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Deutsche Bank Markets Research

Asia China

Economics Foreign Exchange FX Spot

Date 25 October 2013

CNH Market Monitor The burgeoning CNH FX option market

________________________________________________________________________________________________________________

Deutsche Bank AG/Hong Kong

DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013.

Linan Liu

Strategist (+852) 2203 8709 [email protected]

Perry Kojodjojo

Strategist (+852) 2203 6153 [email protected]

The burgeoning CNH FX option market: Since the beginning of 2013, the CNH FX option market has seen significant growth in three dimensions – turnover, option products’ sophistication, and market participation. The vibrant growth in the CNH FX option market has been supported primarily by: (a) substantial growth in offshore RMB FX turnover this year as RMB is being progressively adopted as the settlement/invoice currency for cross-border trade and investment by a growing number of global corporations; and (b) rapid development in the CNH structured FX products market.

We highlight two main themes in the CNH FX structured products market this year: (a) exporters (mostly in the Greater China region) enter CNH structured forwards to manage FX risk exposure; and (b) the birth of CNH structure notes market as investors’ demand for investments with a bullish RMB view met dealers’ demand for volatility hedging.

We believe structure flows have had four key effects on the USDCNH FX volatility market: (a) USDCNH FX implied volatility dropped to record lows; (b) USDCNH FX volatility curve steepened; (c) USDCNH FX volatility is a market of its own; and (d) impact of CNH structured forward flows on the USDCNH spot is more pronounced than on the USDCNH forward curve.

We see three key risk factors in CNH FX option pricing going forward: (a) Risk from a wider USDCNH spot FX intraday trading band; (b) Upside risk in USDCNH spot; and (c) upside risk in USDCNH FX volatility.

In conclusion, while the offshore RMB market is still in its early stages, we believe the burgeoning CNH FX option and structure products market in 2013 marks the start of what we term as ”the market sophistication stage” − a new market development stage underpinned by rapid product innovation, increased market liquidity and more efficient pricing discovery from underlying assets to FX and rates derivatives products. The imbalanced positioning in the structured product market suggests a need for the market to supply more quantity and variety of investment-type CNH structured products. We expect the CNH FX options and structure products market to continue to thrive in the coming years. At the same time, we believe it is important for market participants to analyze dynamics in market positioning and be mindful of the potential risks associated with structured products, such as low liquidity and crowded exposures, which will make the market vulnerable in the event direction of the underlying asset turns sharply.

CNH bond market Q4 supply outlook: We expect funding activities to resume, and we forecast Q4 net supply of RMB60bn, including the planned RMB10bn bonds to be issued by the Ministry of Finance.

Offshore RMB liquidity update: We estimate aggregate offshore RMB liquidity would be approximately RMB1,200bn by the end of September, equivalent to 1.18% of total onshore RMB deposit base. We believe offshore RMB liquidity growth is on track to reach our end-2013 projection of RMB1,275bn.

25 October 2013

CNH Market Monitor: The burgeoning CNH FX option market


The burgeoning CNH FX option market

The spotlight on the offshore RMB market this year has been the burgeoning CNH (offshore RMB) FX option market. The CNH FX option market started in late 2010, when daily turnover was about USD10mn. Back then, as onshore CNY option trading was not permitted, CNY NDF options were the predominant RMB option products. In April 2010, the CNY NDF option daily trading volume was USD5bn, roughly 2.42% of the global FX daily option turnover according to BIS Triennial Central Bank Survey. In the subsequent two years, growth in the CNH FX spot and forward markets overtook that in the CNY NDF market, although CNH FX option trading was at best sporadic with a wide bid-offer spread.

Since the beginning of 2013, the CNH FX option market has seen sizeable growth in three dimensions – turnover, option products’ sophistication, and market participation.

Turnover: We estimate CNH option daily turnover averaged about USD7bn this year, 700 times the 2010 level, implying a 780% annual growth rate in the past three years. Traded tenors extend from 1M-1Y to up to 5Y and single trade can be as much as USD300-–500mn. The sizeable growth in CNH option supersedes that in the onshore CNY deliverable FX options market and CNY NDF options market. Onshore CNY option trading started in 2011 when domestic corporations were allowed to trade risk reversals. Daily turnover of onshore CNY options is about USD5mn, but the bid-offer spread is 1 vol, about 5-10 times wider than that of CNH FX options. The CNH NDF options daily volume has not changed much from 2010 at about USD3bn per day. The CNH FX option turnover has surpassed the traditionally large FX option markets such as KRW, MYR, and TWD markets and has become the most actively traded FX option in the Asia offshore currency options market according to BIS Triennial Central Bank Survey.

