Derivatives Market Trading Division July Understanding RMB Currency Futures Contract (USD/CNH)

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1 Derivatives Market Trading Division July 2012 Understanding RMB Currency Futures Contract (USD/CNH)

2 Part A Trading Arrangements

3 Table of Contents 1 Key Milestones of Development of Offshore RMB market 2 The Reasons for RMB Currency Futures 3 Product Features 4 Applications and Benefits

4 1 Key Milestones in Development of Offshore RMB market 4

5 Key Milestones in Development of Offshore RMB Market Personal RMB Business RMB deposit-taking, cheque, credit / debit card and remittance services RMB Bond Market 1 st RMB bonds by Mainland financial institution (CDB) 1 st RMB sovereign bond (MOF) 1 st RMB bond by overseas corporate (McDonald) 1 st RMB bond by Mainland non-financial institution (Baosteel) RMB Trade Settlement Pilot scheme kicks off in five pilot mainland cities Expanded to 20 provinces and cities in the Mainland Further expanded to nationwide in China RMB Investment RMB ODI and RMB FDI RQFII scheme with initial quota RMB20bn RQFII quota expanded by RMB50bn 5

6 Hong Kong is the Leading Offshore RMB Centre Offshore RMB Deposit 1 Offshore RMB FX Spot Market Offshore RMB Bond Issuance 2011 year-end Deposit, RMB bn Average Daily Trading Volume, USD bn Outstanding Amount by April 2012, RMB bn? % 2 1% % % % Hong Kong London Others Hong Kong handles 80% of RMB trade settlement and 80% of global RMB payments 187 banks participated in Hong Kong RMB clearing platform 968 overseas banks had set RMB correspondent account at Hong Kong banks by 2011, compared to 187 in 2010 Hong Kong plays a leading role in offshore RMB development Note: 1. Estimated figures for deposits in London and other centers Source: FSTB, HKMA, London: A Centre for Renminbi Business 6

7 Trend of CNH Spot Rate PBOC Official Exchange Rate (USD/RMB) & Offshore CNH Spot Rate (USD/CNH) (Period : 27-June-2005 to 29-June-2012) A managed float policy for RMB making reference to a basket of currencies A special exchange rate policy to keep the RMB almost fixed against the USD amid the world financial crisis in 2008 Further push forward the RMB reform by enhancing the flexibility of the RMB exchange rate Growth of CNH Deposit and trading products in HK Offshore CNH officially deliverable in Hong Kong with the existence of CNH spot rate Daily trading band increased to 1% Source: Bloomberg 7

8 2 The Reasons for RMB Currency Futures 8

9 RMB Currency Futures useful as a risk management tool NDF Trading Arbitrage Non-Deliverable vs. Deliverable CNH Deposit Hedging RMB Currency Futures Hedging Trade Finance Arbitrage Spot /Forward vs. Standardized Futures CNH FX Trading RMB Currency Futures will encourage a virtuous cycle of development to advance the chain of CNH product development in HK 9

10 3 Product Features 10

11 What is Currency Futures? Currency futures is a futures contract to exchange one currency for another currency at a specified date in the future at a price that is fixed on the purchase date. 11

12 What is RMB Currency Futures? RMB currency futures are futures contracts based on the exchange rates between RMB and other currencies. HKEx s first RMB currency futures contract is based on the currency pair USD / CNH. CNH [i.e. CNY(HK)] refers to the RMB circulated in Hong Kong. The world s first deliverable RMB currency futures contract ever listed. A financial instrument for managing RMB exchange rate risk exposure. 12

13 Contract Specification of RMB Currency Futures - USD/CNH Futures Item Contract Feature Contract Size USD 100,000 Trading Code Quotation Style CUS RMB per USD (e.g. RMB per USD) Minimum Fluctuation Contract Months Settlement Method and Settlement Currency Trading Hours RMB (4 decimal places) Spot month, the next three calendar months and the next three calendar quarter months (i.e. quarter months are March, June, September and December) Delivery of US dollar against RMB with full principal amount at the Final Settlement Price 9:00 am - 4:15 pm (No lunch break) (Trading hours on the Last Trading Day is from 9:00 a.m. to 11:00 a.m.) 13

