By Ted Howard

China’s recent moves, including devaluing the RMB and cutting rates, have some treasurers reaching for their hedging playbooks.  

When China devalued the yuan back in early August, it was said that the Chinese government wanted to give the market a bigger role in the currency’s movement. Well, China certainly accomplished that mission, and then some. Since then global markets fell down, got up, and now are basically sitting on pins and needles waiting for the next big news event—good or bad.

For treasurers, what is certain is that volatility is back and is expected to remain elevated for a while, particularly in light of China, and coupled with a cycle of dollar-strengthening. Add in a touch of continuing central bank divergence (hawkish in the US, dovish elsewhere) and you have a veritable toxic brew that only an expert FX chemist can sort out.

What’s now important for treasurers is “recognizing that RMB is simply more volatile and perhaps entering a period of higher volatility,” said Amol Dhargalkar, managing director, global corporates sector, at Chatham Financial. “For anyone used to hedging with options, for example, costs have increased markedly in the last few weeks.”

The idea of having more market influence in the RMB’s daily movements was reportedly China’s way of getting the currency closer to international acceptance. It also wanted to, amid an economic slowdown, boost exports. The problem is the markets didn’t see it that way.

China was also likely trying to boost its chances of having the International Monetary Fund grant the RMB Special Drawing Rights (SDR) status. The SDR is an international reserve asset based on a basket of four major international currencies: the dollar, euro, pound and yen. The IMF will finish its twice-a-decade review by the end of the year, and prior to China’s currency moves, there was speculation that getting the SDR status was a fait accompli. However, following the devaluation, the IMF announced a delay in granting SDR status until September 2016.

According to a note from Standard Chartered, the IMF was always a little hesitant about the onshore yuan, and has questioned whether it was sufficiently “freely usable.” The problem, as the Wall Street Journal noted recently, is China’s “two-yuan dilemma”; that is, the onshore RMB, or CNY, has a different value (and more restrictions) than its offshore cousin in Hong Kong (CNH).

“For the offshore CNY (CNH) market to be counted as a valid hedging market, there should be much greater CNY-CNH spot convergence. Full convertibility is not required for SDR, but being ‘freely usable’ is,” Standard Chartered noted.

And the Peoples Bank of China may be setting the stage for greater convergence as it recently opened up its onshore CNY FX rates for cross-border transactions. With this move toward converging onshore and offshore RMB FX rates, Standard Chartered notes:

The PBOC has expanded the scope of RMB FX conversions for cross-border transactions by allowing onshore agent banks, offshore clearing banks and offshore participating banks to buy and sell RMB for goods trade, services trade and direct investment transactions using the onshore CNY FX rate. Under the new rules, onshore agent banks, offshore clearing banks, and offshore participating banks will be able to trade spot, forward and swap transactions and are no longer subject to a 90-day FX conversion window.  

This comes amid speculation that the IMF remains uncertain and concerns that the yuan may yet fail, even after the delay. In its recent report announcing the delay, the IMF said that the nine-month extension “would also allow users sufficient lead time to adjust in the event that a decision were to be taken to add a new currency to the SDR basket.” Hardly a ringing endorsement.

While the world waits for the decision on whether the IMF will or won’t grant SDR status, many have been left to wonder if the recent chaos will have any impact on the RMB’s internationalization. Most agree that the RMB’s rise will continue. “If anything, liberalizing the currency may actually help in the long-run attempts to internationalize the RMB,” says Chatham’s Mr. Dhargalkar.

In the meantime, what’s a treasurer to do? In a spring session of The NeuGroup’s Assistant Treasurers’ Peer Group, members heard of a few strategies to deal with the up-and-down nature of the markets. One presentation suggested that while forwards dominate as the go-to hedge instrument for FX exposure, options continue to be seen as a tool for hedging uncertain exposures (see other tools, chart above).

And while China’s turmoil may prompt more hedging rigor, it’s not necessarily bad for all companies. One treasurer at a company that sources out of China says the company is a “net beneficiary” of the problems. “So we now may go back and lean on our suppliers for better pricing,” he says. “And if you’re billing in RMB, you’re in good shape.” On the other hand, the treasurer says, the issue really isn’t so much about spot RMB rates than it is about an economic slowdown in China. “And that affects all companies. China won’t be buying much anymore, including US debt.” The treasurer also pointed out that in context, the RMB’s moves pale in comparison to the euro over the past five years. “It’s one third of the change in the value of the euro.”