The 2013 BIS Triennial Central Bank Survey shows RMB FX options (including CNY onshore options, CNY NDF options and CNH options) daily turnover reached USD17bn in April 2013, about 5% of average daily global FX option turnover, and ranked 6th globally based on preliminary statistics. This is particularly remarkable, as total RMB FX daily turnover (including spot, forwards, options, cross currency swaps and other derivatives) during the same period was just 2.2% of the global FX market daily turnover, the 9th most traded global currency.

The evolving RMB FX option market

In late 2010 Avg daily volume Avg ticket size Vol bid offer spread

Tenor

CNH option USD10m USD5m 2.0 1M to 1Y

NDF option USD3bn USD50m 0.2 1M up to 7Y

Onshore CNY option Not traded Not traded Not traded Not traded

In 2013

CNH option USD7bn USD50-100m 0.1-0.2 1W up to 10Y

NDF option USD3bn USD50-100mn 0.1-0.2 1M up to 10Y

Onshore CNY option USD5m USD5-10m 1.0 1M to 1YDeutsche Bank

Option products sophistication: In contrast to the onshore deliverable CNY option market where only plain vanilla (calls, puts) European options and risk reversals can be traded, the CNH FX option market now offers a wide range of option products including vanilla options and exotic/complex

25 October 2013



options such as digital options, barrier options (knock-in, knock out options), etc.

Figure 1: RMB FX turnover ranked #9th globally... Figure 2: RMB FX option turnover ranked #6 as of April

2013

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

1998 2001 2004 2007 2010 2013

% shares of global FX market avg daily turnover

0

50

100

150

200

250

300

350

USD JPY EUR GBP AUD CNY CHF CAD BRL MXN KRW

5% of globalFX option daily turnover

Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bank for International Settlement

Market participation: Before the CNH FX market emerged, CNY NDF FX option was the only offshore RMB market for hedge funds and dealers to take option positions. This year, with more corporations trading in the CNH FX option market, the spotlight appeared to have shifted to the CNH FX option market where better liquidity attracted hedge funds interests away from NDF options. Investment returns are hedge funds’ main trading purpose, and as they express their views on the direction and volatility of USDCNH spot/forwards, such trades tend to be “speculative” in nature. Growing participation by corporations with real FX hedging demand greatly changes the supply/demand balances in the CNH FX options market. In our view, corporate flows this year have set the trend of CNH options gradually substituting NDF options as the dominant offshore RMB option trade, similar to patterns of corporate flows seen in the CNH deliverable forwards and CNY NDF market since late 2010.

In our view, the vibrant growth in the CNH FX option market has been supported primarily by two factors:

Substantial growth in offshore RMB FX turnover this year as RMB is progressively adopted as the settlement/invoice currency for cross border trade and investment by a growing number of global corporations. From H2 2012 to 2013, more corporations switched to RMB for settlement purposes. Not only did FX trading volume grow in Hong Kong, RMB FX trading volume in London also more than tripled this year compared with that in early 2012. The 2013 BIS Triennial Central Bank Survey showed RMB trading surged from USD34bn in 2010 to USD120bn in April 2013, “mostly driven by a significant expansion of offshore RMB trading”. October data released by SWIFT suggested that 62% of RMB trading conducted outside China and Hong Kong was through London. We believe the launch of MNC’s RMB cross border inter-company loans pilot programme in Shanghai in Q4 last year, the expansion of RMB business in Taiwan, Singapore and London, and further relaxation of RMB cross border flows in July reinforced the market expectation that RMB is on the right track towards convertibility. Such expectation has led many corporations, who previously had doubts about the potential of RMB internationalization, to decisively shift their treasury/cash management/FX risk management to the CNH market. The entailing improvement in the

25 October 2013



underlying offshore RMB FX market liquidity has provided the necessary market condition for growth in RMB FX options market. In turn, the CNH FX option trading has boosted demand for trading the underlying CNH FX to hedge option risks.