14 Contract Specification of RMB Currency Futures - USD/CNH Futures Item Final Settlement Day Last Trading Day Final Settlement Price Position Limit Large Open Position Holiday Schedule Contract Feature Third Wednesday of the Contract Month Two Hong Kong Business Days prior to the Final Settlement Day Spot USD/CNY (HK) fixing published at 11:15 a.m. on the Last Trading Day by Hong Kong Treasury Markets Association (TMA) 8,000 net contracts in all Contract Months combined; and No more than 2,000 open contracts in the spot month contract during the last five trading days up to expiration. 500 open contracts, in any one Contract Month The products will be open for trading according to the Hong Kong holiday schedule. 14

15 Contract Specification of RMB Currency Futures - USD/CNH Futures TMA s Spot USD/CNY(HK) Fixing https://www.tma.org.hk/en_market_info.aspx The Fixing which serves as the benchmark for market exchange rate of USD against CNY(HK) at 11:00 a.m. Hong Kong time Determined by averaging the middle quotes after excluding the highest two quotes and lowest two quotes from the 15 Contributing Banks. The Spot USD/CNY(HK) Fixing is published at around 11:15 a.m. Hong Kong time each business day (excluding Saturdays). Thomson Reuters is the calculating agent for the fixing. Thomson Reuters RICs <CNHFIX=>; Thomson Reuters pages <CNHFIX>. 15

16 Fee Structure Fee Item Details Exchange Fee RMB 8.00 Commission Levy Nil Brokerage Commission Negotiable 16

17 Market Making Scheme Market Maker Obligations Obligations Assigned Contract Provision of Continuous Quotes (CQ) Spot month, the next three calendar months and the next three calendar quarter months Maximum Bid/Offer Spread Not greater than (30 ticks) Minimum Quote Size Not less than 10 contracts (USD 1 million) Trading Requirement Provide CQ for not less than 70% of the trading hours in each calendar month 17

18 Block Trade Facility and Error Trade Parameters Block Trade Facility The block trade volume threshold is 50 contracts. Error Trade Parameters 1% from notation price The notation price will be determined as follows: The average of the prices of the previous match and the next match in that contract month occurring reasonably close to the time of error trade. If this, in the opinion of the Exchange, fails to reflect a fair price, the notation price will be determined on the basis of item (2) below. The reasonable bid and offer prices available around the time of error trade. If this, in the opinion of the Exchange, fails to reflect a fair price, the notation price will be determined on the basis of item (3) below. The prices obtained by the Exchange from consulting up to 3 independent market practitioners who have no interest in the trade in order to arrive at a valid notation price. 18

19 4 Applications and Benefits 19

20 Applications - Basic Principle Buy or Sell? USD/CNH Futures Contracts Price Dec (1 USD = RMB ) Investor View RMB Appreciate More than Expected Action Sell 10 Contracts Anticipated Outcome Close-Out Contracts in Profit / Loss Gain RMB 40,000* * ( ) x $100,000 x 10 contracts 20

21 Applications - Basic Principle Buy or Sell? USD/CNH Futures Contracts Price Dec (1 USD = RMB ) Investor View RMB Depreciate More than Expected Action Buy 10 Contracts Anticipated Outcome Close-Out Contracts in Profit / Loss Gain RMB 40,000* * ( ) x $100,000 x 10 contracts 21

22 Applications - Hedging for QFII fund managers User QFII fund managers who invest in mainland A-shares to capture the stock appreciation Outlook Anticipate depreciation of RMB over the next 6 months Risk Exposure The gain in mainland stocks may be reduced due to the loss in RMB exchange rate Strategy Buy USD/CNH futures contracts to hedge RMB depreciation 22

