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Yuan midpoint/spot divergence to change hedging trends-StanChart

Monday, 8 Oct 2012 | 6:23 AM ET

HONG KONG, Oct 8 (Reuters) - The divergence between the yuan's official midpoint fixing and spot rate due to its expanded trading band will shift more business to the offshore yuan deliverable (CNH) market from the non-deliverable forward (NDF) market due to a need to hedge exposure, Standard Chartered Bank said on Monday.

The NDF market, directly linked to the midpoint set by the People's Bank of China (PBOC) each day, was frequently used by foreign firms before the CNH market was launched two years ago as it was one of the few ways to reduce yuan currency risks.

However, with the yuan's daily trading range against the dollar extended to 1 percent from 0.5 percent, it is common for the spot rate to deviate more and more from the midpoint, making corporates with NDF contracts less protected.

The yuan is allowed to rise or fall 1 percent against the dollar on a daily basis from a midpoint set by the PBOC.

"The change in the performance of the exchange rate onshore means the NDF market is going to be less important going forward and there will be more focus on CNH trading in the offshore market, either in spot, forward or options markets," Robert Minikin, senior FX strategist at Standard Chartered, told reporters.

The PBOC expanded the yuan's daily trading band against the dollar in April, in a milestone move underscoring its ambition to internationalise the use of the Chinese currency.

The CNH spot and forwards markets are both deliverable and allow for corporates to better hedge risks, while the close link between the two markets is also clearly desirable, he added.

Onshore yuan weakened slightly against the dollar on Monday after touching a record high of 6.2812 in early trade and nearly hitting the upward trading limit of 1 percent compared to the fixing of 6.3426.

Standard Chartered expects the yuan exchange rate to stand at 6.31 and 6.19 at the end of 2012 and 2013, respectively, since weakness in the export sector remains a concern and no clear appreciation trend is seen for the yuan this year.

COMPETITION WITH TAIWAN

The central banks of China and Taiwan signed an agreement on a clearing system for each other's currency in September and Taiwan banks have been sparing no effort preparing to seize opportunities arising from offshore yuan business.

Market players in Hong Kong are worried Taiwan's participation may divert fund flows from the territory, as some Taiwan corporates which used to rely on Hong Kong for yuan trade settlement may switch to Taiwan.

However, Kelvin Lau, regional economist at Standard Chartered, did not see direct competition from Taiwan. He believes Taiwan's yuan market development lies more with local banks taking part in the new business and drawing in yuan from the mainland China.

"Taiwan has its own channel to build up yuan liquidity, which makes it less likely to divert funds and business from Hong Kong," Lau said, noting more yuan outflows from the mainland will also benefit Hong Kong.

The bank expects yuan deposits in Taiwan to grow rapidly in the first year, reaching 150 billion yuan ($23.9 billion) by the end of 2013, though it would still be only 2 percent of total deposits. It could rise to 5 percent of the deposits by 2015 before eventually topping out at 30-35 percent.

Yuan deposits in Hong Kong stood at 552.3 billion yuan ($87.63 billion) by the end of August, representing 8.7 percent of total deposits.

($1 = 6.2849 Chinese yuan)

(Reporting by Michelle Chen; Editing by Jacqueline Wong)

((michelle.chen@thomsonreuters.com)(+852 2843 6587)(Reuters Messaging: min.chen.thomsonreuters.com@reuters.net))

Keywords: MARKETS OFFSHORE/YUAN

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