Rapid development in the CNH structured FX products market. Structured FX products offer tailor-made risk management solutions to meet customer’s specific hedging and investment needs. The emergence of CNH structured FX products this year, in our view, reflects the rapid advancement of innovation in offshore RMB financial products. Such market development is possible because: (a) the CNH FX option market is free of regulatory constraints as those in the onshore market where only vanilla European and risk reversals can be traded, (b) the CNH FX option market offers flexibility of settlement for physical delivery or net settlement options; and (c) valuations of USDCNH forwards relative to onshore USDCNY forwards make it possible for corporations to capture attractive returns via structured forwards. We estimate trading of CNH structured forward has increased sharply this year with average daily turnover of USD3-5mn Vega per day at the beginning of the year and USD1mn Vega recently.

We highlight two main themes in the CNH FX structured products market this year.

(a) Exporters (mostly in the Greater China region) enter CNH structured forwards to manage FX risk exposures. Since the start of this year, we have seen a substantial increase in issuance of CNH structured forwards. We estimate about USD200bn notional of CNH structured forwards have traded in the market on a YTD basis, with over 60% of trading in Q1 when corporations were most active in hedging the risk of RMB appreciation in 2013. The most popular structure is Target Profit Forward (TPF, the structure sometimes carries different name, such as Target Redemption Forward [TRF], but the underlying structure is the same).

The TPF structure allows exporters to sell monthly USD receivables for up to two years, and the strike of USDCNH forward (for example 6.30) is usually much higher than USDCNH spot. On each fixing date, exporters profit from the differences between the USDCNH strike and spot fixing. Survival of the structure depends on whether the structure’s accumulated profits exceed the preset profit target; if so, the structure is knocked out and exporters will lock in gains. There are quite a few variations from the TPF structure by adding digital or other complex options.

Effectively, TPF allows exporters to sell optionality (sell USD calls/CNH puts) by achieving a high USDCNH forward strike. Once the structure is knocked out, as long as CNH does not depreciate much against USD, exporters tend to roll over the structure. Exporters are exposed to the upside risk of USDCNH spot, i.e. if USDCNH fixes above the strike (if USDCNH spot is at 6.35, above the strike at 6.30), exporters are obliged to sell USD at the strike.

Exporters positioning in the CNH structured forwards is net selling CNH FX vol/vega with limited gains (a present profit target) but potentially significant losses if USDCNH rises above the strike (although it is an event with very low probability). Dealers are naturally long vol/vega and need to hedge their positions by selling vol/vega to the market.

(b) The birth of CNH structure notes market as investors’ demand for investments with a bullish RMB view met with dealers’ demand for vol hedging. We believe commercial banks with a large corporate client

25 October 2013



base are long vega (mostly 1Y or under) in the market and they rely on the interbank market to redistribute their vol risk to other banks, as well as to institutional, private banking and retail investors. However, given the significant imbalances between corporations/dealers positioning, and considering the limited depth of the CNH FX option market, we think there remain sizeable residual vega risks concentrated among dealers. Meanwhile, a large supply of USDCNH vols from the structured forwards has created a relatively cheap investment opportunity for investors looking to express a bullish RMB view by buying CNH structure notes. Such investment demand, coupled with dealers hedging needs, has led to the development of a CNH-denominated structure notes market. These notes allow investors to take a bullish view on USDCNH and typically carry a 1Y term, with coupon payment linked to the pace of CNH appreciation against USD. Two popular structured notes are CNH pro-notes and CNH digital notes. CNH pro-notes allow investors to capture CNH appreciation vs. USD at a non-linear fashion, for example, a 20% coupon if CNH appreciates by 10%, while a limited loss of up to 5% of principal if CNH depreciates against USD. The CNH digital notes offer 100% principal protection but fix the coupon rate at a certain levels (say 6%) whenever CNH appreciates against USD over the 1Y period. Buyers of such CNH structured notes effectively purchase a USD put/CNH call option (or digital option) plus a CNH deposit for 1Y. We estimate about USD5bn of CNH structured notes have been issued YTD and are absorbed by retail demand from Asia, Europe and South America.

So how would the above-mentioned flows affect the CNH FX option pricing? We believe there are four main impacts:

USDCNH FX implied volatility dropped to record lows: Against the backdrop of a strong CNH this year (2.35% YTD appreciation vs. USD), the imbalances between corporate flows, dealers positioning, and institutional, hedge funds and retail flows have left the market with a net selling bias on USDCNH FX volatility, which pushed USDCNH implied volatility towards record lows (1.19 vol in 1M). We think USDCNY NDF implied volatility before 2013 and USDCNH implied volatility for 2013 are reliable measures of offshore RMB implied volatility − Figure 3 shows offshore USDRMB 1M implied volatility declined from 8.5 in October 2011 to a historical low of 1.19 in early September, and is currently at 1.3525. We believe vols-selling flows in Q1 and early Q3 were responsible for the declines in USDCNH FX implied vols, as during those periods, realized vols were not falling.