23 Applications - Hedging for QFII fund managers Scenario 1: No Hedging Now Convert USD 10 mil to RMB and buy mainland A-shares 6 months later - 5% stock price increase and sell stocks to get RMB mil - RMB depreciated from RMB per USD to RMB per USD - Convert it back to USD Result: Gain only USD 0.02 mil even A-shares stock prices increase 5% Gain in A-shares was reduced to 0.2% due to RMB Depreciation 23

24 Applications - Hedging for QFII fund managers Scenario 2: Hedging by buying USD/CNH Futures Now Convert USD 10 mil to RMB and buy mainland A-shares 6 months later 5% stock price increase and sell stocks to get RMB mil Convert it back to USD Buy 100 USD/CNH Close and get RMB 3 mil Profit Result: 1) Gain USD 0.02 mil on A-shares stocks 2) Gain RMB 3 mil in RMB Futures (i.e. USD 0.45 mil) 3) Return with hedging : 4.7% vs. Return with no hedging : 0.2% 4) Using RMB Futures as the hedging tool can cover the loss in RMB depreciation and keep the gain in A-shares 24

25 Benefits for trading RMB Currency Futures Hedge or take on RMB exchange rate risk Investors will be able to hedge or take on RMB exposure with USD/CNH futures. There is no restriction on the use of CNH so the CNH market is a good reflection of supply and demand. Delivery of USD for RMB USD/CNH futures will be settled at expiration by exchanging principal (contract size in USD) versus payment in RMB based on the spot USD/CNY fixing published by the Treasury Market Association in Hong Kong. 25

26 Benefits for trading RMB Currency Futures Leverage Futures contracts are traded on a margin basis so only a small fraction of the total exposure is required upfront. Margin basis (as of July 2012, around 1-2% of notional amount, i.e. RMB 7,000 to 12,000) Transparent Pricing USD/CNH futures will be offered exclusively on HKEx s electronic derivatives trading platform, which offers transparent pricing in a regulated centralised marketplace. 26

27 Benefits for trading RMB Currency Futures Access by global market participants market participants from around the world, including banks, funds, proprietary trading firms and active individual traders, access to the RMB Minimal counterparty risk cleared and settled by HKFE Clearing Corporation Limited acting as central counterparty in every transaction Market Makers providing liquidity continuous two-sided markets throughout the trading day to enhance liquidity 27

28 Market Readiness Participants need to arrange for RMB and USD settlement capability failing which trading access will be prohibited. Participants need to prepare clearing, settlement and other back-end systems to clear and settle USD/CNH futures. Available for OMNet Application Programming Interface (OAPI) program readiness tests from 20 April A market rehearsal has been held on 30 June A next round of market rehearsal will schedule on 18 Aug

29 Target Launch Schedule The launch date will be in 3 rd quarter of 2012 subject to participant readiness. Related Circulars Hyperlinks HKFE Circulars HKFE - Readiness for Renminbi Currency Futures (DMD/051/12) HKFE Update on Renminbi Currency Futures (DMD/077/12) HKCC Circulars HKCC - Readiness for Clearing Renminbi Currency Futures (CD/DCO/HKCC/005/2012) HKCC Update on Renminbi Currency Futures (CD/DCO/HKCC/006/2012) 29

30 Part B Risk Management Arrangements

31 Table of Contents 1 How to Calculate Margin and Variation Adjustment 2 Concentration Risk Margin 3 Forms of Payment for Margin and Variation Adjustment 4 Failure to Fulfill Obligations Upon Final Settlement 5 New Margin Parameter - Spot Month Charge (to be introduced after launch) 31

32 How to Calculate Margin and Variation Adjustment (1) LTD-4 LTD-3 LTD-2 LTD-1 LTD LTD+1 FSD (LTD+2) Margin Variation Adjustment (VA) Delivery P/L LTD: Last Trading Day FSD: Final Settlement Day Delivery / Payment Obligation 32

