(Bloomberg) -- Hedge funds and wind-farm companies are doing battle in an opaque corner of financial markets.
The trade is centered on a gap between deliverable and non-deliverable 10-year Taiwan dollar interest rate swaps which is near a five-year high. The spread is the result of a tug-of-war between speculators betting against rising rates and companies — particularly wind power developers — turning to swap markets to hedge their exposure in borrowing costs.
The difference between these swap rates gives traders a compelling trade opportunity. By paying money outside of the island and receiving payments in Taiwan, they can pocket the difference.
The spread between the two prices shows how shifting bets on monetary policy are sending ripples through global markets, and fueling dislocations in areas that form an essential part of the plumbing of global finance.
Security houses and Taiwanese banks’ offshore units are among those executing the arbitrage trade, according to John Luk, head of emerging markets trading for Greater China at Credit Agricole CIB.
The non-deliverable market for Taiwan dollar interest rate swaps, which are largely traded offshore, is dominated by foreign hedge funds. These speculators have lowered their expectations for rates partly because they see other central banks mirroring the Federal Reserve’s policy easing.
But in the deliverable market, where access for foreign firms is limited, swaps prices are being driven by a surge in demand for fixed-to-floating rate swaps from the wind power companies.
Green Push
Taiwan’s government is making a big push toward green energy, and has helped orchestrate a funding channel for wind power projects. Banks typically offer floating rate loans to wind farm developers but they also ask them to hedge at least half of their interest rate risk into fixed payments, BNP Paribas SA Greater China FX & rates strategist Ju Wang and head of sustainability research Trevor Allen wrote in a report.
The result: a surge of demand for interest rate swaps onshore, leading to a spread between the deliverable and non-deliverable swap rates that is much bigger than the difference seen in other Asian markets.
But there is a catch: Because most overseas investors cannot get easy access to the onshore rate swap market, the trade is largely available to local funds and banks with licenses in Taiwan as well as overseas.
The spread is already starting to narrow with the 10-year non-deliverables trading at a 15-basis-point discount to the deliverables as of Thursday, data compiled by Bloomberg show.
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