Last week’s debut of FX option transactions in China will enable onshore companies to better hedge their longer-term currency exposures, according to Deutsche Bank’s Beng-Hong Lee, head of FX trading, China. Effective April 1, the new rules, issued by the State Administration of Foreign Exchange (Safe), will allow trading of so-called European-style FX options between licensed local banks, institutions and corporations.
Options give the buyer the right, but not the obligation, to buy or sell currency at a specified exchange rate during a defined time period. European-style options can only be exercised at maturity.
“From a corporate perspective in China, this onshore FX option market is essential and is a major development,” said Lee. Deutsche Bank was among the first seven banks licensed by Safe for FX options trading, executing the first transaction which referenced US dollars and renminbi. All such transactions must be cleared through China Foreign Exchange Trade System (CFETS), the mainland’s inter-bank market clearing and settlement system.
“For 80% of companies, spots and forwards are sufficient, but for the other 20% when there is some uncertainly over cashflow, spots and forwards might not be the most efficient hedge. Effectively Safe is increasing the options open to corporates to manage their FX exposure,” said Lee.
Under the new rules, companies are only permitted to buy options and not sell them. The number of banks able to trade in the options is also limited to those with more than three years of experience in trading foreign-exchange forwards, as the mainland authorities look to ensure a smoother development of the renminbi and prevent speculation. Aside from Deutsche Bank, the list of licensed banks includes Bank of China, Bank of Communications, ICBC and HSBC.
“We have a lot of companies at the end of the year come to us wanting some longer-dated hedges to manage their expected exposure,” said Lee. In particular, mainland-based companies that have large and uncertain foreign currency cashflows and have until now only been able to resort to spots and forwards, will be able to better manage longer-term foreign currency exposure.
The new regulations follow Safe’s circular in January which extends use of cross-currency swaps beyond the interbank market, and formally establishes the swaps as a new tool for firms to manage risk among qualified entities.
“If you measure, in terms of volume, how many corporates are going to use it, I don’t think it’s going to explode,” said Lee. “But there will be a gradual process where clients will slowly [learn] how to use this tool, in terms of them more effectively and efficiently hedging their FX risk within their business. So this is a big step, and it is a necessary step.”