25 October 2013



Figure 3: CNH FX volatility is considerably lower than last

year

Figure 4: CNH FX implied volatility curve steepened.

0

1

2

3

4

5

6

7

8

9

10

Feb-11 Oct-11 Jun-12 Feb-13 Oct-13

USDCNH 1M ATM Implied Vol

USDCNYNDF 1M ATM Implied Vol

-0.1

0.1

0.3

0.5

0.7

0.9

1.1

1.3

1.5

Jan-13 Apr-13 Jul-13 Oct-13

2Y/1Y ATM implied vol spread

Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bloomberg Finance LP

USDCNH FX volatility curve steepened: The front end of the USDCNH FX implied volatility curve has steepened notably since the start of this year, partly attributable to structured forward flows which have vega exposure largely at or below 1Y tenor.

USDCNH FX volatility is a market of its own: CNH structured flows have resulted in unique dynamics in the CNH FX option market in 2013 – short-dated USDCNH implied vol has demonstrated very low beta to the VIX index and/or EURUSD FX vol. We attribute such behaviour to: (a) there is still a +/-1% spot USDCNY intraday trading band onshore, and USDCNH and USDCNY spot basis trading could have affected the pricing of USDCNH implied FX vol; (b) flows in the USDCNH FX vol market have been overwhelmingly one-way (selling) and relatively low participation by institutional and hedge fund investors to long vols compared with the equity and EURUSD vol markets.

Impact of CNH structured forward flows on USDCNH spot is more pronounced than on the USDCNH forward curve. Dealers delta-hedge their exposures in CNH structure forwards on USDCNH spot and the forward curve. In particular, we estimate in Q1 this year, delta hedging of the CNH structure forwards in the spot market roughly accounted for 30% of spot CNH turnover. However, as pricing of the forward curve has been driven by CNH funding demand and offshore RMB liquidity condition; dealers’ structure forwards-related hedging has been much less significant.

25 October 2013



Figure 5: Low correlation between CNH FX Vol and VIX

Index

Figure 6: Low beta to EURUSD volatility.

0

0.5

1

1.5

2

2.5

3

10

12

14

16

18

20

22


VIX Index USDCNH 1M ATM imp vol

0

0.5

1

1.5

2

2.5

3

6

6.5

7

7.5

8

8.5

9

9.5

10


EURUSD 1M ATM implied vol

USDCNH 1M ATM implied vol, RHS


We see three key risk factors in CNH FX option market pricing going forward:

Risk from a wider USDCNH spot FX intraday trading band: We expect the USDCNY spot intraday trading band to widen to +/-2%-2.5% in the next few months. The CNH FX option market is likely to see kneejerk reaction initially, and medium- to long-term implied vols will likely rise to reflect expectation of China increasing RMB’s two-way volatility till RMB becomes basically convertible in 2015-2016. However, as we expect the CNH structured market to maintain a strong growth pace, we believe corporations FX hedging activities as well as dealers and other players positioning are key to gauge the market’s risk/return profile.

Upside risk in USDCNH spot: In our view, the direction of USDCNH spot is risk to the structured forward market, as a halt in CNH appreciation vs. USD could cause corporations to recognise mark-to-market losses, and could trigger significant unwind/restructure of these structures. In this case, dealers are exposed to non-negligible counterparty risk from corporations with structured forward exposures.

Can USDCNH FX vol decline further?: Given that the outright USDCNH FX implied vol is hovering around historical lows, and considering the risk of Fed tapering early next year that provides support to USD strength and the risk of USDCNH spot FX band widening, we believe USDCNH FX vol curve is more likely to shift upwards. Moreover, the recent collapse in USDCNH forward makes structured forwards much less attractive now given the significant compression in CNH carry (from 3.5% in June to 1.67% currently).

