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Rarely heeded SHIBOR makes a comeback

(China Daily/Agencies)
Updated: 2009-08-31 14:05

A rarely heeded Chinese benchmark, the Shanghai Interbank Offered Rate (SHIBOR), is enjoying new popularity amid a shifting interest rate outlook and easing regulatory barriers.

Signs of monetary tightening are on the horizon as the economy recovers and inflation appears ready to return by year-end, boosting demand for floating rate notes and interest rates swaps using SHIBOR.

And the steady, if gradual, opening of the market to foreigners - with Citigroup Inc approved just this month as a market maker in China's inter-bank bond market - will expand the role of players with expertise and interest in using SHIBOR.

China has been eager to develop the benchmark, which was launched in 2007.

Modeled after London's LIBOR as a commonly accepted money market interest rate curve, it aims to replace heavily regulated deposit and lending rates as a benchmark and will be vital to China's plan to make Shanghai a global financial center by 2020.

But aside from a few signs of interest spurred mostly by central bank prodding, SHIBOR has largely been collecting dust.

Money market traders long shunned it, complaining that contributors of the quotes - mostly cash-rich Chinese banks overwhelmingly on the offering side of transactions - tended to manipulate fixings to keep rates high and maximize their profits.

Those banks were finally compelled to start lowering rates to more realistic levels last summer.

Ironically, the move came during a round of monetary tightening, which forced them to do more transactions on the borrowing side of the market.

Little liquidity

With little liquidity in SHIBOR-based trade, interest rate swaps (IRS) have overwhelming favored the seven-day buyback for the floating portion of transactions, although the buyback can be highly volatile due to supply-demand factors such as funding squeezes during big initial public stock offerings, or IPOs.

Related readings:  Shibor-based floating-rate bond debuts  China to launch trial SHIBOR-based bills  ChemChina issues 1st bonds on SHIBOR  SHIBOR lays money policy foundation

And the issuance of floating rate notes (FRN), once based mainly on one-year deposit rates but now shifting to SHIBOR, was rare in China until recently.

But a number of changes are shaking the cobwebs off SHIBOR and lifting its prospects for a bigger role in the market.

First is a shift in market expectations towards future monetary tightening. The economic recovery spurred the central bank to nudge up bill yields in open market operations in July.

A resumption in equity IPOs in June, spurred by the rallying share market, also triggered funding squeezes in the money market and caused temporary hikes in short-term rates.

One result was a pickup in the issuance of FRNs, popular with investors when expectations rise for higher and longer term rates.

Trade has also intensified in IRS, used for hedging or targeted for speculation when interest rates become volatile.

Both FRNs and IRS are increasingly using SHIBOR.

The volume of three-month SHIBOR-based IRS business was its third-highest on record in July.

Meanwhile, the share of IRS transactions based on SHIBOR has been above 20 percent for the past five months, the longest period above that proportion since the market was launched, according to data from the China Foreign Exchange Trade System & National Interbank Funding Center.

"IRS trade in SHIBOR expanded recently because SHIBOR has embarked on an upward channel, raising the need to hedge risk there, and as banks are eager to diversify their investment products," said Lu Yun, an IRS trader at the Bank of Communications.

Transparency

SHIBOR's transparency has also given it a lift.

"Our customers now access publicly available SHIBOR rates and use them in discussions with our relationship managers to find out about interest rate trends for financing purposes," said Raymond Hui, head of treasury at Societe Generale Shanghai.

Traders expect SHIBOR use to get a further lift from Citigroup's approval as an inter-bank bond market maker, joining 19 Chinese banks and JP Morgan Chase.

Analysts said the approval paves the way for Citigroup to apply for a license in non-proprietary trading of IRS, now held only by Chinese banks, which would open up massive potential for customer business to hedge interest rate risks.

"That license would be very valuable, giving Citigroup a level playing field with its Chinese counterparts in the huge customer flow to sell IRS," said an IRS trader at a European bank in Shanghai.

He expected at least two more foreign banks to obtain bond market maker approval next year.

The IRS trader said foreign banks were more determined than domestic banks to hedge risk using IRS.