bnpp 01-15-15 asia research

8/9/2019 Bnpp 01-15-15 Asia Research

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2 Asia Equity Derivatives Strategy: Guillaume Derville, Winner Lee, Shun Maruyama, Shuai ChenFlow Sales: Hong Kong: (852) 2108 5639, Singapore: (65) 6210 1883

TABLE OFCONTENTS

I. Asia Equity and Derivative Outlook Summary 3

II. Key Themes and Strategies

Theme 1: Chinese Equities in 2015 A Reflation Story 6 Trade Idea 1: Chinese Equity Trades That We Like 18

Vanilla Index Strategies

Single Stocks Soft-Exotic Options

Delta-One Basket Exposure

Conviction Trade : Long/Short Strategies

Short-term Hedging Tools

Theme 2: Korean Equities 2015, the Year of the catalyst 26 Trade Idea 2: Upside Exposure on Kospi2 Index 32

Conviction Trade 3 : Japan vs. Korea Currency War - Call on Dispersion 34

Conviction Trade 4 : Korea Corporate Governance Basket 38

Theme 3: Japan Reflation vs. Stagflation Risk 40 Trade Idea 5: Capturing a NKY Index Trading Range 50

Upside exposure

3-month Daily Range Accrual

Short-dated Hedging Tactic

Trade Idea 6: Hedging Against the Failure of Abenomics 52

Theme 4: A US Dollar Asset Bubble? 55 Conviction Trade 7 : HSCEI and AS51 Valuation Convergence Play 68

Trade Idea 8: Asia Pacific Equities Hedging Tools 72

Risk Parameters Arbitrage Corner 77 Conviction Trade 9: Systematic Strategy on Skew Spreads 77

Trade Idea: 10: Asian Basket Volatility vs. SPX/AS51 Volatility 80

III. Hidden Assets 83

Appendix 1: Country Performance 92

Contacts 94

Important Notice 97


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I. ASIAEQUITY ANDDERIVATIVEOUTLOOKSUMMARY Winner Lee and Guillaume Derville

4Q14 LEGACY

The Bank of Japans additional qualitative and quantitative easing (QQE) on 31 October,came earlier than expected, giving the market a positive shock. Volatilities spiked alongwith panic buying by foreign fast and real money investors; the following week sawrecord volumes. The Japanese indices term structure turned downward sloping and wewitnessed volatility arbitragers entering term structure plays (selling short-dated andbuying long-dated volatilities). Investors sold short- to medium-term calls ahead of thesnap election in early December as the NKY Index was trading at around 18,000 (EDS2014 Index target). As a result of the additional QQE, EDS Asias strong USD andweak JPY story worked well in 4Q. Since our 4Q14 strategy report The Tipping Point ,published on 9 October, the JPY currency weakened from 107.8 to a seven-year low of121.5 on 5 December against the USD.

In China, the Shanghai-Hong Kong Stock Connect Program (Through Train) has been

the main story since April. Since its launch on 17 November, market volumes have beendisappointing (especially on the Southbound). Getting close to the connection, the A/Hpremium almost narrowed to parity; arbitragers who bought A shares and sold H sharesgradually locked profits. As investors expected a quiet year-end, the long-awaited broad-based China easing measures were finally implemented: the PBoC cut lending andsaving deposit rates. As Chinas economic growth remained under pressure, targetedmeasures were deemed not effective enough and expectation of further policy stimuluswould be needed, domestic retail investor sentiment reversed and equity purchaseactivities started. Shanghai A-shares index, rich in financials, rallied over 30% and wassupported by massive market volumes. The Hang Seng China AH Premium Indexpeaked at 132.4 on 7 January 2015.

The US dollar strength was a key market driver in the fourth quarter. Other notableevents were the collapse of oil and commodity prices, caused by a Russian currencycrisis and the ruble plunged by 44% in 2H14. CNY and Asian currencies (ADXY index)have remained relatively resilient so far.