In conclusion, while the offshore RMB market is still in its early stages, we believe the burgeoning CNH FX option and structure products market in 2013 marks the start of what we term as ”the market sophistication stage” − a new market development stage underpinned by rapid product innovation, increased market liquidity and more efficient pricing discovery from underlying assets to FX and rates derivatives products. The imbalanced positioning in the structured product market suggest a need for the market to supply more quantity and variety of investment-type CNH structured products. We expect the CNH FX options and structure products market to continue to thrive in the coming years. At the same time, we believe it is important for market participants to analyze dynamics in market positioning and be mindful of the potential risks associated with structured products, such as low liquidity and crowded exposures, which will make the market vulnerable in the event direction of the underlying asset turns sharply.

25 October 2013



CNH bond market: Q4 supply update

The rally since the beginning of July has pushed the CNH fixed income market back to the peak − the most liquid CNH bonds/CDs tracked by the S&P DB ORBIT Index returned 3.5% since 8 July, and the average yield of the market declined by 115bps to 4.05%. On an YTD basis, total return to CNH- and USD-based investors is 3.04% and 5.46%, respectively. On a currency-adjusted basis, CNH bonds outperformed significantly the USD-denominated Asia Investment Grade debt tracked by the JACI Index, which suffered a loss of 1.39% YTD (see graphs below)

In our view, the rally is attributable to both attractive valuations after the significant correction in June/July and the low volume of CNH bond supply in Q3. We estimate there was RMB58.5bn gross supply of CNH bonds/CDs in Q3, out of which net supply of CDs amounted to RMB22bn and net supply of bonds was at negative RMB7bn. Net supply in Q3 declined by 79.4% QoQ from that in Q2. In our view, weak sentiment in the global credit market driven by a re-pricing of Fed tapering was the main reason for the sharp slowdown of CNH bond supply in Q3. In the first three quarters, net supply of CDs /bonds was RMB150bn, of which bonds accounted for 40%.

We believe the pipeline of CNH bond issuance is now pushed to Q4 and with the US fiscal resolution in place, we expect funding activities to resume and we forecast Q4 net supply of RMB60bn, including the planned RMB10bn to be issued by the Ministry of Finance.

We believe the demand supply balances in the offshore RMB market suggests there is room for further rally supported by robust liquidity growth in the offshore RMB market (to be discussed below), which will be sufficient to absorb the potential net bond supply, in our view.

Figure 7: S&P DB ORBIT Index

Figure 8: Quarterly gross supply

(RMB bn)

86%

88%

90%

92%

94%

96%

98%

100%

102%

104%

106%

108%


JACI IG index DB S&P CNH Index USD

-20

0

20

40

60

80

100

120

Q1 Q2 Q3 Q4

Redemption Net supply: bond Net supply: CD


Linan Liu, Hong Kong, (+852) 2203 8709

September offshore RMB liquidity could have risen to RMB1200bn

RMB deposits in Hong Kong registered 26% YoY growth (2.09% MoM) in August to RMB709.5bn. Total RMB liquidity in Hong Kong including outstanding CDs rose 33% YoY to RMB904bn in August.

In Taiwan, RMB deposits rose to RMB98.66bn by the end of September vs. RMB17.45bn in 2012. RMB deposits with DBU (Domestic Banking Unit) accounted for about 67% of total RMB deposits balance in Taiwan, while OBU held 33%.

25 October 2013



Singapore saw strong growth in deposits after ICBC began to offer RMB clearing services earlier this year -- RMB deposits grew to RMB140bn+ by the end of July, according to MAS. We estimate that the aggregate offshore RMB liquidity would be approximately RMB1,200bn by the end of September, equivalent to 1.18% of total onshore RMB deposit base. We believe offshore RMB liquidity growth is on track to reach our end-2013 projection of RMB1,275bn.

Figure 9: RMB deposits reached

RMB1150bn in August

Figure 10: RMB deposits in Taiwan

(bn)

Hong Kong,

904, 79%

Taiwan, 85.141,

7%

Singapore, 140, 12%

London, 20, 2%

-

10

20

30

40

50

60

70

80

90

Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13

DBU RMB deposit OBU RMB deposit

Source: Deutsche Bank, HKMA, Bloomberg Finance LP Source: Deutsche Bank, CBC


RMB cross-currency swap line with European Central Bank

On 9 October 9th, the PBoC and the European Central Bank (ECB) signed a three-year RMB350bn/EUR45bn RMB-EUR bilateral currency swap agreement. It marked the first major financial cooperation between the PBoC and the ECB and it is the largest RMB swap line in Europe and the third-largest among the current outstanding swap lines between the PBoC and other central banks.

