PBOC’s new FX reserve requirement increases hedging costs for corporates
New move means higher opportunity costs which someone has to pay for
With the new FX reserve requirement notice issued by People's Bank of China (PBoC) effective on August 6, it is likely that CFOs and treasurers from China based MNCs will be subject to higher hedging costs.
According to PBoC, banks are required to deposit 20% of the notional amount of renminbi forward, options and swap contracts that they sell to the corporate clients. For example, if Bank A signs a futures contract with a notional of 10 million yuan, Bank A is required to deposit 2 million yuan to PBoC. The deposits at PBoC will be subject to zero interest rate.
While PBoC officials stated that the reserve deposit is only applicable to banks, market analysts believe that corporates will still be impacted as banks will eventually pass the costs to the corporates.
"From the banks' perspective, whether the deposits come from interbank market or their own capital, they are facing opportunity costs," notes a report from Lianxun Securities, "The costs will be transferred to the corporate clients in the end."
Corporates with FX exposure are able to hedge the FX risk through various derivatives while transferring the risks to banks. In a bid to hedge their own FX risks, banks buy foreign exchange in the spot market immediately after the futures contracts are sold to corporate clients, which then imposes pressure on the renminbi spot price. In other words, the expectation on future depreciation of renminbi accelerates its depreciation in the spot market.
It is not the first time that PBoC has intervened in the FX market by adjusting the FX reserve rate. When Renminbi experienced a sharp depreciation against US dollar following the FX reform in 2015, PBoC also raised the FX reserve requirement to 20% for the banks.
According to Lianxun Securities, instead of directly buying renminbi in the FX market, PBoC chose to fine-tune the existing regulation due to a lower cost of stabilising the exchange rate in the short term.
Currently, 667 qualified financial institutions are able to access the onshore interbank FX market. Data from China Foreign Exchange Trade System shows that the trading volume of the onshore FX spot market increased 4.1% YOY in 2018 Q1, while turnover of the FX derivative rose by 26% in the same period.
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10 Aug 2018