Offshore yuan in liquidity crunch as PBOC reportedly cracks down on cross-border arbitrage

CNH interbank offered rates spiked this week after China’s central bank was reported to have halted cross-border interbank lending

PUBLISHED : Friday, 20 November, 2015, 9:54pm
UPDATED : Friday, 20 November, 2015, 10:19pm

Offshore yuan liquidity has been tightening this week after unconfirmed reports that mainland Chinese authorities implemented unconventional measures to crack down on cross border yuan arbitrage, which traders say is a highly unusual move given the currency is counting down to a key decision at the end of the month.

The Hong Kong interbank offered rates (Hibor) for offshore yuan, or CNH, have been ticking up from Monday. The overnight rate spiked to 4.9 per cent on Wednesday and fell marginally to 3.7 per cent on Friday, compared to just 1.5 per cent in the past few weeks.

Likewise, one-week and one-month CNH Hibor also advanced around 2 per cent this week.

The jump followed media reports, including Reuters and Bloomberg, that the People’s Bank of China had given verbal guidance to certain onshore banks to halt onshore lending to offshore banks, a key source of CNH liquidity in Hong Kong, as well as raising margin requirements on bond repurchases.

The PBOC has made no official statement on the reports.

The moves, if true, are tailored to stop cross-border CNY and CNH arbitrage, which would be oddly timed given that a quinquennial review is underway by the International Monetary Fund on whether to include yuan in the Special Drawing Rights, a decision that would give the currency a confidence boost.

“Regulation fine-tuning happens from time to time. I’m not entirely surprised by the actions, but I am by the timing,” said Cynthia Wong, head of emerging
markets, Asia, Hong Kong and Singapore, at Societe Generale. “I’d expect there would be more easing of cross border flows and convertibility in the run-up to the SDR review, instead of curbing flows.”

She added: “One of the goals was to converge the CNY and CNH gap, rather than influencing spot yuan trading level.”

The CNY and CNH markets have been fraught with carry trades that hoped to profit from the differences between the two exchange rates when the yuan was a one-way up bet and when the CNH had been trading higher than the CNY.

The surprise devaluation of the yuan in August, triggered by a reform in the currency’s central parity rate fixing mechanism, immediately triggered a drastic unwinding of USD/CNH positions. As a result, CNH has been under constant pressure to weaken. On Friday evening it traded at 6.4169 against the US dollar, the weakest level in nearly two months, while CNY closed stable at 6.3835.

“The problem is the unwinding of the USD/CNH carry trade, which is still ongoing, although at a gradual pace. So there’s natural pressure in the market to sell USD/CNH,” said Gerrard Katz, managing director and head of Asia FX at Scotiabank.

“This guidance given by PBOC, if true, is quite unusual. I don’t think I have ever seen anything like this before,” he added.

The Ministry of Finance will issue 10 billion yuan (HK$12 billion) of dim sum bonds via the Hong Kong Monetary Authority’s Central Money Markets Unit Platform next Thursday, HKMA said on Friday.

Although new bond issuance would hold back funds and therefore withdraw liquidity from the market, given the relatively small size of issuance it should have no material impact, Societe Generale’s Wong said.