Hong Kong Financial News

Most local banks, under pressure from the HK government, will start a buyback program for Lehman Brothers’ minibonds next month (December). On the other hand, after working so hard on the buyback program, they were just told that the buyback may not be legitimate under US Bankruptcy law because only the liquidator has the power to buy back or handle any financial instruments issued by Lehman Brothers under the law.

I guess this is more like a technical legal issue. The banks are buying back the minibonds themselves, out of their own money. They are not touching the frozen assets of Lehman at all. I guess lawyers in Hong Kong will just need to meet with the US lawyers handling the Lehman liquidation process to resolve this issue. On the other hand, since today is Thanksgiving, I guess no one on the other side of the continent will work until next week. So the whole buyback of Lehman minibonds will be delayed for a few weeks.

On the other hand, on the face of it, these minibondholders are getting preferential treatment over all other creditors of Lehman, since they probably will get back some money before all other creditors under the buyback program. Will lawyers representing other creditors scream out and block this buyback program that has been pushed so hard by the HK government? I know that if I were one of the other creditors and had enough financial resource, I wouldn’t mind paying some lawyers to try to block this buyback program.

November 28th, 2008 | Tags: buyback, delay, hiccups, Lehman Brothers minibonds | Category: Uncategorized | Leave a comment

While doing more research on the HK dollar peg, I discovered that the range between 7.75 and 7.85 wasn’t established until May 2005 and that there isn’t much correlation between the stock market and the HKD exchange rate. Even if there was correlation, it might not be too reliable given the short history of the dollar peg range.

The peg to the US dollar was started in 1983. This was the time when the UK started the handover discussion of Hong Kong back to China and people started to worry about the future of  Hong Kong. Also it is interesting to note is that the HKD has been steadily depreciating from USD 1 to HKD 5 in the 1970s to USD 1 to HKD 9.6 in 1983.  After October 1983, the peg was set at HKD 7.8 to USD 1. This peg lasted for 15 years and then in 1998, the peg was moved to USD 1 to HKD 7.75 and in May 2005, the peg was changed to a range between HKD 7.75 to HKD 7.85.

If you look at the graphs below, after 2005 when the range pegging was introduced, there was only two instances where the exchange rate was hovering around the edge of HKD 7.75 (Late 05-Early 06, and Oct 07). The first time happened during boom time and the second time happened at the start of the stock market correction. So it’s hard to say that there is any correlation between the HKD exchange range and the Hang Seng index.

November 22nd, 2008 | Tags: hang seng index, Hong Kong Dollar Peg | Category: General Trends | Leave a comment

The Hong Kong Monetary Authority (HKMA) has been interfering with the foreign exchange rate several times in the past two weeks by injecting HKD into the market to stem the rise of HKD against USD.  The exchange rate is now around HKD 7.75 to USD 1, at the left hand edge of allowable range between 7.75 to 7.85.

What makes HKD so strong recently? even stronger than the USD? Below are some plausible reasons:

1. HKD is essentially USD. When people are going for safety in USD, they can find safety in HKD as well. This will prompt people to buy USD and/or HKD.

2. The Hong Kong government now insures every bank account in Hong Kong, with no upper limit, for the next few years. In the US, only up to USD 100,000 was insured. Parking your money in HK is definitely safer than parking money in the US, particularly for big money amount.

3. HK is indeed safer in the sense that there has not been a single bank going under in this financial crisis. If you look at the US, a few of the smaller US banks have gone under already.

4. People are waiting on the sideline to get back into the Hong Kong equity market? In general, people believe that China will recover faster than all developed countries in this financial crisis. So Hong Kong / China stocks should recover earlier and faster than US stocks.

Hopefully No. 4 is true. Then we can probably see a very good bounce back next year! Let me check if there is any correlation between HKD exchange rate and Hong Kong stock market tomorrow! Stay tuned.

November 21st, 2008 | Tags: HKD, HKMA intervention, Hong Kong Dollar, USD | Category: General Trends | Leave a comment

Today’s turnover was only HKD 39.84 billion, the smallest turnover in one and a half  year.  Compared to the daily turnover that was over HKD 150 billion last year, you can see how bad the market is now. Hong Kong Stock Exchange (388) is a stock that tracks quite closely the amount of activity on the exchange and it has also dropped from its height of HKD 250 to the current price of HKD 60. If turnover continues to be at this level, 388 will definitely go down further.

