RMBYuan’s devaluation

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A ugust 11 was a watershed moment for companies in Hong Kong that had

assumptions about the stability and predictability of the RMB-USD exchange rate. The People’s Bank of China changed the way the reference rate was calculated, a move that resulted in a drop of 4.5 percent in three days – more than the currency had moved in four years.

The move was interpreted by some as the beginning of a currency war, an effort to prop up China’s slowing economy. Or it was viewed as a measure to liberalize and inter-nationalize the renminbi so that it can become a reserve currency. Regardless of the PBoC’s inten-tions, the impact was immediate. The devaluation caused many chief financial officers’ assumptions to unravel and reconsider whether they should start hedging their foreign exchange exposure.

Over the last five to six years, the RMB-USD exchange rate was viewed as a one-way bet, says Keith Pogson, Senior Partner, Financial Services, Asia Pacific at EY and a Past President of the Hong Kong Institute of CPAs. The view that the RMB would only get stronger meant that many did not consider

hedging their currency exposure. The PBoC’s action, however, “was a wake up call around the financial markets,” says Pogson.

“It is safe to say a lot more people have shown more interest in hedging since 11 August” and they have moved “away from being naked to at least thoughtful” about the need to hedge, he adds.

Hedging on the horizon The devaluation has resulted in winners and losers. Exporters with costs and debt-servicing in RMB and sales in a foreign currency should benefit. Meanwhile com-panies with excessive U.S. dollar debt stand to lose out as the value of their interest payments on the debt will increase.

The impact of the RMB depre-ciation on the overall business is not always clear. For example, Morningstar Equity Research notes that Chinese technology company Lenovo, as an exporter, should gain. However, the company has factories outside China and many of its sales are to Chinese consum-ers in RMB, which undermines the gain from the depreciating RMB.

PwC notes in its Managing Cur-rency Risk report that a hedging

strategy has to be aligned with the overall business goals, and states that in some cases it may be better to do nothing. Ada Siu, Senior Manager in Corporate Treasury Solutions at PwC and co-author of the report, agrees with Pogson that more clients are considering hedging. “Even at the beginning of last year most of our clients did not do much hedging,” says Siu, who is also an Institute member. Corpo-rates that were already hedging, such as manufacturing companies with significant foreign exchange risk, are now likely to expand fur-ther their activity, she adds.

Allen Cheng, an Institute mem-ber at the Bank of China (Hong Kong), says “For those customers that will repay their USD loans with RMB income source, it is suggested they can lock up foreign currency risk in full or partially through purchasing of foreign cur-rency forward contracts. This will avoid the uncertainty in finance cost caused by the future two-way fluctuation in RMB.” Hedging is likely to increase as the RMB becomes more volatile. Xuong Liu, a Managing Director at A&M Transaction Advisory Group in Shanghai, expects the depreciation

Re-evaluating the RMB

The devaluation of the renminbi after the People’s Bank of China changed the USD-RMB fixing mechanism caught many Hong Kong

companies off-guard and left some exposed. The new volatility in the exchange rate has pushed chief financial officers to re-evaluate the

yuan and reconsider their hedging strategies, as Jane Cooper reportsIllustrations by Takeo Chikatsu

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RMBYuan’s devaluation

to continue. “Given the continuing headwinds domestically, it may not be unreasonable to assume that the RMB will continue to depreciate in the short to medium term, particu-larly if the effects of increases in commodity prices, as a result of unfavourable FX movements, are negated by the historically low oil price,” says Liu.

The expected increase in hedg-ing is good news for Hong Kong, says Thomas Wong, Partner at CWCC Certified Public Accoun-

tants and an Institute member. “We are an international hub – a lot of international currency settlement can be done here in Hong Kong,” he says.

