Chinese Companies Caught in Yuan Riptide; Bets by Firms and Individuals on a Rise in Currency Face Losses as Country Changes Tack

Chinese Companies Caught in Yuan Riptide

Bets by Firms and Individuals on a Rise in Currency Face Losses as Country Changes Tack

ANJANI TRIVEDI

Updated March 17, 2014 11:14 p.m. ET

China’s yuan weakened against the U.S. dollar Monday after the central bank doubled the currency’s daily trading band. The WSJ’s Jake Lee talks to CIBC’s Asia strategist about the effects this move will have on the yuan.

China’s decision to squeeze speculators out of its currency is causing pain for local companies and individual investors.

The yuan fell on Monday to its lowest level in 10 months against the dollar after the government over the weekend doubled the currency’s daily trading range. The decision, foreshadowed by months of hints by Chinese officials, followed a weekslong campaign by the country’s central bank to weaken the yuan.

China is attempting to reduce the amount of money flowing into the country from foreign investors looking to profit on a rise in the yuan. The government sees this cash as inflating asset prices and making the economy more vulnerable to financial shocks.

But the currency’s decline is having a broader impact, particularly on Chinese companies that had placed bets on an appreciating yuan, traders and analysts say.

These companies have placed such bets in recent years to guarantee steady revenue from exports as the currency’s value climbed steadily against the dollar.

Many companies borrow money to make these trades, magnifying gains when the yuan rises but opening them up to big losses if the currency falls.

With the yuan down 2% against the dollar this year, more of the bets are losing money, said Geoff Kendrick, head of Asian currencies and rates at Morgan StanleyMS +0.87%

He estimates that paper losses on one popular way companies hedge their yuan exposure and individual investors bet on the yuan, through what is known as target redemption-forward products, have hit $2.3 billion, on contracts valued at $150 billion.

Beng-Hong Lee, head of markets for China at Deutsche Bank AG DBK.XE +1.01% in Shanghai, says his corporate clients are concerned about how much more the currency will depreciate.

“In the past, when the [yuan] had a clear one-way trend, it used to be really easy for corporates. But now, with two-way volatility it becomes very tricky for them to manage,” he said. “It’s going to be a very different market from here.”

A smaller portion of these bets are made by private-banking clients and wealthy individuals.

Janet Chong, who oversees all wealth-management products at DBS Bank Ltd.’s consumer-banking and wealth-management group in Hong Kong, says her clients are now looking for products that don’t depend on one-way appreciation of the yuan. Many are holding on to contracts with current paper losses that mature in one year.

The problems exporters face with their bets are an example of what is in store for investors and companies as China loosens currency controls and implements broader financial controls. These changes may clear the way for rapid, sustainable economic growth by encouraging domestic consumption and investment. But avoiding collateral damage along the way is proving difficult.

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“There are always unintended consequences to significant changes in fiscal and monetary policies,” said Adrian Miller, director of fixed-income strategy at GMP Securities in New York. “Over the long term these moves are needed and should be positive” on balance for individuals and companies alike, he said.

For now, most of the losses remain on paper because investors and companies haven’t yet sold their positions. However, banks are asking both corporate and individual clients with losing bets to pony up more collateral, traders in Hong Kong say. Banks also are advising companies to restructure their investments around weaker levels for the yuan, a cheaper alternative than completely unwinding millions of dollars of the products, which were originally designed to help companies hedge against gains in the yuan.

While the recent declines likely aren’t big enough to trigger a stampede out of the yuan, the added volatility in the exchange rate may give some investors pause.

The wider trading band also means there is more scope now for the yuan to depreciate on a day-to-day basis, which makes the yuan less of a guaranteed source of returns for many investors.

“If the currency appreciation is no slam dunk anymore…part of the attraction of owning Chinese equities and bonds is being erased,” said Greg Anderson, global head of foreign-exchange strategy for BMO Capital Markets, a subsidiary of BMO Financial Group. “The result will probably be less foreign portfolio investment in China.”

Foreign-exchange options, including these leveraged wagers, are traded over the counter, via the phone, email and other broker networks, rather than on an exchange. As a result, the marketplace is opaque, with little regulatory oversight.

Losses have been limited so far because the currency’s descent remains controlled. The yuan rarely moves to either the top or bottom end of the trading band, and many investors that had been betting on the yuan’s gains say the currency will soon go back to rising.

For some companies, losses on yuan bets will be offset by the benefits of a weaker currency, including lower operating costs and increased demand for their exports.

“Some hedge funds are closing up positions,” said Millie Yim, Asia-Pacific managing director of currency sales at Bank of New York Mellon BK +0.72% in Hong Kong. “Still we believe the yuan will appreciate in the long term. But it may just weaken first before strengthening again.”

Even a small drop in the yuan could trigger big losses. Many investors are vulnerable if the yuan weakens to 6.20 to the dollar, said Khoon Goh, a currency strategist at Australia & New Zealand Banking Group Ltd. ANZ.AU +0.87%

The yuan traded at 6.1781 to the dollar on Monday.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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