According to the ECB, “the swap arrangement has been established in the context of rapidly growing bilateral trade and investment between the euro area and China, as well as the need to ensure the stability of financial markets”.

The swap line is “intended to serve as a backstop liquidity facility and to reassure euro area banks of the continuous provision of Chinese yuan. It has been established at the level of the Eurosystem and will be available to all Eurosystem counterparties via national central banks.”

In September, the PBoC signed RMB bilateral swap agreements with Hungary’s central bank (RMB10bn) and Albania’s central bank (RMB2bn). The PBoC also renewed its RMB bilateral swap line with the central bank of Iceland, and Bank Indonesia. Currently, the PBoC has signed bilateral RMB swap agreements with 21 central banks in the amount of RMB2,484.5bn.

RMB swap line intends to be the last resort of offshore RMB liquidity provision. In the offshore RMB market, RMB liquidity is provided by the following channels:

(a) by RMB clearing banks for RMB cross-border settlement purpose −- currently RMB clearing banks include Bank of China (Hong Kong), Bank of China (Macao), Bank of China (Taipei) and Industrial and Commercial Bank of

25 October 2013



China (Singapore). This is the window for offshore corporations/individuals to access USDCNY exchange rate;

(b) by onshore correspondent banks − these banks provide RMB settlement services to offshore RMB participating banks;

(c) by accessing the offshore deliverable RMB market − offshore corporate and retail investors can buy/sell RMB in offshore markets at these markets’ prevailing RMB exchange rates. Hong Kong has the largest offshore RMB FX market (the CNH market), and considering offshore RMB markets are mostly fungible, offshore RMB traded in Taiwan, Singapore and London are very close to the CNH spot rate.

In the event of RMB liquidity shortage, when the above three channels fail to meet the market demand for RMB, those central banks who have an outstanding RMB bilateral swap agreement with the PBoC may activate the swap agreement and get RMB from the PBoC by pledging their own currency. In the CNH market, the HKMA currently has a RMB liquidity facility which can provide short-term RMB funds to RMB participating banks in Hong Kong, and the source of such funds is the HKD-RMB swap agreement between the HKMA and the PBoC. We understand only a few banks have approached this liquidity window since it was set up last year.

Figure 11: RMB cross currency swap line (CNY bn)

0 50 100 150 200 250 300 350 400 450

HKMAKorea

ECBSingapore

AustraliaUK

BrazilMalaysia

IndonesiaThailand

UAENew Zealand

UkraineHungary

MongoliaPakistan

TurkeyKazakhstanUzbekistan

IcelandAlabania

RMB swapline (RMB bn)

Source: Deutsche Bank, PBoC

RMB cross-border settlement volume up by 57% YoY during Q1-Q3 2013

In the first three quarters of this year, cumulative RMB cross-border settlement volume was RMB3.49tr, up 57% YoY. RMB trade settlement was RMB3.16tr, up 54.4% YoY, out of which 66%, or RMB2.07tr was for merchandise trade settlement. The share of RMB trade settlement in China’s global trade in September rose to 18.5% from 16.19% in August. In the first three quarters, 16.6% of China’s global trade was settled in RMB, up from 12% last year.

25 October 2013



From Q1 to Q3, RMB cross-border investment volume (RMB ODI and FDI) rose by 88% YoY to RMB 332bn. Cumulative RMB FDI from Q1 to Q3 was RMB280.3bn, roughly 50% of the total YTD FDI.

Figure 12: RMB trade settlement as

a share of China’s total trade

Figure 13: Quarterly RMB settlement

volume (RMB bn)

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

201

02

01

1Ja

n-1

2Fe

b-1

2M

ar-1

2A

pr-

12

May

-12

Jun-1

2Ju

l-12

Aug

-12

Se

p-1

2O

ct-1

2N

ov-

12

De

c-1

2Ja

n-1

3Fe

b-1

3M

ar-1

3A

pr-

13

May

-13

Jun-1

3Ju

l-13

Aug

-13

Se

p-1

3

Share of RMB settlement in China's global trade

0

200

400

600

800

1000

1200

1400

Q12012 Q22012 Q32012 Q42012 Q12013 Q22013 Q32013

Trade settlement Investment settlement

Source: Deutsche Bank Source: Deutsche Bank


25 October 2013



Spreads monitors

Cross-border spreads

Onshore vs. offshore spot Onshore vs. offshore 12m deliverable forwards

-2

-1.5

-1

-0.5

0

0.5

1

6.00

6.10

6.20

6.30

6.40

6.50

6.60

Jul-11 Apr-12 Jan-13 Oct-13

spread (RHS)USD/CNY spotUSD/CNH spot

pips (,000)

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

6.20

6.30

6.40

6.50


spread (RHS)USD/CNY 12M fwdsUSD/CNH 12M fwds

pips (,000)

Sources: Bloomberg Finance LP and Deutsche Bank. Sources: Bloomberg Finance LP and Deutsche Bank.

