Capital Markets Trading and Investment Strategies in China (eBook)

After graduating from Carnegie Mellon, Xiaojing Zhang worked at various global financial institutions, including HSBC, ABN AMRO, TIAA-CREF, and Lehman Brothers in the areas of foreign exchange, fixed income, derivatives trading, and portfolio management. Since returning to China, he has been working in the banking industry, as a front office business architect in global capital markets department, consolidating international and domestic business practice, covering foreign exchange, money markets, derivatives, fixed income trading and portfolio management.

Contents 5
Introduction 10
1 Building Blocks of an Investment Portfolio 11
1.1 Foreign Exchange Instruments 11
1.1.1 Onshore CNY FX Instruments 11
1.1.1.1 Global Context 11
1.1.1.2 The Market Place 14
1.1.1.3 FX Spot 19
1.1.1.4 FX Forward 22
1.1.1.5 FX Swap 24
1.1.1.6 FX Option 27
1.1.1.7 Cross Currency Pair Trades 28
1.1.2 Offshore CNY/CNH FX Instruments 29
1.1.2.1 The Market Place 29
1.1.2.2 Deliverable Versus NDF 29
1.1.2.3 FX Forward Trade 30
1.1.2.4 FX Option 30
1.2 Traded Money Market Instruments 30
1.2.1 Onshore CNY Market 30
1.2.1.1 Diversified Participants 30
1.2.1.2 Liquidity and Historical Development 31
1.2.1.3 The Markets Maturity Distribution 31
1.2.1.4 Pledged Repo and Reverse Repo 31
1.2.1.5 Outright Repo and Reverse Repo 34
1.2.1.6 Interbank Lending 36
1.2.1.7 Interbank Deposit 39
1.2.1.8 FX Deposits 39
1.2.1.9 Commercial Paper 39
1.2.1.10 Short Commercial Paper 39
1.2.1.11 Central Bank Bill 40
1.2.1.12 Sec Lending 40
1.2.1.13 Forward Rate Agreement 41
1.2.1.14 Cross-Border CNY Financing with Loan/Depo 42
1.2.1.15 CD 42
1.2.1.16 MM Funds 43
1.2.1.17 Different MM Indices 45
1.2.2 Offshore Money Market Management 46
1.2.2.1 Repo and Reverse Repo 47
1.2.2.2 Loan Deposit 47
1.2.2.3 Commercial Paper 47
1.2.2.4 FX Swap 48
1.3 Fixed Income Instruments 48
1.3.1 Instruments Types 49
1.3.1.1 Book-Entry Treasury Bond 52
1.3.1.2 Local Government Bond 54
1.3.1.3 Policy Bank Bond 55
1.3.1.4 China Development Bank (CDB) 56
1.3.1.5 The Export-Import Bank of China (EIBC) 59
1.3.1.6 Agricultural Development Bank of China (ADBC) 61
1.3.1.7 Corporate/MTN 63
1.3.1.8 Different Assets Issued by Banks 67
1.3.1.9 ABS 70
1.3.1.10 Foreign Entity-Issued Bonds 71
1.3.2 Instruments by Cashflow Structures 72
1.3.2.1 Fixed Rate Bond 72
1.3.2.2 Zero Coupon, Discount and Floaters 73
1.3.2.3 Option-Embedded Bonds 74
1.3.2.4 Convertibles 74
1.3.2.5 Small-and-Medium Enterprise Collective Notes (SMECN) 76
1.3.2.6 High Yield 76
1.3.2.7 Asset-Backed Securities 77
1.3.3 The Market Place 81
1.3.3.1 Exchange, Interbank, and Retail Market 81
1.3.3.2 Regulatory Regime for the Fixed Income Market Place 90
1.3.3.3 Participant Distribution for Trading 91
1.3.3.4 Investment Community Distribution 92
1.3.3.5 Specific Interbank Market Versus Exchange Market Differences 93
1.3.3.6 Liquidity and Issuance 93
1.3.3.7 Participants and Risk Appetites 95
1.3.3.8 Leverage Usage 95
1.4 Derivatives 96
1.4.1 Swaps 96
1.4.1.1 Instrument Definition, Indices and Application 96
1.4.1.2 Participants and Trading Liquidity 97
1.4.2 Bond Futures 97
1.4.2.1 Contract Definition and Instrument Application 97
1.5 Gold Contract on Shanghai Gold Exchange 99
1.5.1 Physical Gold 99
1.5.2 Deferred Delivery Gold 100
2 Macro Economics, Monetary Cycle, Industry Cycle, Monetary Condition, Supply and Demand 102
