THEEDGE SINGAPORE | SEPTEMBER 21, 2015 • 25
Will the China crisis be a trigger for financial innovation?
OPINION
Crude convulses amid economic uncertainties
O
and intensity, in the global econo- rivatives markets fail within a few
nce again, investors were World Trade Organization while
my. In particular, I advocated the years of their openings.
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ugust There
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recently
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| BY PATRICK LECOMTE |
second-quarter
supply-demand
and cut
output,
possibly
in our economies by enabling
havea noIran
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China.
tainable
global
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the summer.
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three
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Energy
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atives
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economy
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ers outside
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lem
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it, and
Administration
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years
laureate
Shiller
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pegged
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year’stransparoversupplyan
at MNC,
its prominence
potential ripple
the
regiontively
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The Prize
fact that
signsRobert
of strain
are evident
| BY VANDANA
HARI | inves- tion
for actors
in the financial
sector,
be the
tor managing an equity portfolio, country’s
grasp it.
producers
are cuthas been
both
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“Macro
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thatand
is, markets
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series
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published
disclosure
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in prices.
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million bpd
average todifosincreased
for the global
ic risk.
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eventful
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bpdrelated
(in contrast
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2014)
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front-month
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largest,
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ter innovation
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in spring
Bank ofand
China’s
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for2013,
June, down
from 9.4 million
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omy.6%
Three
years ago,
economists
the time isthat
ripeOpec
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supply
to rise bypolicy
2.7 million
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meted
in a single
day to
close at US$42.69
to the argument
mightfinancial
or should
greater society
in 9.6
themillong term.
suggested
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instruhave madeWhat
the matter
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Chi-routI tells
in May, and
the year-to-date
high of
at thewhile
International
Monetary
innovation, and China might be
the August
us is that
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crude slipped
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E
Launching
be about
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na’s
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for it. seems remote. Opec
market participants
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5.5%
to US$38.24
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So far,
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possibility
ments
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newface
economic
by a year
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the demand
world’s growth
vulnerability.
7%embodied
higher than
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temic
risk in
posed
by China’s
story in the
of eco-reality
8.5%
plunge
China’s
ShanghaiabilComposite
might decide to wait out a bit longer. That
derivatives
a costly
and risky
the fast
and her
Whethernomic
you are
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In Russia,
where the
rouble hasare
almost
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ity to
keepsent
growing
the levels
Lecomte
senior research
headwinds,
including those
in emergence
Europe. of China
Index,
which
shockat
waves
across equity
won’t bePatrick
because
of any is
consensus
for doing
venture
inasmuch
scope
a corporateoftreasurer
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valueinfrom
a year
ago against
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dol-new
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at ESSEC Asia
supply overhang
now importance,
extend in both
markets
sodewithinfellow
the organisation,
butPacific
simply because
Crude ticked up in fits and starts in the fol- beyond 2016, and Nymex crude is below the lar and helped offset the oil price collapse for the Saudis might be able to prevail again at the
lowing days, but Brent still closed the month US$55 mark on the forward curve through producers, crude and condensate output rose December meeting with the argument that it
2% on year to 10.68 million bpd in August, is a question of market share and this battle
20% below its year-to-date high of US$67.77. end-2016. with
exports
non-CIS
(Commonwealth
theEdge
meantime,
production
fromCopyright
the Or- ©
Alarm bells were
already ringing
on Beiis going
to take Worldwide.
time to win. Russia has made
Reproduced
by permission
ofIn
The
Publishing
Pte Ltd.,
2015
The toEdge
Publishing
Pte Ltd. Allof Rights
Reserved
jing’s move on Aug 11 to devalue the renminbi ganization of the Petroleum Exporting Coun- Independent States) countries jumping 11%. all the right noises, but doesn’t appear in the
and the subsequent government interventions
least bit inclined to cut, either.
to manage the currency’s descent while trying
A handful of small US shale producers have
ICE Brent and Nymex light sweet
to contain the domestic stock market rout at
already gone bankrupt this year. A confluence
the same time. Poor economic data, showing
of factors, including Nymex crude languishing
US$ a barrel
70
more pronounced contraction in manufacturin the US$40s, flow of funds to some of the
ing activity and a slump in Chinese exports,
weaker independents becoming difficult and
65
reinforced a more pessimistic prognosis for the
the producers entering 2016 far less hedged
world’s second-largest economy.
than 2015, might just bring about a sharper
60
While China’s crude imports in the first sevdownturn in US output in the coming months
en months of the year grew by a healthy 10%
than currently anticipated.
