
This investment is suitable for investors who are sitting on idle USD cash and do not mind converting USD
into CNH.
Allows the investor to take advantage of the implied (from the FX market) and real (from the depo) CNH
yield difference as well as access to the CNH option market
This investment offers higher returns compared to the vanilla money market rates or the sell/buy USD/CNH
FX swap plus CNH deposit structure (USD 1.00% p.a.)
Risks
If there is depreciation on the Renminbi, the investor could be receiving less than his original invested
principal in USD terms.
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CNY Credit Linked Note
Indicative Terms & Conditions
CNY Principal : CNY 200 million, settled in Settlement Currency
Reference Obligation : China Sovereign
Tenor : 5 years
Coupon : CNY 2.50% p.a. settled in Settlement Currency
Redemption : 100% at maturity, or in event of default the recovery value after close-out of
hedges, settled in Settlement Currency
Settlement Currency : USD or HKD (as mutually agreed on Trade Date) using onshore Spot
References
Rationale and Benefits
This investment is suitable for investors who are in need of CNY linked assets and who are comfortable with
China Sovereign credit risk
Different reference obligations can be used for a tailored risk/reward profile
This investment offers higher returns compared to the vanilla CNH money market rates and is available to
HK investors
Risks
Basis risk between CNH and CNY for investors hedging CNH liabilities
China Sovereign in addition to the usual issuer credit risk
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Disclaimer
•This material has been prepared for information purposes only. The investments and investment services referred to herein are available only to persons to whom this
material may be lawfully delivered in accordance with applicable securities laws. This material is being distributed only to, and is directed only at, persons who have
professional experience in matters relating to investments, falling within Article 19(1) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 or to
other persons to whom this material may lawfully be communicated. This material is not available to retail customers within the meaning of the rules of the Financial
Services Authority (“FSA”). No securities (nor any related securities or other financial instruments or their related derivatives) (together “Securities") discussed herein may
be offered or sold in the United States (“US”) except pursuant to an exception from the registration requirements of the Securities Act of 1933. The material should not be
construed as an offer or solicitation to buy or sell any securities or any interest in securities.
•The information contained herein is confidential and is intended for use only by the recipient (the “Recipient”). It should not be reproduced or disclosed to any other person
without the consent of The Royal Bank of Scotland plc. The material remains the property of The Royal Bank of Scotland plc and/or its affiliates (“RBS”) and must be
returned to RBS on request and any copies the Recipient has made must be destroyed.
•The information contained herein has been prepared by RBS on the basis of information provided by the issuer or one of more of its affiliates to assist interested parties in
making a preliminary analysis of this Private Placement transaction and does not purport to be all-inclusive or to contain all of the information that a prospective investor
may require to make a full analysis of the transaction.
•The terms of this presentation are qualified in their entirety by the Information Memorandum, which will be made available by RBS in respect of the transaction described
herein, which will supersede the terms hereof.
•This material is distributed on the express understanding that, whilst the information in it is believed to be reliable, it has not been independently verified by RBS. RBS
makes no representation or warranty (express or implied) of any nature, nor does RBS accept any responsibility or liability of any kind, with respect to the accuracy or
completeness of the information in this material. This shall not, however, restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations
of any jurisdiction, which may not lawfully be disclaimed.
•The Recipient of this document should make its own independent evaluation of the transaction and of the relevance and adequacy of the information in this document and
should make such other investigations as it deems necessary to determine whether to participate in the transaction.
•RBS, and its connected companies, employees or clients may have an interest in the Securities mentioned in this material. This may involve activities such as dealing in,
holding, acting as market-makers, or performing financial or advisory services, in relation to any of the Securities referred to in this document. RBS may also have acted as
a manager or co-manager of a public offering of such Securities, and may also have an investment banking relationship with any of the companies mentioned in this
material.
•Any views or opinions (including statements or forecasts) constitute the judgement of RBS as of the date indicated and are subject to change without notice. RBS does not
undertake to update this document. The Recipient should not rely on any representation or undertaking inconsistent with the above paragraphs.
•Outside the United States, this material is issued by The Royal Bank of Scotland plc which is authorised and regulated in the United Kingdom by the FSA. In the United
States, this document is issued by RBS Securities Inc. a member of FINRA and an indirect wholly-owned subsidiary of The Royal Bank of Scotland plc. RBS Securities Inc.
acts as agent for The Royal Bank of Scotland plc in connection with Securities activities in the United States.
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