2.1 Traditional Macro Cycle Indicators 102
2.1.1 GDP and Growth Contribution 102
2.1.2 Electricity Generation and Industrial Growth 103
2.1.3 Pork and Copper Price as Growth Indicators 103
2.1.4 Export Dependency and Market Distribution 105
2.2 Real Estate Cycle Specificities 108
2.2.1 New Construction, Sales and Existing Inventory 108
2.2.2 Real Estate Dependency 110
2.3 Government-Driven Investment 112
2.3.1 Government Spending and Its History 112
2.3.2 Budgetary Deficit Constraint 114
2.4 USD Cycle 116
2.4.1 Global Monetary Condition and Funding Cost 116
2.4.2 Exchange Rate Fluctuation and Its Impact on Commerce 117
2.5 Industrial Cyclical Specificities 119
2.5.1 Industry Classification 119
2.5.2 State-Owned Versus Private-Owned 130
2.5.3 Cycle and Seasonal Patterns 132
2.6 Monetary Cycle 134
2.6.1 Quantity Versus Price Target 134
2.6.2 Quantity Target, M1, M2, and Total Social Financing 135
2.6.3 Regional Distribution of Aggregated Social Financing 140
2.6.4 A Distribution Perspective from Financial Intermediary 145
2.6.5 Price Target, 10 Year Bond Yield and 7D Repo Rate 148
3 Applied Pricing Curve in the Market and Term Structures 150
3.1 Curves and Term Structures 150
3.1.1 FX Curve and FX Swap Points 150
3.1.2 Money Market Curves Across Different MM Segments 151
3.1.3 Government Bonds and Interest Rate Term Structure 155
3.1.4 Central Bank Bill Curve 156
3.1.5 Tax Spread Curve and Policy Bank Bonds 157
3.1.6 Credit Curve by Rating and Industry 157
3.1.7 Bond Future IRR, Contract Spread and Roll-Over 159
3.2 In-depth Factors Driving Onshore FX and Money Market Curves 160
3.3 Monetary Policy-Driven Supply Policy Factors 162
3.3.1 Deposit Reserve Ratio 162
3.3.2 Open Market Operation 162
3.3.3 Discount Window 163
3.3.4 Short-Term Liquidity Operations 163
3.3.5 Standing Lending Facility 163
3.3.6 Mid-term Lending Facility 164
3.3.7 Pledged Supplementary Lending 164
3.3.8 Non-monetary Policy-Driven Supply Factors 164
3.3.8.1 Funds Outstanding for Foreign Exchange 164
3.3.8.2 Treasury Deposit 165
3.3.9 Structural Factors 166
3.3.9.1 IPO and Other Investment Flows 166
3.3.9.2 Bank Fund Volatility 167
3.3.10 Seasonal Issues and Market Expectation 168
3.4 In-depth Factors Driving Fixed Income Portfolio Return and Risk Curve Parameters 168
3.4.1 Cross-Border Monetary Flow and Pricing Transmission 168
3.4.2 Domestic Monetary Supply 169
3.4.3 Product Supply and Demand 169
3.4.4 Tax Consideration 170
3.4.5 Cost of Funds and Risk Appetite 171
3.4.6 Credit Allocation Limits and Industry Policy Issued by Government 172
3.4.7 Bond Future Net Basis, Implied Repo Rate and Cheapest-to-Deliver Optionality 172
3.5 MTM Basics for Listed Capital Markets Products 174
4 Regulatory Regime and Some Policies in Focus 175
4.1 Central Bank Objectives and Its Balance Sheet Analysis 175
4.2 Foreign Exchange Trading Regulation and Mid Pricing Guideline 178
4.3 Leverage Regulatory Requirement 179
4.4 ABS and Its Related Regulation 179
4.5 Currency Account and Capital Account Market Liberalization 180
4.6 CFETS (China Foreign Exchange Trade System) 182
4.7 China Banking Regulatory Commission and Interbank Market 183
4.8 China Securities Regulatory Commission and Exchange Markets 183
5 Market Participants 185
5.1 Fixed Income Institution Players, Market Making Participation 185
5.1.1 Interbank Money Market Activities by Bank Types 187