55
and refinery throughput was 4.7% higher than
The question then is to what extent the re50
in the corresponding period of 2014, its stockmoval of even a few hundred thousand barpiles of crude as well as products have been
rels from daily supply would prop up oil pric45
rising, suggesting much lower rise in end-uses. And, more importantly, what impact would
er consumption.
that price recovery have on US production. E
40
China is expected to continue ratcheting up
ICE Brent
Nymex light sweet
its crude imports between 2015 and 2020 at an
Vandana Hari (vandana@platts.com) is Asia
35
average rate of about 5.5%, importing rougheditorial director at Platts, a global energy, pet30
ly 210,000bpd for stockpiling over this perirochemicals, metals and agriculture informaJanuary
February
March
April
May
June
July
August 2015
od, while its oil demand grows at just around
tion provider and a division of McGraw Hill
3.6% annually, according to a recent report by
Financial
INTERCONTINENTAL EXCHANGE
A
Will the China crisis be a trigger for financial innovation?
O
nce again, investors were
caught by surprise when the
Chinese stock market crash
this summer. There are two ways to
make sense of investors’ apparent
surprise. First, one can find comfort
in common investing wisdom. As
the Wall Street adage goes, “Sell in
May and go away.” Alternatively,
one can look at what could have
been done to prevent investors’
knee-jerk reactions and panic, and
lay the groundwork for more sustainable global financial markets.
The Chinese economy’s rise to
prominence over the last 30 years
has been both a tremendous opportunity for the world and a source of
increased risk for the global economy. Three years ago, economists
at the International Monetary Fund
became concerned about the systemic risk posed by China’s ability to keep growing at the levels
it had enjoyed since joining the
World Trade Organization while
shifting its focus from fixed asset
investments to domestic consumption. They ran sophisticated models
based on former US Federal Reserve
chairman Ben Bernanke’s academic research, and estimated that a
1% decline in China’s investment
would mean a reduction of 0.1%
in global growth.
When suddenly confronted with
this risk over the summer, investors were at a loss. Admittedly, they
have no easy way to allocate China-related risk, let alone to effectively hedge it, and little transparency to fully grasp it. Uncertainties
stemming from a relative lack of
disclosure related to the People’s
Bank of China’s monetary policy
have made the matter worse. China’s perceived vulnerability has
become the world’s vulnerability.
Whether you are an institutional
investor, a corporate treasurer in
| BY PATRICK LECOMTE |
an MNC, or an individual investor managing an equity portfolio,
how do you hedge China?
In a series of articles published
in Asia and Europe in spring 2013,
I suggested that financial instruments be designed to capture the
new economic reality embodied by
the fast emergence of China and her
growing importance, both in scope
and intensity, in the global economy. In particular, I advocated the
launch of economic derivatives on
the Chinese economy as a way to
easily hedge China-induced risks.
Arguably, what has been happening in China over the last few
months reveals the financial sector’s
shortcoming at being forward-looking and innovative. Thanks to past
landmark innovations such as derivatives pricing models, financial
markets globally serve a useful purpose in our economies by enabling
optimal risk allocation. The problem is that there are no incentives
for actors in the financial sector, be
they investment banks or standardised derivatives exchanges, to foster innovation that would benefit
greater society in the long term.
Launching new derivative instruments such as China’s economic
derivatives are a costly and risky
venture inasmuch as most new de-
rivatives markets fail within a few
years of their openings.
With the proper incentives in
place, the financial sector could
become an important engine in
promoting sustainable and efficient capitalism. Derivatives aimed
at managing risks stemming from
large economies, including the Chinese economy, are long overdue.
Their relevance has been proven
during the global financial crisis
of 2008, and more recently over
the summer. These types of derivatives would be part of what Nobel
Prize laureate Robert Shiller calls
“Macro Markets”, that is, markets
to manage society’s largest economic risk. After an eventful summer,
the time is ripe for some financial
innovation, and China might be
E
the trigger for it.
Patrick Lecomte is senior research
fellow at ESSEC Asia Pacific
