Rise of the Asian currencies

An increased self-confidence in their own region’s growth and assets, a parallel weakening of Western economic fundamentals and a quest for diversification have led wealthy Asian private investors to re-think currency needs and question their investment identity and mentality, claim bankers.

One of the key manifestations of these trends has been the internationalisation of the renminbi, a hot topic among Far Eastern and global private banking communities for the last two years, although still some distance from a free float. Offshore deposits harboured in Hong Kong reached RMB627bn ($100bn) during 2011. In the last seven years, the RMB has appreciated 30 per cent against the US dollar and the trend is expected to continue. Economists expect a further 3 per cent upsurge during 2012.

Recently liberalised offshore RMB fixed income instruments – known as ‘dim sum’ bonds and widely seen as a stepping-stone from the Chinese government to full internationalisation – jumped from RMB42bn to RMB190bn between the beginning of 2010 and the end of 2011, according to HSBC.

The bank says retail investors are scrambling not to just gain exposure to the Chinese currency, but also the country’s potential economic growth. As well as Chinese commercial banks and institutions, the asset class is developing a global following, with Air Liquide in France and the UK’s Tesco and BP among issuers of RMB-denominated bonds.

Speaking recently in Shanghai, Huang Fan, head of Private Wealth Management for Deutsche Bank in China, said: “While the pathway is not fully open, there are some holes appearing in the gate.”

That gate, say bankers, is unlikely to open for the next 10 years. Gradual liberalisation and the opening of occasional windows are normally the preferred route of Chinese authorities when it comes to economic policy.

Global rebalancing

But the rise of the currency of China and surrounding regions has not happened in a vacuum. It is part of a rebalancing of global power, with a once dollar-obsessed region totally re-evaluating its own self image.

“The perception of the US dollar has been slowly ebbing away over the last 10 years, as the greenback has been gradually declining,” says Paul Mackel, head of Asia Currency Research at HSBC. Along with other analysts, he can imagine the RMB eventually becoming the dominant trading and reference currency for wealthy families across Asia, although he stresses this is looking at a “very long time-frame”.

“I still think that the underlying focus for Asian investors is the dollar as a base currency, because this is what they are familiar with,” believes Mr Mackel.

“But private investors have had to become increasingly more in tune with how exchange rates impact their portfolio.” This has led to the increasing use of simple hedging strategies, such as forward contracts, recommended by wealth managers to rich clients.

Those private investors opting for RMB products should not however be deluded that their investment will bring immediate gains. “Investment strategy should really be based on diversification and the underlying macro story within China, which is still relatively positive in relation to other economies,” says Mr Mackel.

“I don’t think these products exist solely because people think the currency will go up, as that is not necessarily going to happen.”

UBS is reporting more clients either using Asian currencies, rather than the dollar, as their new reference, or more likely diversifying across a basket of regional currencies due to their insufficient depth. The Australian dollar, buoyed by the country’s strength in natural resources, is also becoming a popular choice.

Since the Asian crisis of 1997/8, Asians have gradually become more confident of their own currencies, says David Lim, CEO of Bank Julius Baer in Singapore, although many hold substantial dollar positions, despite a long-term decline in US economic fundamentals.

“The Chinese have been very active in developing the RMB’s acceptance both by international business and wealth managers,” says Mr Lim, also pointing to the structural strength of Asian economies boosting regional currencies.

“For example, the Singapore Monetary Authority’s budgeting has proved very stable and there is little desire here to move out of Asian currencies into dollars, unlike during the 1990s, when there was stability in the US.

“Today, there is a lot less US dollar accumulation in Asia when it comes to private banking,” says Mr Lim. “But we haven’t diversified all of our dollars away and are finding other means to achieve returns.”

This more active thought process includes investing in dollar-denominated assets such as high dividend US equities, which have performed well. “The question is ‘how do you get a currency adjusted return that makes up for US dollar weakness?’ More thought is being put into this, rather than just holding money on deposit,” says Mr Lim.

Asian banks say that many private clients have yet to make a conscious decision about their base currency, failing to take advantage of hedging techniques which can minimise risk from fluctuations. “I wouldn’t bet against the Chinese yuan becoming Asia’s reserve currency of choice one day,” says Su Shan Tan, head of wealth management at DBS Bank in Singapore.

