One-month CNH forwards moved into positive territory, compared with -4/-5 last week, after the HKMA allowed netting of open positions in deliverable CNH forwards. Positions are limited to 10% of a bank’s overall CNH assets or liabilities, whichever is larger.
Banks are able to place CNH on deposit with the Bank of China’s Hong Kong branch at a rate of about 0.5%. However, offshore banks with units in Hong Kong are faced with constraints in transferring customer deposits because this consumes their internal money market lines.
At the same time, banks have been faced with an insatiable demand from investors to own CNH-denominated assets, based on the view that the Chinese currency will continue to appreciate, while there is a limited supply of available instruments to invest in, because the CNH-denominated bond and equity markets are in the early stages of their development.
“In the past, when the market sold spot CNH, investors had two choices. They could either use the money market limit to deposit it and get some basis points, or roll it forward in the CNH forward market,” says a chief non-deliverable-forward trader at a UK-based bank.
The large build-up of CNH balances, the limited capacity on money market lines for deposits and restrictions on open positions in the forward market meant that the forwards began to price in an implied negative yield, because banks would be forced to clear their forward positions to stay within the 10% limit.
The decision by the HKMA to allow netting now means that the CNH forward market is likely to begin pricing like a conventional market, where the forward points reflect the interest-rate differential between CNH interest rates and US rates. Price action suggests that this is already happening.
“Eventually, once the full detail is known, we should see [as with all interest-rate markets] the FX curve implied interest rate move in line with the differential in rates between dollars and CNH,” says another NDF trader.