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| Hong Kong Exchanges and Clearing chairman Chow Chung-kong (L) and Hong Kong chief executive Leung Chun-ying pose before hitting a gong during the launch ceremony of the Shanghai-Hong Kong Stock Connect in Hong Kong November 17 |
The impact on the offshore spot currency market has been relatively muted since the launch of the landmark HK-Shanghai Stock Connect. By contrast, it has kicked off a quiet revolution in funding arbitrage opportunities with corporates issuing in the CNH market and swapping back into dollars.
The Connect allows investors in Hong Kong and China to trade each other’s stocks by trading on the Hong Kong Stock Exchange and the Shanghai Stock Exchange. The significance for Hong Kong is greater as it allows the city to position itself as the gateway to China for global investors.
As the biggest pool of RMB liquidity outside of China, banks and investors in Hong Kong went into overdrive pre-funding their CNH accounts in the lead up to the launch, in anticipation of high demand for the currency for trading on the connect.
CNH rates shot up significantly, with the CNH Hibor touching 7% in October at one point before retreating back to under 2%. Cash volumes during the summer were also elevated.
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We are going to see more conversions of other currencies into the RMB, so yields might come down instead of going up
Jeffrey Yap
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According to Jessica Roberts, global head of CNH at EBS – Icap’s FX trading arm – there were four consecutive months of growth in CNH volumes on EBS ahead of the launch of the Stock Connect during the summer.
EBS markets head Darryl Hooker also pointed out that CNH bid-ask spreads, especially with the US dollar, have reduced by almost 60% since the beginning of the year, indicating increased liquidity in the pair. “Overall spread compression has halved over the last nine months,” he says.
However, CNH forward implied and cross-currency swap (CCS) yields saw the most dramatic impacts, with one-month CNH forward implied yields up 225 basis points to 3.3% and three-year CNH CCS yields up 186bp to 2.89% since April compared with a 45bp change in the Hibor and CD rate, according to a November 14 research report by Deutsche Bank.
Linan Liu, greater China rates and FX strategist at Deutsche Bank in Hong Kong, attributes this rise to global banks pre-funding in CNH for their own, or their clients’, accounts.
“Most global banks have a limited pool of offshore RMB deposits, but do have relatively easy and cheap financing access to the US dollar,” she says. “They tend to convert dollars into RMB in the spot market and then sell RMB and buy dollar back in the forward market.
“That has been the driver of the changing level of the forward curve, which also affects the CCS curve.”
Heightened flows
According to Liu, corporate flows into the CNH bond market have been especially heightened as offshore CCS rates have been attractive compared to issuing US dollar bonds.
“Because the CNH CCS curve is quite high now, it actually makes a lot of sense to issue in CNH,” she says. “By issuing in CNH and converting into dollar [via the CCS route], a corporate can save in terms of implied spread over the dollar-Libor funding cost compared to borrowing directly by issuing USD bonds.”
According to analysis by Standard Chartered Bank in a November 18 research note, a similar dynamic was at place for CNH-KRW CCS. Korean corporates can shave off close to 150bp issuing in CNH and swapping back into KRW compared to issuing directly in KRW, according to the note.
The tightness in liquidity implied by elevated spot and forward rates, however, is reverting back to normal levels as mainland-bound flows have continued to remain muted since the launch of the stock connect.
After the first day, which saw CNH11.2 billion (or about 1.2% of Hong Kong’s RMB deposit base, according to Standard Chartered Research) of flows to the Shanghai Stock Exchange, demand quickly moved down to close to CNH2 billion in the ensuing week.
Additionally, a quota of RMB300 billion in northbound trading as well as various intraday and emergency RMB liquidity facilities by the Hong Kong Monetary Authority have calmed any fears of a liquidity crunch.
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CNH forward rates have moved downwards, especially since the 40bp cut in lending rates by the People’s Bank of China on November 21. According to Jeffrey Yap, managing partner and chief investment officer at Hong Kong-based hedge fund Ark One, CNH forward implied and CCS rates have come down by about 50bp on the short end and 25bp on the long end.
Liu at Deutsche Bank adds that the curve is also affected by corporate flows. Liability swapping by corporates using CCS has pulled down the medium to long end of the CCS curve. CNH bond yields, on the other hand, have proven stickier as offshore yields are also impacted by the differences in legal and tax frameworks between the onshore and offshore bond markets.
According to Yap at Ark One, the scope of the funding arbitrage using CCS will become limited as swap rates go down quicker than bond rates.
“[Bond] yields are going to eventually come down to catch up with the drop in CCS and once that happens we could see the issuers coming back into the market,” he says.
Yap adds that liquidity in the CNH market will rise instead of tightening as volumes pick up in the stock connect.
“We anticipate that there could be more liquidity flowing into the CNH market, as investors look at investing in mainland stocks through the Stock Connect or if they are interested in investing in other RMB assets,” he says. “In both cases, we are going to see more conversions of other currencies into the RMB, so yields might come down further instead of going up.”