Offshore basis spreads

12m NDF vs. 12m offshore forwards

Implied appreciation NDF vs. CNH market*

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

6.10

6.20

6.30

6.40

6.50

6.60


spread (RHS)USD/CNY 12m NDFUSD/CNH 12m fwd

pips (,000)

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

1M 2M 3M 6M 9M 1Y

CNH forwards*

NDFs**

implied RMB appreciation (annualized)

using PBoC USD/CNY fixings as spotreference for NDFs

Sources: Bloomberg Finance LP and Deutsche Bank. Sources: Bloomberg Finance LP and Deutsche Bank.*using CNH spot for CNH forwards

Onshore-offshore spreads

12m NDF vs. 12m onshore forwards

Offshore CNH funding rate (6m)

-2

-1

0

1

2

6.15

6.25

6.35

6.45

6.55

6.65

6.75

6.85

Jan-10 Oct-10 Jul-11 Apr-12 Jan-13 Oct-13

spread (RHS)onshore USD/CNY 12m fwdoffshore USD/CNY 12m NDF

Pips ('000)

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

Oct-11 Mar-12 Jul-12 Dec-12 May-13 Oct-13

6M CNH fwd implied yld

6M CD

6M interbank offer rate


25 October 2013



Cross-market comparisons

RMB forward curves in various centers NDF implied appreciation vs. CNH-CNY spot spread

5.95

6.00

6.05

6.10

6.15

6.20

6.25

6.30

Spot 2M 4M 6M 8M 10M 1Y

USD/CNY (onshore fwds)USD/CNHNDF

Forward outrights (mid rates)

using PBoC USD/CNY fixings as spotreference for NDFs

-1.5-1.3-1.1-0.9-0.7-0.5-0.3-0.10.10.30.5

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%


12M NDF implied appreciation

USD/CNY - USD/CNH spread (RHS, inverted)

pips (,000)% annualized


CNY NEER basket USD/CNY spot fixings vs. USD-currency basket of key

trade partners

90

95

100

105

110

115

120

125

130

05 06 07 08 09 10 11 12 13

CNY NEER basket

6.15

6.20

6.25

6.30

6.35

6.40

84

86

88

90

92

94

96

Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13

USD basket of China's key trade partners (LHS)

USD/CNY Fix (RHS)

21 July 2005=100


25 October 2013



CNH bond issuance and total return monitor

Historical CNH bond yield at issuance CNH bond maturity profile (RMB bn)

0%

2%

4%

6%

8%

10%

12%

14%

Oct-06 Feb-08 Jul-09 Nov-10 Apr-12 Aug-13 Dec-14

1Y 2Y 3Y 5Y 7Y 15Y 30Y

-

50

100

150

200

250

300 Bond maturity CD maturity

Source: Deutsche Bank, company data Source: Deutsche Bank, company data

HK-China trade settlement vs. CNH deposit base

(RMB bn)

CNH fixed income market size (RMB bn)

304

14.5

0

100

200

300

400

500

600

700

800

-100

-50

0

50

100

150

200

250

300

350

400

Jun-10 Jun-11 Jun-12 Jun-13

Monthly HK-China cross-border settlement (RMB bn)Monthly increase in RMB deposit baseRMB Deposit base

0

100

200

300

400

500

600

Jul-08 Oct-09 Feb-11 May-12 Sep-13

Bond Outstandinbg CD Outstanding

Sources: Deutsche Bank, HKMA, PBoC Sources: Deutsche Bank, HKMA, Bloomberg Finance LP

S&P DB ORBIT (CNH Bond) Total Return Index S&P DB ORBIT Index (average yield %)

Index Code on Bloomberg: DBCNH Index – S&P DB ORBIT total return index in CNH DBCNHA Index – S&P DB ORBIT total return index (USD)

97

99

101

103

105

107

109

111

113

115

117

Mar-11 Aug-11 Jan-12 Jun-12 Dec-12 May-13 Oct-13

DB CNH bond index (CNH total return)