5.1.2 Banks 3-Tiered Banking Systems in Details 192
5.1.2.1 State-Owned Commercial Banks 195
5.1.2.2 Share-Holding Commercial Banks 199
5.1.2.3 Urban Commercial Banks 200
5.1.2.4 Rural Commercial Banks 205
5.1.3 Mutual Funds, Tax Policy and Carry Advantage 208
5.1.4 Insurers and Long Investment Horizon 213
5.1.4.1 Social Security 214
5.1.4.2 Corporate Annuity 216
5.1.4.3 Commercial Pensions 217
5.1.5 Foreign Financial Institutions 222
5.1.6 Private Equities, a Growing Presence 228
5.1.7 Trust 229
5.1.8 Securities Firms 236
5.2 FX Trading Players 238
6 China, International Trade and Global Supply Chain 240
6.1 Major International Supply Chains 240
6.2 Electronics and Electric Supply Chains 241
6.3 Automotive Supply Chain 249
6.4 Chemicals and Pharmaceutical Manufacturing 256
6.5 Apparel Sector 264
6.6 Agricultural Sector 265
7 Portfolio Objectives and Trading and Investment Strategies 269
7.1 Onshore CNY Liquidity Portfolio Management Objectives 269
7.1.1 Asset Liability Management (ALM) 270
7.1.2 Reserve Management 271
7.1.3 Diversification on Maturity and Counterparty 271
7.1.4 Support for Central Open Market Operations 272
7.2 Offshore FX Liquidity Portfolio Management Strategy Objectives 272
7.2.1 Funding Cost, Return Rate and Liquidity 272
7.2.2 SAFE Limit, Cross Border Flow and CNH Liquidity Condition 273
7.3 Trading Accounts FX MTM and Strategies 273
7.3.1 FX Strategies 273
7.3.2 Trade-Financed CNY CNH Interest Rate Arbitrage 285
7.3.3 Cross-rate Split Strategies 287
7.4 Trading Accounts Bond Strategies 288
7.4.1 Trading Mechanism 289
7.4.2 Rate View from Global Perspective 291
7.4.3 Rate View from Domestic Perspective 297
7.4.3.1 Leveraged Carry Trade on the Exchange and the Interbank Market 308
7.4.3.2 Bull Bear Duration and Rating Strategy 313
7.4.3.3 Term Spread Mean-Reverting Strategy 316
7.4.3.4 Tax Spread Strategy 317
7.5 Bond Future Net Basis Strategy and Negative Implied Repo Rate 318
7.5.1 Net Basis Strategy 318
7.5.2 CTD Conversion Strategy 319
7.5.3 On-the-run, Existing Issuance and Tax Spread 319
7.5.4 Domestic Market’s Short Sale Implication 320
7.6 Investment Accounts Objectives and Strategies 320
7.6.1 Some Basics 320
7.6.1.1 Cost of Funds 320
7.6.1.2 Asset Liability Management Objectives 321
7.6.2 Garden Variety of Portfolio Objectives and Investment Strategies 321
7.6.2.1 Return Before Tax and Return After Tax 321
7.6.2.2 Newly Acquired Investment Yield 322
7.6.2.3 EVA 322
7.6.2.4 RAROC 323
7.6.2.5 Portfolio Duration and Risk Management 323
7.6.2.6 Sector Duration and Risk Management 324
7.6.2.7 Total Portfolio Profit and Loss 324
7.6.3 Insurance Companies’ Long End ALM Strategies 324
7.6.4 Mutual Fund Investment, a Mixed Asset Pool to Start With 326
7.6.5 Foreign Banks’ Short Duration and Carry Trade 326
7.6.6 Off-balance Sheet Wealth Investment, a 3 Trillion USD and Still Growing Sector 326
7.6.7 Trust-Based High Yield Regulatory Arbitrage Strategy, a Substantial Sector with Limited Potential 329
7.6.8 Asset-Backed Securities Investment, Regulatory Capital Advantage, Risk Diversification, and Yield Enhancement 330
7.6.9 Convertible Strategy and Callable Implications 330
7.7 Trading and Investment in Gold 331
7.7.1 Physical Gold Segment 331
7.7.2 Deferred Delivery Gold 333
8 Risk Management Practice 334
8.1 Trading Accounts Limits Allocation 336
8.2 Investment Accounts Risk Allocation Practice 336