1Q15 OUTLOOK ONE MORE TIMEA US DOLLARASSETS BUBBLE?The US dollar (DXY index) rose 10.8% in the second half of 2014. BNP Paribas GlobalFX team remains bullish on the US dollar in the long run and expects the DXY (DollarIndex) to reach 94 by end-2015. BNP Paribas Equity and Derivative Strategy (EDS)believes the US dollar strength should weigh further on emerging currencies and equities,especially Asian. But 2015 might witness one more round of easing by the BoK, PBoC,BoJ and ECB as the global economic situation deteriorates and deflation pressureescalates. Given the low crude oil prices, we believe there is a higher probability of theBoJ effecting additional QQE to achieve its 2% FY2015 inflation target for Japan. Theensuing currency war should drive up Asian equities and risky assets one more time in2015 and this might be the last round of the world reflation trade. Equity markets withattractive valuations, like Korea and China, should benefit from this reflation in 2015.This catalyst is likely to be accompanied by reforms in Asia and an Asia corporategovernance improvement theme. Investors bullishness being excessively high, priceactions have been extreme recently; we believe the first quarter of 2015 should offerbetter entry levels.

CHINESEEQUITIES IN2015 A REFLATIONSTORY In 2015, Chinese equities should be driven by the top-down reflation macro story. BNPParibas China Chief Economist, Xingdong Chen, expects two more interest rate cuts in

2Q and 3Q 2015 (25bp each for deposits and lending) and 2-3 cuts in RRR (50bp each). After fighting corruption and consolidating power in the past two years, President XiJinping and policy makers are likely to focus on growth stimulation. In the coming years,

The BoJs additional QQEdrove the NKY index to18,000 in 2014

The HSAHP index surgedto 132.4 on 7 January2015, implying A shares areon average trading at32.4% premium over Hshares.

The US dollar strength was

a key market driver in thefourth quarter. CNY and Asian currencies areresilient.

We expect one more roundof easing from BoK, PBoC,BoJ and ECB if theeconomic situationdeteriorates.

Reflation should benefitequity markets withattractive valuations suchas Korea and China in2015.

EDS Asias strong USD andweak JPY story worked wellin 4Q.

Shanghai A-shares index,

rich in financials, ralliedover 30%, on massivevolumes.

President Xi Jinping and policy makers are likely tofocus on growth stimulation.

EDS Asia remains positiveon A shares and forecastsSHCOMP Index to reach3,500, HSCEI 12,600 andHSI 27 620.


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banking sector reforms, RMB internationalization and the opening up of Chinas capitalaccount will be on Xi Jinpings agenda. EDS Asia remains long-term positive on A sharesand forecasts the SHCOMP Index to reach 3,500 in 2015. Besides, we target the HSCEIto reach 12,600 and the HSI 27,620. Chinese banks and insurers will benefit from themonetary easing cycle.

KOREANEQUITIES IN2015 THEYEAR OFTHE CATALYST The Deputy Prime Minister, Choi Kyung-hwan, has been relatively quiet about the needfor further stimulus after two rate cuts in August and October. Recent falling oil andcommodity prices have eased inflation pressure, providing more room for the BoK toease. BNPP Regional Economist, Mark Walton expects two more rate cuts in 1Q and2Q. Since Abenomics started, the Japanese yen depreciated more than 35% against theKorean won; a meaningful KRW depreciation might be necessary at some stage torestore exporters competitiveness. Possible additional options include further FXintervention and acceleration of overseas investment for the National Pension Service(NPS). EDS Asia believes Deputy Prime Minister Choi will have to push for aggressivemeasures in 2015 to reverse the current negative investor bias toward Korean equities.

We believe political pressure will play a major role in this, while BoK might be pushed toreact aggressively.

BNP Paribas EDS Asia reiterates its bullish stance on Korea, as 1) regional and GEMfunds are now massively underweight on Korea, 2) Korean equity valuations remaincomfortably low compared to the Asia ex-Japan universe, 3) the Korean governmentencourages corporates to enhance profitability and increase dividends, 4) the NPS(AUM: KRW458t as of September 2014) intends to increase domestic equity allocation,and 5) potential large corporate restructuring.

J APAN REFLATION VS. STAGFLATIONRISK

Multiple factors such as 1) corporate earnings growth, 2) greater shareholder returns, 3)domestic pension portfolio adjustments, and 4) additional QQE offer visible support to

Japanese equities in 2015. Our NKY Index 2015 mid-year and year-end forecasts areJPY18,000 (JPY120/USD). We would like to see fundamentals improve and corporategovernance attract quality long-term investments; the greater depth this would createcould be then considered as a sustainable support to Japanese equities. Japans QQEcannot solve its structural problem.