33 How to Calculate Margin and Variation Adjustment (2) - Delivery P/L LTD LTD + 1 Market Open Final Settlement Price (FSP) Determination Market Close Intra-day Assessment 09:00 11:15 16:15 Long a CNH at FSP = Underlying close = :00 Underlying price = VA = (FSP traded price) x contract size = RMB[( ) x 100,000] = -RMB 100 (Loss) Delivery P/L = (underlying close FSP) x contract size = RMB[( ) x 100,000] = -RMB 200 (Loss) => Loss will be collected as margin requirement Or (Any profit can be offset against margin requirement) Delivery P/L = (underlying price FSP) x contract size = RMB[( ) x 100,000] = -RMB 8,000 (Loss) 33

34 How to Calculate Margin and Variation Adjustment (3) - Margin Summary (RP003) Delivery P/L 34

35 Concentration Risk Margin Triggering Conditions Market Level Net open interest of USD/CNH currency futures contracts exceeds: 10,000 during last 5 business days before final settlement day; or 20,000 on all other business days And Participant Level More than 30% of total position delta of all Participants with same directional risk Additional Margin 20% of Clearing House margin requirements 35

36 Forms of Payment for Margin and Variation Adjustment Minimum settlement currency requirement Payment for Margin At least 50% of margin requirement in each CCMS account must be covered by cash in the settlement currency (i.e. RMB) Other approved collateral Remaining margin requirement can be satisfied by other forms of approved collateral after haircut (e.g. HKD, USD, bank guarantee, etc.) Payment for VA Variation adjustment must be satisfied by payment in the settlement currency (i.e. RMB) 36

37 Failure to Fulfill Obligations Upon Final Settlement Failure to fulfill obligations upon final settlement constitutes an event of default pursuant to HKCC Rule 509 HKCC would take such actions against the defaulting Participant as it considers appropriate HKCC may execute buy-in and/or borrowing of the currency to effect settlement Defaulting Participant may be imposed a penalty charge (0.25% of the market value of RMB currency futures on final settlement day) Defaulting Participant shall indemnify the clearing house and the exchange against all costs, fees, expenses, liabilities, losses and damages that may be incurred in executing a buy-in, effecting a purchase or borrowing and taking such other action as the clearing house considers appropriate 37

38 New Margin Parameter - Spot Month Charge (1) Applicable Contracts Spot month contracts When to Apply Last 4 business days before the day preceding the final settlement day Spot Month Charge Rate 20% of Clearing House and Client margin levels Implementation After product launch (Q tentatively) Participant Readiness HKCC will provide a set of simulated Risk Parameters Files (RPF) for Participant s system readiness test (separately arranged, not covered in the market rehearsals) 38

39 New Margin Parameter - Spot Month Charge (2) LTD-4 LTD-3 LTD-2 LTD-1 LTD LTD+1 FSD (LTD+2) Margin (Scan Risk + Inter-month Spread) Margin (Spot Month Charge) VA Delivery P/L LTD: Last Trading Day FSD: Final Settlement Day Delivery / Payment Obligation 39

40 New Margin Parameter - Spot Month Charge (3) - Margin Summary (RP003) Margin (inclusive of Spot Month Charge, if any) Delivery P/L 40

41 Part C Clearing and Settlement Arrangements

42 Table of Contents 1 Settlement Currency 2 Final Settlement Process 3 Settlement Bank Accounts 4 Highlight in DCASS and CCMS for USD/CNH Futures

43 1 Settlement Currency 43

44 Clearing Arrangements Settlement Currency Daily Settlement Final Settlement Trading Fees RMB Variation Adjustment RMB Margin Obligation Settlement Fees USD Both RMB & USD are involved in settlement 44

45 2 Final Settlement Process 45

46 Day-end Processing After 18:45 Set CQ ~18:00 Trading Hours (09:00 16:15) USD/CNH Futures Final Settlement Process LTD LTD + 1 Final Settlement Day(LTD+2) 1. Final Settlement Price will be determined around 11:15am 5. Any resulting Shortfall to be settled by 9:15 am 6. CPs can withdraw any resulting surplus on Final Settlement Day 3.Buyer Pay RMB Seller Deliver USD Delivery and payment obligations will be netted by currency with other settlement obligations 2. DCASS Report - Delivery obligations 4. CCMS Report - Settlement amounts 46