“But clients are very naughty. If the US dollar goes up, they will claim it is their base currency. If the Singapore dollar goes up, they say the Singapore dollar is their base currency. Previously a lot of Asians were holding a lot of US dollars. Now they are asking ‘do I ever go to the US? Do I really need so much?’ The answer is they don’t really need it.”

As a result of this questioning process, many local clients have been either switching wholesale to Singapore dollars or diversifying their currency exposure. The status of Singapore’s currency has been further boosted by increasing volumes of bond issuance.

The short-term mentality of many Asian business people when it comes to their personal investments also clouds some of these decisions, says Rajesh Malkani, group head of East Private Banking at Standard Chartered. Current economic uncertainty is making this problem even more acute than before.

“A couple of years ago, short-term meant under a year, medium-term one to five years and long-term five to 10 years,” recalls Mr Malkani. “Today, long-term means one year, as nobody wants to make commitments. We have seen a dramatic change in our clients’ thinking.”

This has simplified the work of private bankers into choosing between basic building blocks of equities, bonds and funds, with structured products and derivatives currently out of favour. This more blinkered vision can however harm clients’ currency positions because they are left with less tools with which to hedge risks.

Derivatives became very popular between 2005 and 2008, as client speculation on equity prices and foreign exchange positions reached a crescendo leading up to the latest crisis. But for the time being, at least, they have lost their popularity.

“Unfortunately, in the past, private clients have used derivatives to increase risk in their portfolios,” says Mr Malkani. “We would like to see derivatives used as a hedge, to protect against risks, rather than to take risk.”

A broader relationship

In order to ease Chinese and South Asian clients into a longer-term mindset, there are non-financial factors which should also be introduced into a discussion, to broaden the relationship between customer and private banker, believes Pakorn Boonyakurkul, head of North Asia at Barclays Wealth. The bank’s asset allocation system has recently been modified to accommodate behavioural theory, so that each client’s financial personality can be identified and satisfied.

“People would like to understand not just the financial aspect, but the personality side,” says Mr Boonyakurkul. “How does each one of us respond to the situation, particularly the negative situation we are seeing during the last few months? This is our key differentiator. It allows us to have a meaningful discussion with the clients to go beyond the normal asset allocation model.”

This modified approach, says Barclays, leads not only to a better investment outcome, but to a better understanding of what makes a client satisfied, as well as an intimate knowledge of their attitude to risk.

Yet despite these improvements coming from global names, the question remains of whether Asian institutions have sufficient commitment to devise innovative strategies to take advantages of regional opportunities. After all, regional expertise is their selling point, as opposed to the global model preached by the universal players from the US and Europe.

“Most of us are able to source globally,” says the head of products at a major Asian bank. “You don’t see a lot of innovative products developed in Asia. Sure, we look out for best of breed products and Asian banks have platforms allowing these to be offered. But you don’t see anybody coming in with something designed in our region, which will really break the mould.”

Keeping an eye on the West

Analysts, while stopping short of predicting any euro-style currency union, are predicting a greater understanding among Asian central banks over time, including co-ordination of interest rate responses. “Asian central banks want to promote financial stability within the region and to limit exceptionally volatile movements in markets,” says HSBC’s Mr Mackel.

“But while you could have greater co-ordination among Asian central banks, a lot is dependent on whether the Western world chooses to adopt similar economic policies, rather than what has been evident during the last decade.”

Criticism of governments of developing economies for using currency as a political weapon has abated slightly, now that the dollar is relatively strong. “Many countries would prefer weaker currencies in challenging times for global growth,” he says. “But not everybody can have a weak currency at the same time.”

Asian currencies, believe the region’s analysts, can still be held hostage to events in the eurozone, despite the region’s relative economic strength. The problem in Asia, leaving its currencies prone to contagion-led dislocation, is a lack of liquidity and depth in markets, which means they can still be undermined by Western events.

Take the free-floating Singapore dollar, for instance, which has been very volatile in recent months, despite being associated with one of the world’s safest and fastest growing economies.

“Just because a government and its central bank are transparent and demonstrate credibility, it doesn’t necessarily make their currency stronger,” says Mr Mackel. “For the Singapore dollar to have more of a ‘save haven’ status, it would have to be used a lot more in global currency transactions on a day to day basis.”

There is also much concern for huge numbers of investors in India, holding assets in rupees, despite the government’s bid to boost weak capital markets by allowing foreign investors – previously restricted to mutual funds - to buy directly into local stocks. Rupee weakness has been mainly a function of Eurozone problems, says Mr Mackel.