As it is already close to the end of the year, I won’t be surprised that volume won’t pick up until after Chinese New Year (i.e. February 2009). Until then, since volume is thin, people can drive the stock price up or down quite easily. So probably the Hang Seng will be range-bounded between 10000 - 15000 till February 2009. That’s my prediction.

November 18th, 2008 | Tags: 388, Daily Turnover, Hong Kong Stock Exchange | Category: General Trends | Leave a comment

While I was reading through the 26 page announcement made by CITIC Pacific on how their parent company would rescue them, I found out the difference between the two derivative products that CITIC Pacific was buying: daily accrual forward contracts and target redemption forward contracts. In the announcement, the daily accrual forward contract is described as follows:

Under the AUD daily accrual forward contracts, the strike rate (i.e. the rate at which deliveries of currencies are made) and the accumulation/ knock-out rate (i.e. the rate at which no delivery of currencies will be made if such rate is lower than or equal to the spot rate) are fixed. A notional amount of AUD will be delivered at the relevant instalment dates at the strike rate if at the relevant time, the spot rate is between the strike rate and the accumulation/ knock-out rates. In the event that the spot rate is lower than the strike rate at the relevant time, a pre-determined amount of AUD (which is greater than the notional amount) will be delivered.

And the target redemption forward contract is described as follows:

Under the AUD target redemption forward contracts, the strike rates (which may have a step-up feature (i.e. to reflect an appreciation of the currency over the term of the contract)) are fixed. If the spot rate on any given day during the contract period is equal to or above the strike rate, a notional amount of the AUD will be delivered at the strike rate. The difference between the strike rate and the spot rate will be treated as a profit in respect of that particular contract and when the cumulative profit reaches the maximum profit stipulated in the contract, that particular contract will be knocked-out (i.e. the obligation to deliver further currencies will cease). If the spot rate is below the strike rate, a pre-determined amount of the AUD (which is greater than the notional amount) will be delivered at the strike rate.

They both sound very similar, don’t they? The main difference is how these contracts will be knocked-out. In the first one, as long as the FX rate has reached the knock-out rate, the contract will expire. In the second one, there is not such knock-out rate. There is, however, a target redemption rate: once the culmulative profit of the contract has reached the target redemption rate, e.g. 50% of the principal, the contract will expire. One can see that with the current depressed AUD exchange rate, the chance of the contracts in both variations knocking out is very very slim.

For more details on this Citic Pacific saga, you can check out the following posts:

http://www.hkfinancialnews.com/?p=96

http://www.hkfinancialnews.com/?p=94

http://www.hkfinancialnews.com/?p=89

http://www.hkfinancialnews.com/?p=83

http://www.hkfinancialnews.com/?p=82

 http://www.hkfinancialnews.com/?p=81

Finance Asia also has an article explaining the rescue: http://www.financeasia.com/article.aspx?CIaNID=88950

November 15th, 2008 | Tags: 267, CITIC Pacific, daily accrual forward contracts, Target Redemption Forward Contracts | Category: Companies | Leave a comment

Maybe this is Chinese family value. Citic Group, the parent company of Citic Pacific, is assuming all liabilities of Citic Pacific’s FX derivative trades and giving Citic Pacific a loan of HKD 11.6 billion, which will be later converted into a convertible bond with a conversion price of HKD 8.00. This is just like a father-son relationship. No matter how naughty the son is, how wrong the son has done, the father is always forgiving and will give unconditional love to the child.

Or maybe it is a question of face. Nothing should go wrong within the Chinese government. With Citic Group being a Chinese government investment arm, nothing should go wrong within the Citic enterprise. The government just wants to end this saga as soon as possible and move on. And hopefully investors will forget it very soon.

Next time, when people see a governmental or semi-governmental company failing and its share price drop, buy the stock as the company will eventually be bailed out by someone higher up and the share price will subsequently go back up!

November 14th, 2008 | Tags: 267, bailout, CITIC Pacific, convertible bonds, loan | Category: Companies | Comments (2)

After more than 7 hours of debates, the Legislative Council has finally voted yes to invoke special power in investigating the selling of Lehman minibonds. The two notable persons who opposed to this motion were David Li Kwok-Po, Chairman of Bank of East Asia and Regina Ip Lau Suk-Yee.