47 Day-end Processing After 18:45 Set CQ ~18:00 Trading Hours (09:00 16:15) USD/CNH Futures - Final Settlement Process for Buyer (for illustration purpose only) LTD - 1 By 09:15 LTD By 09:15 LTD + 1 Final Settlement Day(LTD +2) By 09:15 Buy 1 spot month RMB Collect RMB 7,571 ( RMB 10 + RMB 7,561) ~11:15 Final Settlement Price: RMB Collect RMB 300 (RMB RMB 200 ^) Collect RMB 622,239 After 14:30 Upon receipt of withdrawal request from Participant, release the USD delivery of USD 100,000 to Participant s bank account CQ : RMB Underlying market close : RMB VA loss : X 100,000* = - RMB 10 VA loss: X 100,000* = - RMB100 RMB payment obligations Net shortfall Final Settlement Value 630,000 Margin release 7,561 Delivery P/L release 200^ RMB 622,239 Assume Margin Requirement # : - RMB 7,561 Delivery P/L (DR): X100,000* = - RMB 200^ USD delivery USD100,000 CQ Closing Quotation LTD Last Trading Day VA Variation Adjustment * Contract size = USD 100,000 # Spot month charge included, if applicable ^ Losses arising from the Delivery P/L will be added to and collected as Clearing House margin payable 47

48 Day-end Processing After 18:45 Set CQ ~18:00 Trading Hours (09:00 16:15) USD/CNH Futures - Final Settlement Process for Seller (for illustration purpose only) LTD - 1 By 09:15 LTD LTD + 1 Final Settlement Day(LTD+2) By 09:15 Sell 1 spot month RMB Collect RMB 7,551 ( - RMB10 + RMB 7,561) ~11:15 Final Settlement Price: RMB After 14:30 Upon receipt of withdrawal request from Participant, release the VA gain and Delivery P/L (Cr), i.e. RMB 300 (RMB RMB 200^) to Participant s bank account Collect USD 100,000 After 14:30 Upon receipt of withdrawal request from Participant, release the RMB payment of RMB 637,361 to Participant s bank account CQ : RMB Underlying market close : RMB VA gain : X 100,000* = + RMB 10 VA gain: X 100,000* = + RMB 100 USD delivery obligation USD100,000 Assume Margin Requirement # : - RMB 7,561 Delivery P/L (CR): X100,000* = + RMB 200^ RMB receivable Final Settlement Value 630,000 Margin release + 7,361^ RMB 637,361 CQ Closing Quotation LTD Last Trading Day VA Variation Adjustment * Contract size = USD 100,000 # Spot month charge included, if applicable ^ Profits arising from the Delivery P/L will be offset against Clearing House margin payable, i.e. RMB 7,561 RMB 200 = RMB 7,361 48

49 3 Settlement Bank Accounts 49

50 Clearing and Settlement Arrangements Settlement Bank Accounts Clearing Participants House account Client account RMB account USD account RMB account USD account Clearing Participants need to have house and client bank accounts in both RMB & USD 50

51 4 Highlight in DCASS and CCMS for USD/CNH Futures 51

52 Highlight in DCASS and CCMS for USD/CNH Futures DCASS Clearing Information Window Outstanding positions on Last Trading Day CUSXX Mark-to-market Variation Margin CNY LTD LTD+1 CUSXX Closing Delvery vs Payment 1 1 CUSSP LTD LTD+2 CUSXX Closing Other quantity 1-630, CNY LTD LTD+2 CUSXX Closing Fee CNY LTD LTD+1 USD 52