DB CNH bond index (USD total return)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Mar-11 Aug-11 Jan-12 Jun-12 Dec-12 May-13 Oct-13

Average Yield of S&P DB CNH bond index


25 October 2013



CNH market asset tracker

Asset Type Outstanding Amount RMB bn Average Life

CNH bonds/CDs 533 1.69yrs

Sovereign, Quasi-Sovereign, Supranationals 102

Bank, Insurance 271

Corporates 160

CNY bond access 300

RQFII access 134.3

CNH equities 11

Total 977 Source: Deutsche Bank

Onshore fixed income monitor

Seven day repo vs. SHIBOR rate

-4

-2

0

2

4

6

8

10

12

Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

7-day repo rate3M SHIBOR3M CNY fwd implied yields3M deposit rate

%

Sources: Deutsche Bank, PBoC

25 October 2013



China inflation vs. policy tightening tools

0

4

8

12

16

20

24

-4

-2

0

2

4

6

8

10

05 06 07 08 09 10 11 12 13

1Y deposit rate (LHS)CPI YoY (LHS)RRR rate (RHS)

% %

Sources: Deutsche Bank, PBoC

25 October 2013



Appendix 1

Important Disclosures Additional information available upon request For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr Analyst Certification

The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Linan Liu/Perry Kojodjojo

25 October 2013



Regulatory Disclosures

1. Important Additional Conflict Disclosures

Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.

2. Short-Term Trade Ideas Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at http://gm.db.com.

3. Country-Specific Disclosures

Australia and New Zealand: This research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act and New Zealand Financial Advisors Act respectively. Brazil: The views expressed above accurately reflect personal views of the authors about the subject company(ies) and its(their) securities, including in relation to Deutsche Bank. The compensation of the equity research analyst(s) is indirectly affected by revenues deriving from the business and financial transactions of Deutsche Bank. In cases where at least one Brazil based analyst (identified by a phone number starting with +55 country code) has taken part in the preparation of this research report, the Brazil based analyst whose name appears first assumes primary responsibility for its content from a Brazilian regulatory perspective and for its compliance with CVM Instruction # 483. EU countries: Disclosures relating to our obligations under MiFiD can be found at http://www.globalmarkets.db.com/riskdisclosures. Japan: Disclosures under the Financial Instruments and Exchange Law: Company name - Deutsche Securities Inc. Registration number - Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No. 117. Member of associations: JSDA, Type II Financial Instruments Firms Association, The Financial Futures Association of Japan, Japan Investment Advisers Association. This report is not meant to solicit the purchase of specific financial instruments or related services. We may charge commissions and fees for certain categories of investment advice, products and services. Recommended investment strategies, products and services carry the risk of losses to principal and other losses as a result of changes in market and/or economic trends, and/or fluctuations in market value. Before deciding on the purchase of financial products and/or services, customers should carefully read the relevant disclosures, prospectuses and other documentation. "Moody's", "Standard & Poor's", and "Fitch" mentioned in this report are not registered credit rating agencies in Japan unless "Japan" or "Nippon" is specifically designated in the name of the entity. Malaysia: Deutsche Bank AG and/or its affiliate(s) may maintain positions in the securities referred to herein and may from time to time offer those securities for purchase or may have an interest to purchase such securities. Deutsche Bank may engage in transactions in a manner inconsistent with the views discussed herein. Russia: This information, interpretation and opinions submitted herein are not in the context of, and do not constitute, any appraisal or evaluation activity requiring a license in the Russian Federation.

Risks to Fixed Income Positions

Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to pay fixed or variable interest rates. For an investor that is long fixed rate instruments (thus receiving these cash flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets holding limits for different types of investors), changes in tax policies, currency convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates - these are common in emerging markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended to track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs from the currency in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options in addition to the risks related to rates movements.

David Folkerts-Landau

Group Chief Economist Member of the Global Executive Committee

Guy Ashton

Global Chief Operating Officer Research

Marcel Cassard Global Head

FICC Research & Global Macro Economics

Richard Smith and Steve Pollard Co-Global Heads Equity Research

Michael Spencer Regional Head

Asia Pacific Research

Ralf Hoffman Regional Head

Deutsche Bank Research, Germany

Andreas Neubauer Regional Head

Equity Research, Germany

Steve Pollard Regional Head

Americas Research

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