Sales jockeys sending yuan customers on to the rocks
Financial products based on confidence in an ever-rising yuan may turn out to be disastrous for buyers, given the currency's recent decline
Jake van der Kamp
China's central bank has decided to double the daily trading band for the yuan against the US dollar from tomorrow, marking a step forward in giving the currency more flexibility.
SCMP, March 16
Just tally up those calm, masterly words of assurance - "daily trading band" … "step forward" … "more flexibility".
They give you the impression that the captain is on the bridge of the ship, feet planted firm, hands behind his back, happy in the knowledge that the helmsman has the ship on course and there are no unexpected blips on the radar.
Except of course that this just might be the good ship Costa Concordia approaching an underwater rock with the captain not really knowing what risks he is taking.
The rock has a name, too. It's called a "target redemption forward" (TRF) and there are in fact a very large number of them out there. No one knows for sure but guesses run to upwards of US$300 billion worth and most of the holders are reportedly mainland companies.
Now let me make a confession here. I can give you a simple explanation of a TRF but for the nitty gritty go to the investment bank lawyers who devised them. It's my guess that a good number of people on bank dealing desks are also not fully up to speed on what they are selling.
In essence a TRF is a bit like that thing called an "accumulator", which in the 2008 financial crisis was nicknamed the "I'll kill you later" and did, in fact, kill a good number of fortunes. A TRF pays the holder the difference between a future series of market-determined prices or rates and a fixed strike price. It expires once the total payout reaches a target figure.
Still confused? Sorry, that's the best I can do.
The point is that if all goes well you get a very good return but if it goes wrong you cannot easily get out. Your exit price is based on future commitments and your bottom could be way, way down.
Why do banks sell these things to people?
Simple. As Jake's Sixth Rule of Investment holds, for every word you add to the instrument's name, you add at least 1 per cent to the fee.
A bank sales jockey (personal financial consultant, ha ha) slaving under the sales director's whip on the dealing desk to meet his monthly revenue target does not make much money if he sells you a yuan bond or accepts a yuan deposit from you.
They are distasteful to him anyway. With the bond or deposit, you can easily find a quoted price and relevant exchange rate at any time. Just flip a few pages in this business section or turn to a Bloomberg screen. It's what you call an on-screen market.
Bank sales jockeys don't like on-screen markets. They much prefer the off-screen ones where the price is whatever they say it is and you can't check if it's true, where they can slice off a huge commission for themselves and you will never know.
Thus with the yuan rising steadily against the US dollar all last year their pitch to customers was that a strong yuan is an absolute certainty. Beijing wills it, as anyone can see, and what Beijing wills, Beijing gets.
So why eat just plain rice when much tastier fare is on offer? You don't want just a yuan deposit or bond. You want something with some kick in it, something that will, let's say, double your money when the yuan only goes up a few notches.
And guess what, says the sales jockey, we've got just the thing for you right here.
Not everyone who is given the pitch bites. I am sure most people do not. But when the sales jockeys are told to ransack the world I am sure they can find US$300 billion of foolish money.
The word is now that if the exchange rate goes past 6.20 to the US dollar, a level already passed on the non-deliverable forwards market, there will be serious failures.
And if this starts to snowball, I would not give much for Beijing's conceit that it can play games with the yuan against the market. Hello, Costa Concordia.