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Beijing to launch yuan options trading
Reuters in Beijing
4:26pm, Feb 16, 2011


China will launch yuan options trading, the government said on
Wednesday, a market that will help pave the way for a more flexible
exchange rate but will be limited in scope at first.
The move is Beijing’s boldest attempt yet to give firms more hedging
tools to cope with steady yuan appreciation as well as uncertainties
in global currency rates.


“This marks an important step in the development of the yuan
derivatives market,” said Zhao Xijun, senior economist at Renmin
University in Beijing. “The exchange rate regime will become more
market-oriented and the yuan will be more flexible.”

The foreign exchange regulator said that onshore options trading will
be restricted to firms and banks using it for hedging purposes rather
than for speculation about currency fluctuations.

Yuan options are currently tradable in the offshore market, primarily
in Hong Kong. Within China, firms have been able to use forward
contacts to hedge their foreign exchange exposure.

The State Administration of Foreign Exchange said that the yuan was
now sufficiently flexible to merit onshore options. It added that its
launch on April 1 would just be the first step in developing an
onshore market.

“The key purpose for the options is to eventually hand over the
function of setting the yuan’s exchange rate to the market, and in
this sense, it is the biggest reform so far in China’s rigid currency
regime,” said a senior trader at a European bank in Shanghai.

The government keeps the yuan on a very tight leash and has allowed it
to rise just 3.5 per cent against the dollar since it was de-pegged in
mid-last year.

The regulator said that the onshore options would be European-style,
meaning that it would only be possible to exercise them when they
mature and not beforehand.

A currency option is the right – but not the obligation – to buy or
sell a set amount of one currency for another at a predetermined price
at a predetermined time in the future.

A key provision in the new rules is that firms will only be permitted
to trade call options, not put options, a defensive move that traders
said was meant to prevent short-selling and keep the options business
confined to genuine hedging.

Along with other restrictions such as strict vetting procedures for
banks seeking licences, traders expect that initial volumes will be low.

“With the yuan exchange rate becoming increasingly flexible, there is
greater demand from banks and firms to hedge FX risks through
derivative trading. This is the impetus for the launch of options
trading,” SAFE said.

“In the future, except for the appearance of some special situations,
such as global financial crisis, the yuan exchange rate will become
increasingly flexible.”

The move follows a stream of tweaks to foreign exchange policies in
recent months.

SAFE said at the end of December that it would let more banks sell
currency forwards to their clients to further develop demand along
with the nascent derivatives market.

It also published new rules at the end of last year classifying forex
market makers into a number of categories, clarifying which can handle
derivatives such as forwards and swaps, and opening up forex trading
to some smaller banks that had not been able to participate before.

The National Association of Financial Market Institutional Investors
(NAFMII), an industry association set up under the central bank, also
said late last year there were plans to develop more forex-based
derivatives to provide more opportunities to hedge risks.

The yuan rose against the dollar on Wednesday after an editorial in an
official newspaper urged the government to use the exchange rate as a
main weapon to fight imported inflation.

Sentiment towards the Chinese currency was also boosted after the
People’s Bank of China fixed a stronger yuan mid-point, only six pips
weaker than the fixing’s record high.

Spot yuan was trading at 6.5845 to the dollar at midday, up from
6.5885 at Tuesday’s close and within an arm’s reach of its record
trading high of 6.5808 set on January 24. It has now risen 3.67 per
cent since its de-pegging from the dollar in June last year.

Traders have long predicted the yuan will appreciate 5 to 6 per cent
this year as China is expected to use the currency as part of its
strategy to fight high consumer inflation at 4.9 per cent in January.

The China Securities Journal said in its editorial that the yuan’s
exchange rate had proved to be the most effective tool in pressing
down consumer prices and should be let appreciate to help curb
imported inflation.

The comments, which do not necessarily represent the voice of decision-
makers, indicated greater domestic support for a faster appreciation
of the currency, traders said.

“Chinese critics have long been fighting against US pressure for the
yuan to appreciate but their voices appear to be softening in recent
months along with surging global commodity prices,” said a European
bank dealer in Shanghai.

“We maintain the prediction for the yuan to appreciate 5 to 6 per cent
this year, with much of the appreciation being focused in the first
half.”

Before trading began, the PBOC fixed its daily mid-point at 6.5855 to
the dollar, up from Tuesday’s 6.5929 and compared with the fixing’s
record high of 6.5849 set on February 10.

The mid-point, from which the yuan can trade up or down a maximum 0.5
per cent in a given day, is the tool that the central bank uses to
express the government’s intention on the currency.

The PBOC has taken a slew of steps, including three official interest
rate hikes, since mid-October to fight high inflation.

An academic adviser to the central bank said in remarks published on
Wednesday that the government must continue tightening to tackle the
stubborn inflation.

On top of strong domestic food prices, surging global commodity prices
have contributed to inflation.

China is the world’s fastest growing market for staple commodities.
The benchmark Reuters Jefferies CRB index, which covers 19 mostly US-
traded commodities, has leapt around 35 per cent since June last year.

Data showed on Monday, China’s trade surplus fell to its lowest in
nine months in January after its import bill surged on rising
commodity prices.

Buoyed by the spot yuan’s strength, dollar/yuan offshore forwards fell
on Wednesday to imply more yuan appreciation in the future, traders
said.

Benchmark one-year dollar/yuan non-deliverable forwards were bid at
6.4240 at midday, versus 6.4330 at Tuesday’s close. Their implied yuan
appreciation in a year’s time rose to 2.56 per cent from 2.42 per cent.

But the NDFs’ implied yuan appreciation still lags market expectations
as dealers say hedge funds, the main players in the forwards cut back
on exposure to Asian emerging markets in favour of dollar assets as
the US economy recovers.