Given the BoJs potential additional QQE to ensure its 2% FY2015 inflation target, weestimate the NKY Index might test JPY19,000; this represents a 12.5% upside fromcurrent levels.

HIDDENASSETS

In the recent collapse of EM currencies and commodities, Asian currencies and equitiesremained relatively resilient. Asian skews remain cheap as a result of the extendeddemand on structured product activities, while local events drove investor bullishness inthe fourth quarter. HSCEIs extraordinarily low skews have been driven by upsidevolatility demand as investors turned bullish on Chinese equities. NKY index volatilitiesand skews have been trending higher as investors took profits ahead of the snapelection.

Skew discrepancies between Developed Markets (DM) and Asian indices are reachingnew highs as developed world indices skews remain elevated. Within DMs, DAX andSX5E indices belong to the high volatility universe, while SPX and AS51 indices areenjoying relatively low volatility. Risk parameters, especially skew discrepancies, areoffering directional trade opportunities as we believe Asian equity markets shouldoutperform US equities in 2015

HSCEI skews at lows;investors aggressively

bought upside volatilities ofthe A50 Tracker.

Fundamentals andcorporate governanceimprovement are needed to

sustainably push Japanesee uities further.

Recent falling oil andcommodity prices haveeased inflation pressure,

providing more room for theBoK to ease.

Korean authorities will haveto push for aggressivemeasures in 2015 toreverse the currentnegative investor bias

toward Korean equities.

Korean equities constituteBNP Paribas EDS Asias

preferred market for 2015.

NKY Index might test19,000 on BoJs additionalQQE, but upside remainslimited at this stage.

Skew discrepancies areoffering directional tradeopportunities as we believe

Asian equity marketsshould outperform USequities in 2015.


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Top Trade Ideas (with indicative pricing) Trade Idea 1: Chinese Equity Trades That We Like

Vanilla Index Strategies Buy Mar-15 103/110% Call Spread on HSCEI at 2.07% and/or Buy Mar-15 105% Call on H-FIN at 3.8%

Single Stocks Soft-Exotic Options Buy Mar-15 105% Worst-of-Call on Chinese Banks (CCB [939 HK], ICBC [1398 HK] and BOC [3988 HK]) at 2.5% (34.8%

discount to the cheapest individual call on ICBC at 3.84%, implied correlation offer at 93%) Delta-One Basket Exposure:

Buy High Yield A-shares Basket and/or Buy China Properties Basket

Conviction Trade: Long/Short Strategies Buy Jun-15 105/115% Outperformance Call Spread on HSCEI ETF (2828 HK) over A50 Tracker (2823 HK) at 3.35% Buy Jun-15 105% Timer Outperformance Call on HSCEI ETF (2828 HK) over A50 Tracker (2823 HK) at 3.55% [with Vol

budget at 17%] Buy Chinese Banks & Insurers (or Buy H-FIN) and Short Chinese Brokers

Short-term hedging tools Sell Mar-15 110% Call and Buy 90% Put on HSCEI receives 0.33%

Trade Idea 2: Upside Exposure on Kospi2 Index Buy Mar-15 105/115% Call Spread on Kospi2 at 0.65% Buy Dec 15 105% Down-and-In Call on Kospi2 with 95% KI barrier (daily close observation until Mar-15) at 1.05% Buy Dec-15 110% Lookback Call on Kospi2 Index (daily close lookback until Mar-15) at 4.3%

Conviction Trade 3: Japan vs. Korea Currency War Call on Dispersion

Buy Jun-16 Call on Dispersion on Japanese and Korean Exporters Basket, 30% strike, at 2.7%

Conviction Trade 4: Korea Corporate Governance Basket

Buy Korea Corporate Governance Basket

Trade Idea 5: Capturing a NKY Index Trading Range

Upside Exposure

Buy Mar-15 17,500-19,000 Call Spread on NKY Index at 366.5 index-point (~2.15%, spot ref: 17,040)3-month Daily Range AccrualShort-dated Hedging Tactic

