China is urging banks to encourage clients to hedge against currency risks after the yuan appreciated by about 6% over a year, impacting exporters' profits amidst soaring energy and metal costs.
On September 14, 2569, at 10.22:1 AM, Bloomberg News reported that Chinese foreign exchange regulators in several regions are pressuring banks to support business clients in increasing foreign exchange hedging after the yuan appreciated by about 6% against the US dollar over the past year, becoming the best-performing currency in Asia and putting increased pressure on Chinese exporters.
Sources indicate that at least two regional branches of China's State Administration of Foreign Exchange (SAFE) have mandated banks to increase the proportion of yuan hedging for their clients, setting specific targets for this business and summoning banks that fall short of their targets for discussions.
Regulatory pressure has led some banks to increase incentives for customers to hedge against currency risk, by offering better terms and more flexible transaction structures. Meanwhile, SAFE in some regions is also subsidizing local companies that follow these guidelines.
The Chinese authorities' move comes as the yuan has appreciated by approximately 6% against the dollar over the past year, posing challenges to exports. At the same time, the Chinese economy faces pressure from weak investment and sluggish domestic consumption, forcing the government to prioritize maintaining the strength of exports, a key driver of the economy.
Dariusz Kowalczyk, Head of Cross-Asset Strategy for Asia at BBVA, stated that soaring energy prices driven by the ongoing conflict in the Middle East, coupled with rising metal prices, will squeeze the profit margins of Chinese exporters. In this environment, companies need to mitigate exchange rate volatility, even if it means incurring hedging costs.
Although Chinese companies have made significant progress in using financial instruments to manage currency risk over the past decade, data compiled by Bloomberg indicates that the percentage of Chinese companies hedging the yuan has fallen to 36.84% in July from a record high of 38.92% in June.
SAFE states that as economic and trade relations between China and other countries become more interconnected, companies need to pay more attention to managing exchange rate risks in cross-border trade and investment.
Businesses can choose risk management methods that suit their specific circumstances, such as natural hedging by balancing revenue and expenses in foreign currencies, adjusting pricing and invoicing currencies, and passing on costs. Derivatives are another tool for managing currency risk.
The appreciation of the yuan has become an increasing burden for Chinese exporters this year, causing many companies to face exchange rate losses and impacting their profitability. For example, Guangdong TCL Smart Home Appliances, listed on the Shenzhen Stock Exchange, reported a nearly 20% drop in net profit in the first half of the year compared to the same period last year, primarily due to significant exchange rate losses.
China has been promoting a policy for years to raise awareness among businesses about the importance of hedging against exchange rate risks. This is partly in preparation for the long-term goal of enhancing the role of the yuan, which may eventually challenge the dollar in the global financial system.
These efforts began to bear fruit, with the volume of yuan options trading conducted by banks on behalf of clients reaching a record high of $1.108 billion in June, before declining in the following month.
For domestic yuan hedging transactions in July, forward contracts accounted for the highest proportion at 37%, followed by options at 32% and swaps at 30%.
Sources indicate that, in order to meet regulatory targets, some banks are incentivizing clients to fully engage in hedging, even lowering their own profit margins. Meanwhile, some banks are negotiating with clients to convert spot yuan trading into short-term forward contracts to increase derivatives trading volume.
Furthermore, banks are incentivized to offer hybrid transactions comprising multiple options because they can result in a reported principal value at least twice that of using forward contracts.
A Bloomberg review of publicly available data reveals that SAFE's branches in several provinces, including Zhejiang, Henan, Hebei, and Yunnan, have implemented financial incentives for currency hedging companies since last year. These incentives include subsidizing part or all of option premiums and providing direct financial support.
SAFE reported that in the first seven months of this year, the contract value of foreign exchange derivatives used for hedging exceeded $1.6 trillion, an increase of more than 40% compared to the same period last year.
While the FX Hedging Ratio, the proportion of hedging transactions to all foreign exchange transactions in the business sector, stood at 35.5%, an increase of 5.5 percentage points from the level for the whole of 2568.
SAFE stated that the bank has a variety of exchange rate risk management products and services based on market mechanisms and the diverse needs of different business sectors. The bank is committed to promoting a "risk-neutral" approach to exchange rate management and enhancing its capacity to cope with currency volatility risks.
Zhaopeng Xing, Senior China Strategist at Australia & New Zealand Banking Group (ANZ), stated that many listed companies with overseas operations continue to report significant foreign exchange losses. The actual damage, coupled with increased awareness of market risk, is likely to encourage Chinese companies to increasingly utilize hedging tools.
Reference: bloomberg.com
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