Hedging strategyHowever, as Pogson at EY points out, RMB hedging is very expen-sive to do. There is also more discussion, he says, about the right price of the RMB. Prior to 11 August there was confidence in the predictability and stability of the

exchange rate because the PBoC was controlling the fix within a tight range. The central bank announced that it would be chang-ing the way the fix is calculated, which means that market rates and the previous day’s close would be considered when setting the daily reference rate. The PBoC wasn’t technically devaluing the RMB, but rather letting the market devalue it. The expectation of stability and predictability, a “bubble,” has been burst, says Pogson. He notes there

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are different ways to hedge. One is for foreign companies to borrow onshore in China so that their assets and liabilities are in the same currency. This, however, has its downside as interest rate margins are wider in Mainland China than they are elsewhere, and borrowing in Hong Kong is much cheaper.

“A smarter approach is to look for pseudo hedge currencies as a proxy [for the RMB],” says Pogson. By looking at the correlations between the RMB’s depreciation

and other currencies – such as the Korean won, Malaysian ringgit or Singapore dollar – companies can hedge those currencies instead.

Becoming more agile Siu of PwC and Ian Farrar, the firm’s Corporate Treasury Leader for China and Hong Kong, and co-author of the firm’s Managing Currency Risk report, note there are a number of things that companies can do to better respond to foreign exchange uncertainty. One is to

become more agile. Some compa-nies already have finance or risk committees, which report to the company’s board, and set the strat-egy for responding to currency risk.

For companies that do not have such a committee, they should con-sider establishing one to increase their agility in responding to an event like the RMB devaluation. Also, it is important that the deci-sion makers on this committee are empowered and not restricted by a company’s bureaucracy and do not

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RMBYuan’s devaluation

have to wait until the next board meet-ing for every financial decision to be approved, the PwC report explains.

In addition, companies can enhance their internal reporting so that senior managers can be briefed more effec-tively on the company’s currency risk. PwC notes that qualitative reporting of risks is rarely included in the notes that are sent to the board members. One solution would be to give senior managers briefings on scenario analysis – if the RMB drops by X, the financial impact would be Y – or to use more sophisticated value-at-risk or cash-flow-at-risk models that show how exposed a company is to RMB volatility.

RMB trade settlementAlthough the August devaluation may have shocked some, the longer-term strategy of the PBoC to international-ize the currency should come as no surprise. Many viewed the change of the fix as a bid for the RMB to be included in the International Monetary Fund’s basket of special drawing rights currencies, thus making it a global reserve currency.

Siu of PwC notes that with the internationalization and liberalization of the RMB, companies will try to avoid foreign exchange borrowing as much as possible and will borrow in RMB to reduce their currency exposure. Liu of A&M agrees: “As the RMB continues to gain traction as a global currency, the impact to Chinese businesses – and of interest to Hong Kong and China-based CFOs – is that ultimately, it will cost them less to borrow. And it will become easier for companies to raise money, because

there would be a stronger global demand for RMB denominated assets.”

The internationalization of the Chinese currency so far has meant that companies trading with China are able to settle their transactions in RMB. The devaluation has prompted companies that are not already settling trade in RMB to reconsider doing so, says Pogson at EY.

Rather than converting payments from their home currency into U.S. dollars and then RMB, they can pay their Chinese trading partner in RMB

from an offshore RMB account, thus removing the USD exchange risk. Also, invoicing in RMB can increase sales, says Michael Vrontamitis, Head of Trade Product Management at Standard Chartered Bank. He gives an example of a foreign watch manufac-turer that gained new buyers in China because those buyers were excluded from the foreign exchange market and could only pay for goods in RMB.

More companies in other regions, such as Latin America and Africa, are considering settling their trade

“ In the long term, we also want to see more companies using RMB as the functional currency in financial statements and contracts.”

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payments in RMB. Wong at CWCC notes that his firm has seen an increase of enquiries from international companies looking to expand into China. Many of his clients are from Latin America, a region that has been increasing its trade with China in recent years. Delilah Li, a Senior Manager in the Latin department at CWCC, also notes that RMB internation-alization will make it easier for foreign companies to hold the cur-rency and set up business in China.

“In the long term, we also want to see more companies using RMB as the functional currency in financial statements and contracts,” she says.

For now, companies in Hong Kong must grapple with their immediate exposure from the devaluation in the RMB and rethink their assumptions about the currency’s predictability. Even if they decide not to hedge just yet, at least they are now more self-aware and realize how exposed they actually are.

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