By Samuel Shen and Andrew Galbraith
SHANGHAI (Reuters) - In a Shanghai room packed with small businesses ranging from furniture makers to garment exporters, Zhu Yuan, a currency expert at Bank of Communications, explains why Chinese companies need to build their defenses against currency volatility.
"Currency swings are now largely at the mercy of geopolitics and Sino-U.S. relations. The yuan's value is getting nearly impossible to predict," he told members of the city's chamber of commerce.
The yuan has fallen about 11 percent against the dollar since Washington announced its first hefty tariffs on Chinese imports 17 months ago.
The latest jolt came early this month, when authorities surprised markets by letting the yuan slide through the psychological support level of 7 to the dollar to decade lows, unsettling Chinese firms such as exporters and heavy borrowers of foreign debt.
Executives listened intently as Zhu drew parallels with a house on sale to explain the basics of one hedging tool, a currency option. It's like putting down a deposit, he said, so that one has the right to buy the property in three months at a fixed price, no matter how prices change.
With no quick end to the trade war in sight, Chinese bankers, consultants and exchange operators are milking the opportunity to sell risk-mitigating tools that they claim will allow company bosses to sleep better at night.
"Uncertainty will only increase," said Zhu Jianhua, a senior executive at commodities importer Shanhan Resources.
Currency volatility is relatively new for Chinese businesses. Until 2015, when Beijing adopted a more market-driven currency policy, the heavily managed yuan had been on an almost uninterrupted decade-long rise against the dollar.
But the protracted trade war with Washington has spawned increased uncertainty and volatility.
At the end of 2018, only 230 China-listed companies - less than 7% of total - were engaged in hedging, as per their disclosures to the exchange. Analysts say that partly explains why earnings in China, and hence share prices, are more volatile than those in the United States.
According to Industrial Bank Co, daily average trading in onshore yuan derivatives accounted for just 0.05% of the country's total import and export volumes in 2016, compared with 0.9% in the United States, and 0.88% in Japan.
China Merchant Securities estimates that, if the yuan falls 3% against the dollar in 2019, China-listed airlines and other transport companies could see a combined 5.6 billion yuan ($793 million) loss, equivalent to 4.3% of their net profit.
(Graphic: China's weakening yuan link: https://tmsnrt.rs/2NiTbtz)
THE BUSINESS OF RISK
China's central bank has urged firms to take precautions.
"We hope that companies don't expose themselves to currency risks too much," the People's Bank of China (PBOC) said on Aug. 5, hours after the yuan broke through the 7-mark. It said companies should use derivatives to manage actual business risks, rather than making currency bets.
Zheshang Bank has started promoting an online trading platform for yuan options. Its advertisements say volatility could easily "wipe out profit", and "cause financial losses".
In addition to embracing onshore hedging tools, an increasing number of Chinese firms are starting to access overseas derivative markets, which are often more liquid and less costly.
The Hong Kong Exchanges and Clearing Ltd (HKEX) <0388.HK> has seen rapid growth in the trading of futures and options involving the U.S. dollar and CNH, or offshore yuan. <0#HCUS:> <0#HCUS*.HF>.
In 2018, HKEX's USD/CNH futures trading volume more than doubled from a year earlier to almost 1.8 million contracts, and has been rising this year. Average daily volume in June represented a 173% increase from 2017, HKEX said on its website.
Rival bourse Singapore Exchange Ltd
In the second quarter this year, trading volume in the exchange's USD/CNH futures <0#SUC> surged 119% from a year earlier to $232.4 billion, the bourse said in an emailed statement. Trading in the derivative has repeatedly set new records this year as trade tension worsened.
"Demand for FX risk management tends to increase during periods of geopolitical or market uncertainty...," said KC Lam, Singapore Exchange's head of FX and rates.
After heavy losses due to currency swings a few years ago, Golden Chemical Co, a Chinese chemical importer with annual overseas purchases of as much as $100 million, now uses both domestic and overseas derivative tools.
Jin Shengrong, its treasurer, said that since mid-2018, the company increased hedging: "We therefore avoided quite substantial risks."
(Reporting by Samuel Shen, Winni Zhou and Andrew Galbraith; Editing by Vidya Ranganathan & Kim Coghill)