Chinese companies race to hedge against a swinging yuan with regulatory encouragement

Chinese companies have rushed to derivatives for protection from currency exposure as a rising yuan has hurt some exporters for months and - more recently - the war in Iran has ramped up volatility.

The trend is breaking records and, sources said, is being encouraged in part by authorities. ​For now, short-term risk-aversion is driving investors, businesses and other participants into the dollar and an 11-month yuan rally has paused.

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But in the longer run, hedging will deepen the market and ‌the scramble to do so suggests a major shift is underway as exporters reduce their dollar exposure, which could soon set the yuan higher particularly as exports boom.

Using forwards, a popular way for businesses to offset exposure by agreeing on foreign-exchange prices in advance, net selling of foreign currencies jumped to a record $39 billion in January.

That followed a record outright net selling of dollars to Chinese banks of $100 billion in December and a hefty $80 billion in January.

The trend will likely continue as China's exports surged 22% in January and February, putting the ​economy on track to top last year's record $1.2 trillion trade surplus.

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Chinese exporters, who make sales abroad in dollars, have long kept most of the proceeds and invested them, converting to yuan only what they need ​to cover business costs at home.

A rising yuan presents a problem: Their dollar holdings diminish in value. So they have been selling dollars and increasing hedging, which has only ⁠added upward pressure on the yuan, in turn encouraging even more dollar selling.

"We have seen a stark transformation in market participants' view on the yuan over the past year," said Lynn Song, chief economist for Greater China at ​ING in Hong Kong.

"Where overwhelmingly we had a strong yuan depreciation bias in the markets, (we now have) almost a consensus yuan appreciation bias," he said, which in turn is encouraging hedging that ends up bolstering yuan gains in spot ​trading.