TAIPEI: Taiwan's banks are facing losses of millions or possibly billions of dollars from customer defaults on a popular derivative product - falling victim to the unexpected slide in China's currency.
The island's financial regulator is scrambling to get a grip on the issue after China surprised global markets in August by devaluing the yuan. It has demanded higher bank provisions against potential losses and punished banks for misselling the product.
Taiwan's experience shows the ripple effect of China's market turmoil, which has prompted many investors to rethink a long-held assumption that the yuan would only rise.
The product causing the angst is a derivative called a target redemption forward (TRF).
It pays the holder a monthly income so long as the yuan remains above a trigger price against the dollar.
If the yuan falls, the investor has to payout. For years, they seemed a sure bet to a steady income as the value of the yuan rose steadily against the dollar. The yuan's devaluation and subsequent slide have wiped away those assumptions and left many investors regretting the day they bought the product.
"TRF is worse than gambling, where your chance is at least 50-50 in gambling. However, with TRF you'll lose everything to a point where you just want to kill yourself," said Kevin Kuo, a small-business owner who invested in TRFs.
"Something bad always happens sooner or later," said Kuo, adding he lost around T$13 million ($390,000) from trading two TRF contracts.
"NOBODY KNOWS"
Austin Chan, director general of the FSC's banking bureau, said the commission was monitoring the situation and hoped "potential losses will be minimised."
The full extent of the losses from investors defaulting on their contracts is not clear. Under a worse-case scenario, Fitch Ratings estimates bank losses could amount to $2.4 billion.
The regulator's estimate, based on banks' feedback, is much more modest at about $120 million. However, it is not mandatory for banks to declare their losses publicly, which has left investors uncertain.
Some are hedging their bets. Taiwan's financial stock market sub index fell more than a fifth from a November high to a January low, compared with a 14 percent slide in the main stock index.
Most of the contracts were sold when the yuan exchange rate ranged between 6.35 and 6.5 per dollar, Fitch Ratings said in December.
The yuan fell as low as 6.75 in January and on Friday was changing hands at 6.5790, suggesting many retail investors would be out of the money.
Offshore forwards markets are pricing in further losses for the yuan, quoting the currency at 6.74 in six months. Hong Kong and Taiwan are Asia's two biggest markets for TRF options due to their close trade ties with China.
In Taiwan, the product took off in 2013 as international banks introduced them to the market.
So far, Taiwan's banks have declared little about their financial exposure to TRFs and investors may not get their first glimpse of the depth of the problems until the banks publish 2015 full-year results due by late March and first-quarter results due in early April.
About half of the TRF contracts expired in January and the rest expire between February and June, regulatory sources said. Still, the TRF market is shrinking as the currency falls.
Total TRFs amounted to T$66.7 billion ($2 billion) as of Jan 8, down from T$82 billion last year and T$160 billion the year before, data from the regulator shows.
That compares with total bank assets of some T$43 trillion. "The government has not made the whole situation clear so far, but it will have to sooner or later.
The point is, nobody knows how much provision banks should set aside.
They won't tell you unless the government makes it mandatory to disclose," said James Yeh, a fund manager of JPMorgan Asset Management in Taipei.
"Banks will not set aside all of the provisions all at once. You know that based on what they did during the subprime crisis," Yeh said, adding he expects profits at financial companies to decline this year.
The FSC said on Jan 26 that it will punish nine banks for misselling the product in an effort to prevent further losses. Banks including Citibank, Standard Chartered, Cathay United Bank, Taipei Fubon Bank and Bank Sinopac will be punished, it said. "How volatile will the yuan be? Is it going to appreciate or depreciate? Nobody knows," said Austin Chan, director general of the FSC's Banking Bureau. "We're doing what we can in hope to minimise the losses."
Comments
Comments are closed.