China intends to build a strong onshore foreign-exchange market for the yuan, as the launch of exchange rate futures contracts for domestic investors is rapidly climbing up the work agenda of Beijing’s policymakers.
In a working paper released on Tuesday, researchers at the People’s Bank of China (PBOC), the nation’s central bank, called for the creation of a yuan futures market in China to help investors better hedge against currency risks.
A futures contract would allow investors to buy or sell a certain amount of yuan at a set price at a specific time in the future. This would allow investors to lock into an exchange rate to secure future business transactions and guard against bouts of appreciation or depreciation of the Chinese currency. It would also allow investors to speculate on the future value of the currency.
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The Hong Kong stock exchange, the Singapore Exchange and the Chicago Mercantile Exchange already offer futures contracts for offshore yuan trading. The Hong Kong exchange plans to launch “mini” futures in the first half of this year to meet the needs of small-market participants. However, domestic Chinese investors are not yet allowed to trade in foreign financial instruments, though the government said it is considering allowing them to do so.
The PBOC paper, written by researchers Lei Yao and Han Xintao, found extensive links between exchange rates in mainland “onshore” markets and those in “offshore” markets such as Hong Kong, London and Singapore.
“The one-way effect of the onshore [yuan exchange] rate on the offshore spot rate is more significant, and the futures price is more influential than the [real time] spot rate in offshore exchange rates,” the paper said.
The PBOC paper joined calls for building a global yuan financial centre in Shanghai, the country’s economic and financial hub. Creating a domestic centre for trading the yuan would be in line with the government’s dual-circulation economic strategy for the country to become more self-reliant to minimise the impact of external threats.
Jiang Yang and Tu Guangshao, two former vice-chairmen of the Chinese Securities Regulatory Commission, suggested to Beijing policymakers last month at the “two sessions” meetings of the National People’s Congress and Chinese People’s Political Consultative Conference that the country should accelerate the broadening of yuan exchange rate derivatives available in Shanghai, by expanding its product portfolio to include spot, forwards, futures, options and swaps contracts.
“It’s not hard, technically,” said Liu Shengjun, head of the Shanghai-based China Financial Reform Institute. “It should already be in the final stage for approval.”
The launch of such a market would help millions of Chinese exporters better hedge against the exchange rate risks. At the same time, it could attract more international investors to buy yuan-denominated assets, given concerns about the sharp rise in global liquidity due to US economic stimulus efforts.
“It would be China’s strategic choice and opportunity,” Liu added.
Beijing’s endeavour to promote more overseas use of its currency has progressed slowly and still lags far behind that of the US dollar, despite the fall in the dollar’s global shares of payments, transactions and foreign exchange reserves in recent years.
We need to strengthen monitoring of global yuan flow … and steadily promote internationalisation
People’s Bank of China working paper
A lack of progress forced policymakers to adjust their internationalisation strategy last year, and the creation of an onshore futures market is widely believed to be vital to the building of a global yuan exchange rate market.
“We need to strengthen monitoring of global yuan flows, asset allocation and price changes, improve the macro-prudential assessment of exchange rates and steadily promote internationalisation,” the PBOC working paper said.
China’s rapid economic recovery from the coronavirus, coupled with better returns on offer from domestic stock and bond investments, has made China a magnet for international investors. It surpassed the US to become the world’s largest foreign direct investment recipient nation last year, attracting US$163 billion. At the same time, foreign investors’ holdings of Chinese bonds rose 62 per cent from a year earlier to 3.7 trillion yuan (US$565 billion) at the end of February.
Yuan futures trading will most likely begin on the Shanghai-based China Financial Futures Exchange, which now offers stock index futures and treasury bond futures, with its transactional value rising to 115 million yuan last year, up 65.8 per cent from 2019.
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