Obscure Chinese Derivatives Suddenly Popular After Rates Revamp

(Bloomberg) -- A sleepy corner of China’s derivatives universe is suddenly popular, as corporates rush to hedge swings in borrowing costs after the nation revamped its interest-rate system.

The transaction volume of interest-rate swaps linked to the loan prime rate surged to 18.6 billion yuan ($2.6 billion) in August, the largest monthly turnover since authorities started publishing the data in 2016. The jump came as China asked banks to price new loans based on the more market-based LPR rather than the benchmark lending rates last month. That move may make the cost on loans harder to predict, creating demand for hedging.

“Corporates need to use LPR-linked IRS to lock in the funding costs on their loans,” said Brian Lai, head of the fixed-income department of Shanghai SilverLeaf Investment Co. Many brokerages and banks are also trading the products to bet China’s interest rates will decline, he added.

Despite the surge in popularity, such contracts took up only 1.2% of the total turnover in the IRS market, according to official data. Products that are based on the seven-day repurchase agreements are the most popular, accounting for more than 70% of the total transactions, the data showed.

To contact Bloomberg News staff for this story: Claire Che in Beijing at yche16@bloomberg.net;Wenjin Lv in Shanghai at wlv8@bloomberg.net

To contact the editors responsible for this story: Sofia Horta e Costa at shortaecosta@bloomberg.net, Tian Chen, Philip Glamann

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With assistance from Bloomberg