Sell Mar-15 105% Call and buy 95% Put on NKY at 0.17% Buy Mar-15 95/85% Put Spread on NKY at 1.62%

Trade Idea 6: Hedging Against the Failure of Abenomics

NKY Put Quanto vs Put at Flat Premium (i.e. Zero Cost) Buy Dec-17 NKY ATM Put Quanto USD, and Sell Dec-17 NKY 96% Put in JPY

Conviction Trade 7: HSCEI and AS51 Valuation Convergence Play Buy Mar-15 105/120% Outperformance Call HSCEI over AS51 condition on HSCEI return >0 at 2.7% [implied correlation bid at

20%], without condition at 3%

Buy Mar-15 95/85% AS51 Put Spread at 1.15% and sell Mar-15 95/85% HSCEI Put Spread at 2.01%Trade Idea 8: Asia Pacific Equities Hedging Tools

Short term tail-risk hedge Best of Put on Asian Indices Buy Mar-15 95% Best-of Put on AS51-TWSE-HSI at 0.53%, AS51-TWSE-NKY at 0.52%, AS51-TWSE-Kospi2 at 0.42%

Buy Protection on Indian Equities Buy Feb-15 95% Put on Nifty Index at 85bp and/or Buy Feb-15 95/85% Put Spread on Nifty Index at 75bp

Conviction Trade 9: Systematic Strategy on Skew Spreads

Asia Smiles strategy: an Asia over US outperformance play Buy every month a 3M 100/104 call spread on Asian Index Basket and sell a 3M 100/104 call spread on SPX Index with 0%

floor overall payoff offered at 4.4%

Trade Idea 10: Asian Basket Volatility vs SPX/AS51 Volatility

Buy Basket of Dec-16 80% Put on Asian Indices [NKY, HSCEI and Kospi2] and Sell Basket of Dec-16 80% Put on GlobalIndices [SPX, AS51] at 0.04 vol-pt difference


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II. KEYTHEMES ANDSTRATEGIES Theme 1: Chinese Equities in 2015 A Reflation StoryWinner Lee and Guillaume Derville

A controlled easing cycle China finally started broad-based monetary measures: The asymmetric interest ratescut on 21 November confirmed that previous targeted measures were not effectiveenough and economic growth remains under pressure. Market participants expect furthermonetary easing sooner rather than later; they speculate that the PBoC will cut thereserve requirement ratio (RRR) and/or relax the loan-to-deposit ratio (LDR). Monetaryeasing in China is not aimed at boosting equities, but at stabilising growth. EDS Asiabelieves policy makers will continue to review the effectiveness of measures beforeaggressively pumping further liquidity into the financial system.

The PBoC cut interest rates in June and July 2012. It cut savings deposit rates twice by25bp each, and lending rates first by 25bp and then by 31bp. After that, it did notintervene on interest rates for more than two years.Two more interest rate cuts and 2-3 RRR cuts: BNPP China Chief Economist,Xingdong Chen, expects two more interest rate cuts in 2Q and 3Q 2015 (25bp each fordeposits and lending) and 2-3 cuts in RRR (50bp each). China Perspective-091214.pdf: http://www.bnppresearch.com?E=dehfjkbgff

Chinas asymmetric lending and deposit rate cuts Potential RRR cuts in 2015

1.0

2.0

3.0

4.05.0

6.0

7.0

8.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

China Best Lending 1-year Rate

China Household Saving Deposits 1-year Rate

(%)

4.0

8.0

12.0

16.0

20.0

24.0

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

(%)

Sources: Bloomberg, BNP Paribas; data as of 2 January 2015 Sources: Bloomberg, BNP Paribas; data as of 2 January 2015

Reform programmes lead to short-term pain, but long-term gains

According to Xingdong, China experienced more downward pressure on growth in 2014than initially expected, the official annual GDP growth will likely average 7.3% in 2014.

Xingdong believes China will continue to set a growth target in 2015 as this is the basisand key guideline for making macroeconomic policy. He expects the target to be lowerthan 7%, but this target is likely to be flexible. Chairman Xi Jinpings new strategy aims atgenerating growth from services and consumption, while FAI remains the key driver. Thegovernment will likely boost investments in infrastructure, public utilities and socialhousing especially when growth is too weak. We believe the property and housingmarket will continue its correction, but freefall will not be tolerated. Monetary policy willbe accommodative: we expect more interest rate cuts, with RRR cuts to offset reformshocks in the money market.

