Their plans to expand China’s capital markets

Calvin Tai, Head of Clearing, HKEX Group explains the firm’s plans to open China’s capital markets to the rest of the world

Access to the Chinese markets has become essential for the global investment community, which has witnessed an unprecedented change in capital flows over the past decade. No firm is more committed to taking advantage of this tectonic shift than Hong Kong Exchanges and Clearing Limited (HKEX).

According to Calvin Tai, Head of Clearing at HKEX, the firm’s strategic priority for the next three years is opening mainland China to the world. According to Tai, “Our vision is connecting China with the world, and our goal is to reshape the global market landscape. We want to be the global exchange of choice across asset classes – equity, commodities, fixed income and currency – for our Chinese clients and international investors seeking China exposure.”

Mainland China is without doubt a powerhouse in the global markets. The country has invested more than $1.2 trillion outstanding in US Treasury bonds, and the recent purchase of the Chicago Stock Exchange by Chongqing Casin Enterprise Group shows how far the influence of Chinese entities is spreading in the equity markets.

“We want to be the global exchange of choice across asset classes – equity, commodities, fixed income and currency – for our Chinese clients and international investors seeking China exposure”

With open two-way capital flows, domestic reforms, and renminbi globalization, the scale and depth of the world’s interaction with Mainland China and its investors is rapidly transforming – unveiling compelling opportunities in multiple asset classes for the firm and Hong Kong.

“We want to build on our position as a leading cross-border destination,” said Tai. “HKEX is taking a long-term view of its investments and business initiatives. We aim to expand our presence in the region and become a true multi-asset platform that connects China with investors around the globe.”

Central Clearing – An Engine for Growth

HKEX is a conglomerate made up of multiple entities, and one of the group’s primary engines for growth is OTC Clear – a subsidiary and standalone central counterparty (CCP). OTC Clear sees huge opportunities for its business, which has experienced a surge in interest and clearing membership since 2015.

The firm has lofty ambitions. “We want to provide regional market participants with state-of-the-art central clearing capabilities,” said Tai. “Our strategic focus is twofold and is a function of our base in Hong Kong, which is the world’s largest offshore renminbi center.”

Specifically, the two dimensions of their strategy are:

  1. To provide clearing solutions for the diverse regional trading community, while simultaneously encouraging mainland banks to join as direct members
  2. To provide clearing services for the rapidly-expanding renminbi-based interest rate and currency OTC derivatives traded by its stakeholders

“The Group avoids short-term thinking and seeks to help its market participants position themselves for price gains and retreats by offering products that are suitable for different periods of the market cycle”

“We feel our strategy is a great fit for the current market environment,” said Tai. “The continued and rapid internationalization of the renminbi currency combined with the growing presence of Chinese banks gives us a lot of room to expand.”

Cross Currency Swaps – The Next Frontier

One of the key areas of expansion for OTC Clear in 2016 is the upcoming addition of cross currency swaps. The motivation for adding this particular product reflects the broader fixed income trends in China. According to Tai, “The development of the offshore renminbi bond market in Hong Kong (also known as the dim sum bond market), has seen parallel growth in the cross currency swap market as issuers can swap the bond proceeds to get a pick-up in yield. They are also popular with investors who wish to purchase foreign assets but seek to eliminate foreign currency risk. And they are used by liability managers looking for synthetic foreign currency liabilities.”

One reason OTC Clear is so bullish on the prospects of their new offering is because the biggest constraint to using cross currency swaps is the high regulatory capital requirements which result from trading with a bilateral counterparty. Trading these types of OTC contracts through a qualifying CCP substantially lowers the counterparty risk weighting, vastly reducing the capital requirements and making them much more accessible to all kinds of investors.

Clearing also eliminates some of the credit constraints imposed by banks on their bilateral counterparties. This is often a significant issue when international banks trade with mainland names.

Innovative Risk Management

Traditionally, managing the risks associated with the exchange of principal values at the start and end of swap contracts (so called Herstatt risk) has posed a significant challenge to CCPs that considered cross currency swaps.

To manage this risk, OTC Clear utilizes the payment versus payment (PVP) settlement capabilities within its local Hong Kong Real-Time Gross Settlement (RTGS) system, operated by the Hong Kong Monetary Authority. As Tai explains, “Our clearing solution benefits from the important strategic infrastructure investments that have been made locally. By leveraging the strengths of this infrastructure and its industry-standard core technology, we are uniquely empowered to satisfy the demand for cross currency swaps.”

Built for the Long Run

Although the mainland economy is no longer seeing the annual double-digit gains it enjoyed a few years ago, authorities’ GDP growth target for this year is still 6.5% to 7%.

Regardless, Tai says that HKEX doesn’t worry too much about temporary market hiccups. “The Group avoids short-term thinking and seeks to help its market participants position themselves for price gains and retreats by offering products that are suitable for different periods of the market cycle, including stock index and individual stock put and call options. Another example is our renminbi currency futures, which can be used to hedge currency risk.”

Tai adds, “One consequence of the recent market and economic developments in the mainland has been a large increase in the volatility of renminbi-based products. As you know increased volatility increases trading opportunities and the demand for hedging products, which is positive for an organisation which provides risk management solutions for derivatives markets.”

HKEX Group’s discipline and strategic approach is the driving force behind its success. By planning for the long-term and anticipating market needs, HKEX is well on its way to achieving its three-year goal of becoming the gateway to China.