53 Highlight in DCASS and CCMS for USD/CNH Futures DCASS Report/information for USD/CNH Currency Futures Clearing Report/Function Field Description Remarks Class Delivery vs Payment Other Quantity Refer to delivery of the underlying, i.e. USD upon final settlement Refer to cash payment in CNH (currency code being CNY ) upon final settlement Event qty Number of contracts involved Outstanding positions on Last Trading Day a) Deliveries Details (TP010) b) Clearing Information Window Delivery qty Number of units of underlying delivery in USD 1 unit of delivery qty = 1 * USD100,000 + => receive USD - => deliver USD Amount of payment obligation in CNH Payment amount in CNH + => receive payment - => make payment Delivery series CUSSP CNY Refer to delivery obligation upon final settlement (i.e. USD) Currency code for CNH to be paid upon final settlement 53

54 Highlight in DCASS and CCMS for USD/CNH Futures CCMS Report- CCMPY02 Posting/Collateralisation Result Report CHSTM=CNY Payment UNSTM= USD Delivery 54

55 Highlight in DCASS and CCMS for USD/CNH Futures CCMS Report CCMDS01 Statement of Collateral Account CS- Ledger posting of CNY payment US-Ledger posting of USD payment 55

56 Highlight in DCASS and CCMS for USD/CNH Futures CCMS Reports for USD/CNH Futures CCMS Report Field New Data Value Remarks Product RMB USD/CNH Futures a)posting/collateralisation Result Report (CCMPY02) OB/TXN CHSTM Payment obligation upon final settlement (i.e. CNY) UNSTM Delivery obligation upon final settlement (i.e. USD) b)statement of Collateral Account (CCMDS01) CS Ledger posting for settlement of payment (i.e. CNY) c)participant Collateral Account Movement Report (CCMMV01) Movement Type US Ledger posting for settlement of delivery (i.e. USD) 56

57 Q & A 57

58 Disclaimers TMA s Spot USD/CNY(HK) Fixing https://www.tma.org.hk/en_market_info.aspx The Fixing which serves as the benchmark for market exchange rate of USD against CNY(HK) at 11:00 a.m. Hong Kong time is determined by averaging the middle quotes after excluding the highest two quotes and lowest two quotes from the 15 Contributing Banks. The Spot USD/CNY(HK) Fixing is published at around 11:15 a.m. Hong Kong time each business day (excluding Saturdays). Thomson Reuters is the calculating agent for the fixing. Thomson Reuters RICs <CNHFIX=>; Thomson Reuters pages <CNHFIX>. The following disclaimers and copyright notice regarding information provided on the Treasury Markets Association's website: a. The price fixings and reference rates in this website are provided with delays for general information purposes. While the Treasury Markets Association (TMA) will make all reasonable efforts to ensure a continuous, accurate and timely service, the TMA and other data providers make no warranties, representations or undertakings, expressed or implied by law or otherwise, in relation to the price fixings and reference rates and are not responsible for any errors or omissions, or losses caused by disruptions in the service or late publication of the daily rates or inaccuracy of the daily rates or otherwise arising from the use of or reliance on the price fixings and reference rates. By viewing or downloading these rates, you implicitly accept this disclaimer and agree to its terms. b. TMA shall not be liable for any loss or damage suffered as a result of any use or reliance on any of the information provided on its website. c. The content available on this website, including but not limited to all text, graphics, drawings, diagrams, photographs and compilation of data or other materials, are protected by copyright. TMA is the owner of all copyright works contained in this website. The information or part of it may be re-disseminated or reproduced provided the source of the information is acknowledged. Risks of Trading Futures Futures involve a high degree of risk. Losses from futures trading can exceed your initial margin funds and you may be required to pay additional margin funds on short notice. Failure to do so may result in your position being liquidated and you being liable for any resulting deficit. You must therefore understand the risks of trading in futures and should assess whether they are right for you. You are encouraged to consult a broker or financial advisers on your suitability for futures trading in light of your financial positions and investment objectives before trading. Hong Kong Exchanges and Clearing Limited (HKEx) All rights reserved. Nothing herein is to be construed as a recommendation to purchase or sell futures and / or options contracts or to provide investment advice. While efforts are made to ensure the accuracy of information contained in this publication, HKEx and its subsidiaries do not warrant its accuracy, timeliness, completeness or fitness for a particular purpose and do not assume any liability for any errors or omissions or any action taken on the basis of such information. 58

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