After two years of fighting corruption, correcting official behaviour and consolidatingpower, Xis aggressive reforms programme and rule of law will likely be implemented in2015. These reforms include a negative list management of government power, state-

owned enterprises (SOEs), hukou (household registration), land reforms, and financial,fiscal and RMB internationalisation. However, some reforms programmes will lead toshort-term pain for long-term gains.
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Chinese banks likely to perform in 2015Since we published our EDS Asia Thematic Strategy: China, The Biggest KnownUnknown on 27 February 2014, Chinese bank share prices have been staying firm (H-share Chinese banks rebounded by an average of 32.7%). In February 2014, we argued

that investor concerns over asset quality deterioration were priced in. Since then, policymakers have continued to find ways to strengthen asset quality, such as issuingpreferred shares. BNPP China Financial Analyst, Judy Zhang, has highlighted that therecent interest rate cuts will result in declining non performing loans (NPL) formation andspeed up interest rate liberalisation. Judy believes bank earnings are far more sensitiveto NPL formation than to NIM (net interest margin) earnings growth usually acceleratesafter rate cuts.

China Banks-241114.pdf: http://www.bnppresearch.com?E=defjdkbgff

The PBoC met with banks in Beijing to discuss deposit insurance scheme (DIS), whichmight be effectively implemented in January 2015. Chinas DIS will cover deposits of upto RMB500,000. The DIS is considered a precondition for China to free up deposit rates,which is the last and most important step to interest rate liberalisation.

China Banks-281114.pdf: http://www.bnppresearch.com?E=degghkbgff

In her sector report 2015 Outlook: five drivers to re-rate Chinese banks (5December 2014), Judy Zhang provided five reasons why Chinese banks should re-rate:

1. Chinese banks have transformed themselves from credit asset holders to traders viathe fast development of asset-backed securities (ABS) and diversified risk/leverageto non-bank financials,

2. they have lower balance sheet risk after rate cuts, following the introduction of localgovernment debt regulation and the acceleration of NPL write-offs/disposals,

3. the risk-free rate has been lowered, given government efforts to gradually remove itsimplicit guarantee on trusts and WMPs,

4. LDR relaxation and potential RRR cuts are easing NIM pressure, and5. share incentive schemes are improving bank productivity, leading to better ROEs.

Judy thinks Chinese banks current valuations imply NPL for FY15 at 21.2% of ChinasFY15 GDP. We believe it is overly pessimistic.

China Banks-Dec14.pdf: http://www.bnppresearch.com?E=dehcfkbgff EDS Asia expects to see further reforms progress for state-owned banks in 2015, andwe believe the recent sector-wide re-rating has removed key roadblocks for the reforms.Key upcoming reforms for the banking sector include 1) employee equity offeringsprogramme, 2) introduction of private strategic investors, and 3) asset restructuring.These measures would help banks source additional funding to strengthen their coretier-1 capital, align bank employee incentives better, improve overall asset quality, andultimately boost operating efficiency.

Chinese banks - consensus valuations and BNP Paribas target pricesCode Name Mkt Cap

(HKD b)Last(HKD)

PE (x)FY14

PE (x)FY15

EPSGrowth

y-y%

PB (x) DY (%) BNPPrating

TargetPrice(HKD)

Upside(%)

Chinese Banks939 HK CCB 1,621 6.43 5.6 5.2 6.2% 1.0 6.3 BUY 8.00 24.4%1398 HK ICBC 2,173 5.71 5.8 5.5 4.9% 1.1 5.9 BUY 7.00 22.6%998 HK China Citic Bank 405 6.11 5.5 5.2 6.8% 0.9 5.1 BUY 7.10 16.2%3988 HK BOC 1,464 4.41 5.9 5.5 7.9% 0.9 5.8 BUY 4.92 11.6%3328 HK BoComm 576 7.03 6.4 6.1 4.8% 0.9 4.6 BUY 8.00 13.8%1988 HK Minsheng Bank 422 9.97 5.8 5.5 5.8% 1.1 3.1 BUY 10.80 8.3%1288 HK ABC 1,552 4.02 5.6 5.3 7.4% 1.0 6.2 BUY 4.03 0.2%3968 HK CM Bank 509 18.86 6.6 6.0 10.0% 1.2 4.3 HOLD 18.14 -3.8%Sector Average 8,722 5.8 5.5 6.5% 1.0 5.7 14.0%

