BY Tony Hall - global head of macro trading, financial markets at Standard Chartered
Unsurprisingly, restricted Foreign Exchange (FX) markets are typically found in developing economies. A global market accessibility review1 published by MSCI in July 2019 refers to constraints on the onshore currency market in a number of countries including Malaysia where FX transactions must be linked to security transactions, China which also maintains a separate offshore market for its currency, and Bangladesh where FX transactions must be executed by the local custodian.
Typically, we see the most severe restrictions in smaller economies which are most vulnerable to large external capital flows but these are often lifted over time as the economy matures. For example, the market is waiting to hear the final outcome of India’s announced review of the existing facilities for hedging of foreign exchange risk by non-residents and residents. In other cases, a country may maintain restrictions even as it moves beyond developing status or may re-impose restrictions when their economy experiences a downturn.
In this context, there is considerable value for corporates in working with a partner whose global expertise and local presence positions them well to guide corporates through complicated and developing FX restrictions.
Proof of intent
Governments typically intervene in FX to limit the flow of funds into and out of a country for several macroeconomic reasons. Such restrictions are generally positive for onshore corporates – as having a relatively stable exchange rate also makes it easier to access offshore financing.
Implementation of FX restrictions varies widely but usually requires the party involved to demonstrate that they require FX for real economic activity. For example, regulators may require ‘proof of underlying’ from an investor, such as the purchase of onshore bonds. A corporate might be required to prove it has cash flows related to its onshore business. The objective here is not necessarily to achieve exchange rate stability, but rather to ensure the FX level accurately reflects the economic fundamentals of the country.
While these FX restrictions may make it difficult for global investors to take advantage of opportunities in local securities markets, we frequently see regulatory changes aimed at increasing cross-border flows. Indeed, staying ahead of upcoming regulatory change by working with a partner can ensure you are well positioned to take advantage of these developments as soon as possible.
China, for example, has been actively opening its capital markets to foreign investors yet maintains its FX controls. This is where having a reliable partner, with global reach and local presence, will be necessary to bridge the gap: for example, to access the Bond Connect programme and associated hedging channels where Standard Chartered is a leading market maker2.
A little understanding
The implication of this for offshore corporates and multinationals looking to do business in many locations is the need to deal with complexities of a multitude of different national regulations. In some cases, a corporate will be required to have an onshore subsidiary or face an onshore bank directly, which requires the establishment of a local legal entity and credit lines.
To add even more complexity, these situations are rarely static. As such, having a local presence is vital to maintain an understanding of what’s happening – and what is likely to happen – at the regulatory level in jurisdictions with FX restrictions. Central banks and regulators in such markets often conduct industry consultations to understand how the FX market is evolving and typically turn to banks with both onshore and offshore presence to share global best practices.
There is also great value in connecting offshore corporate treasurers with central banks and regulators. This is a focus for Standard Chartered: to help both sides understand how market structure can be enhanced to achieve better outcomes for those seeking to maintain currency stability and market visibility, as well as those seeking to invest in a country.
Keeping it simple
Understanding the regulatory picture is just one part of the puzzle – the nature of restrictions in many markets also limits the type of hedging products that can be employed. For example, some markets only allow spot or forward transactions, whereas others may allow corporates to buy vanilla options but not to use leverage. As such, working with a bank with local networks is vital for corporates trying to identify which products they can access in a particular country to provide the most cost effective and efficient hedge. On top of this, there are likely tax, legal, accounting and documentation implications to navigate.
To reduce complexity for clients, Standard Chartered enables trading of restricted currencies in some markets using an offshore International Swaps and Derivatives Association (ISDA) master agreement. This means clients don’t have to re-paper with each of the Bank’s onshore entities. This specific approach is not applicable to every jurisdiction and is only available through discussion with regulators – something we are well-placed to support given our long-standing commitment to many restricted jurisdictions.
To give an example, if an investor buys an onshore bond and needs local currency to complete the transaction, they could sell dollars to our regional hub under their global dealing relationship. Our onshore entity would then be instructed to deliver the local currency to the client’s securities custodian. We can also liaise directly with the custodian to complete the documentation required to support the FX transaction. For some markets, this process can also be executed on our electronic dealing platforms.
International banks – especially those operating from hubs in locations such as London, New York, and Singapore – tend to focus more on the offshore market. Banks with deep local knowledge, like Standard Chartered, are also able to assist clients with restricted markets wherever required – at the client’s corporate headquarters, at their regional treasury or with their onshore subsidiaries.
In challenging market environments – which aren’t expected to become any less so in the near term – corporates and investors should take care to partner for their FX needs with a bank that has the right on-the-ground perspective.
This article was also published in Euromoney.
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