* Estimated $350 bln of structured products sold in past 14
* 6.20 yuan per dollar seen as inflection point below which
* Regulators looking into impact of yuan fall on FX trades -
* Yuan set for biggest weekly loss on record
By Saikat Chatterjee
HONG KONG, Feb 28 China's weakening of the yuan
over the past 10 days has exposed risks created by the rapid
growth of offshore derivative products, with holders seen
potentially facing billions of dollars of losses if the currency
Bankers say the buyers of these leveraged bets -- and
Deutsche Bank estimates $100 billion have been sold this year
alone -- have largely been Chinese companies with large dollar
receivables, who saw the products as a way to earn some extra
income given the seemingly inexorable rise of the yuan.
These products, also known as target-redemption forwards
were initially aimed at companies in China wanting to hedge
their FX exposure. But they soon morphed into a product that
offered regular income as long as the yuan did not weaken
The danger is that buyers are not hedged against a weaker
yuan, and analysts worry that could leave them open to expensive
Indeed, banking sources have told Reuters that China's
foreign exchange regulator is looking into the possible impact
on the yuan's fall on foreign exchange transactions at domestic
banks and companies.
The key level, market players say, is 6.20 yuan per dollar
in the offshore market, which will trigger requirements for
payments. In just over a week, the offshore yuan (CNH) has also
fallen by 1.6 percent to six-month lows near 6.13 per dollar, a
massive move by its quiet standards.
On Friday, in the onshore market, the spot rate
fell to a 10-month low of 6.1806, extending sharp losses from a
close of 6.0641 on Feb. 17. The offshore market normally trades
at a premium to the onshore market because of the limited
availability of the yuan.
Implied volatility on one-month offshore yuan, a
gauge of perceived price swings, was just below a record 3.8 vol
on Friday, nearly double its level through most of 2013.
"The CNH market is set to be more volatile in the future and
higher volatility will likely be the new norm in the backdrop of
foreign exchange market reform," said Ju Wang, a senior FX
strategist at HSBC in Hong Kong.
China set up an offshore yuan market in Hong Kong in 2010 to
promote the use of the yuan in global trade. It has since
established yuan trading hubs in Singapore, Taiwan and London.
Deutsche Bank and Morgan Stanley both estimate that about
$350 billion of structured-product trades have been sold since
the beginning of 2013.
Morgan Stanley says if the yuan breaks below 6.20 per
dollar, holders face potential losses of up to $200 million per
month. With average maturities of the structured products around
24 months, total losses could run into billions of dollars.
The yuan has risen against the dollar every year since 2010,
and structured products were growing rapidly on expectations of
another 2-3 percent appreciation this year.
The yuan's fall -- seen as driven by the central bank
wanting more two-way volatility in the market as preparation for
more reforms -- has shattered complacency about its direction.
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Greater yuan volatility increases the risk of holding these
products because of their asymmetrical nature.
As long as the yuan stays above a particular level, the
holder earns the difference between the market price and the
strike price of the product multiplied by the notional value.
Below that level, the holder has to pay out twice the
difference multiplied by the notional value to the bank which
sold the product. That could raise the risk of some defaults on
repayments if losses mount quickly, traders said.
"Breaking a level of 6.20 would really hurt the offshore
market," said the head of FX trading at a European Bank in Hong
($1 = 6.1695 Chinese yuan)
(Additional reporting by Michelle Chen; Editing by John Mair)