It is not surprising to see this motion pass because all the political parties in Legco are pro-masses and supporting this motion. But the passing of this motion has great impact that the legislators may have ignored:

i) The free market in Hong Kong is gone. From now on the financial markets will be a lot more regulated. On the other hand, the free market spirit is already gone in other parts of the world anyway as banks in the UK and the US are now getting government’s funding and are under strong scrutiny from the government.

Now the banks have an excuse not to pay back the mini-bondholders anymore, until the entire investigation is finished. The whole investigation will probably take at least a year. With some of the banks that have considered repaying the mini-holders next month, will they hold on to their promise and pay back the poor mini-bondholders?

Will the value of the minibonds be diminshed further after a year? Those bonds are not like gold bullion that have more or less a stable value. These products can be a piece of worthless paper anytime and what good can the investigation give to the bondholders who have lost their fortune?

From now on, banks may not be bold enough to issue similar structured products like the minibonds anymore.  This is a big blow to the finance community as the bull market a year ago was more or less driven by the proliferation of structured products. A lot of banks were growing quickly because they have made a killing on these products. And also, this type of products support a whole spectrum of people: traders, structurers and sales in investment banks, sales in private banks and retail banks, etc…  A lot of these people will be out of job!

November 12th, 2008 | Tags: david li, legislative council, lehman, minibonds, regina ip | Category: General Trends | Leave a comment

I’m trying to find what exactly the FX “target redemption forward contracts” are, as the term was mentioned in Citic Pacific’s (267) profit warning back in late October. After googling the term, I couldn’t find much info. But according to the profit warning, they should not be too different from the accumulator structure that I talked about previously (http://www.hkfinancialnews.com/?p=89). If any reader knows what exactly this is or has a sample termsheet, please send it to me.

Instead, I’ve found a lot of entries on TARN (Target Redemption Notes), which is a totally different beast. TARN is another structured product, but then its downside is protected as it’s principal protected. It also provides a guarantee of a certain amount of coupon over a period of time (hence the name target redemption). For example, if the target is 20% and the tenor of the note is 6 years, the note guarantees that the note holder will have gotten accumulative coupons of 20% of the principal value by the end of the sixth year. It also has a knock out feature where once the target coupon amount has reached, the note will be redeemed immediately at 100%. In the example, if the noteholder receives 8% in the first year, 9% in the second year, and the theoretical coupon rate in third year is 5%, then the noteholder will only receive a 3% coupon since the max coupon allowed is 20%. The amount of coupon is usually linked to the performance of a currency pair or a stock above or below a given strike on a series of fixing dates.

If Citic Pacific bought this type of TARNs instead of the FX accumulators, they would have suffered a much smaller loss!

November 11th, 2008 | Tags: 267, CITIC Pacific, Target Redemption Forward Contracts, Target Redemption Notes, TARN | Category: Companies | Comments (1)

Every week there are more companies which announce that they are losing money with the hedging strategies that they are using. A lot of the strategies are bull market strategies and have unlimited loss if prices drop. With commodities, commodities currencies, equities–essentially all asset classes–collapsed in the past month, it is not surprising to see companies announcing to public that they have suffered serious derivative losses.

According to newspaper, Cathay uses zero cost options to hedge fuel costs. They long a call option so that they will earn money from the option if fuel price goes above the strike. Also, in order to have zero cost strategy, they sell a put option is to offset the entire cost of buying a call option. At the same time, this short put creates an unlimited downside to the company. When fuel price drops below the strike price, the company will need to purchase fuel at the strike price which is higher than the current price.

By using this strategy Cathay does not need to worry about fluctuation in fuel price. They have probably set a fixed price for fuel in their business projection and having a fixed fuel price definitely makes planning much more easy. Unfortunately this created an unintended side effect of creating big financial loss when the hedge goes the wrong way.

With what has happened in this financial crisis and all this negative publicity surrounding derivatives and structured products, companies will definitely be very cautious when bankers sell them all these hedging solutions. From now on, they will very likely resist all hedging solutions with possible unlimited downside!

November 7th, 2008 | Tags: 293, cathay pacific, fuel, hedging, unlimited downside, zero cost option | Category: Companies | Leave a comment