Sources: Bloomberg; BNP Paribas; data as of 6 January 2015
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LDR rules relaxed by treating interbank deposits as normal deposits China Banks-291214.pdf: http://www.bnppresearch.com?E=deijikbgff On 27 December, the PBoC released Document No. 387, in which it said that it wouldtreat interbank deposits as normal deposits but keep their reserve requirement at zero.The PBoC did not rule out the possibility of charging a reserve on interbank deposits inthe future. Judy expects this to lower listed Chinese bank LDRs by 4-5ppt after interbankdeposits are included in the LDR calculation.The new measure helps relieve bank LDR constraints as the process should improve themoney multiplier and, in turn, improve their liquidity environment. However, we do notexpect massive credit to be granted, as banks are still subject to loan quotarequirements and they are cautious about granting loans because of increasing assetquality concerns. We expect the new loan quota in 2015 to be set at around RMB10t(+12% y-y), similar to next years M2 growth target of 12%. Total new loans rose 8% y-yto RMB9.08t in January-November 2014.The relaxation may trigger arbitrage as banks replace deposits with interbank deposits.Judy Zhang expects banks to practice arbitrage, as they replace bank deposits withinterbank deposits to take advantage of the RRR exemption. However, interbank depositrates are fully liberalised and very volatile, which may increase potential liquidity risks forbanks. Also, it may lead smaller banks to aggressively compete on pricing of interbankdeposits, which may increase funding costs and compress net interest margins (NIMs).However, as the measure is part of the governments efforts to lower funding costs of thereal economy, we believe it will keep relatively ample liquidity, to prevent any unexpectedliquidity risks.Judy believes there is no urgency for RRR cuts; the market was expecting 100-150bpRRR cuts to offset the impact of including interbank deposits of RMB7t in the LDRcalculation, which may lead banks to submit reserves of RMB1.4t. Since banks areexempt from maintaining reserves on interbank deposits, it seems that the urgency to cutRRR is decreasing.

China new loans LDR for Chinese banks 3Q14

(50)(40)(30)(20)(10)01020304050

-

200

400

600

800

1,000

1,200

1,400

Jan-13 Jul-13 Jan-14 Jul-14

China New Loans (LHS)

y-y% (RHS)

(Rmb b) (y-y %)

0.0%10.0%20.0%30.0%40.0%50.0%60.0%70.0%80.0%90.0%

B o

C o m

B O C

C M B

C i t i c

C E B

M i n s h e n g

C C B

I C B C

A B C

C R C B

3Q14

Sources: Bloomberg; BNP Paribas; monthly data as of November 2014 Source: Company data

China 10-year bond yield SHIBOR 1-week was stressed in late December

2.5

3.0

3.5

4.0

4.5

5.0

2007 2008 2009 2010 2011 2012 2013 2014 2015

China 10-year Bond Yield(%)

1.0

3.0

5.0

7.0

9.0

11.0

13.0

2012 2013 2014 2015

Shanghai Interbank Offered Rate Fixing - 1 week(%)

Sources: Bloomberg; BNP Paribas; data as of 5 January 2015 Sources: Bloomberg; BNP Paribas; data as of 5 January 2015
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China Real Estate Dual-speed bifurcation bottoming outBNPP Head of Regional Property, Wee Liat Lee, published his latest sector report on 2January 2015. China Real Estate-Jan15.pdf: http://www.bnppresearch.com?E=deijbkbgff

Wee Liat has turned bullish on the China real estate sector in anticipation of a partial

bottoming out in 2015. The start of this structural bottoming out trend will be underpinnedby two factors:

a) Incremental policy support in 2015 should cushion downside risks

The 40bp rate cut in November 2014 has started to materially lower mortgage rates andimprove transaction volumes in tier-1 and some tier-2 cities. Our house view of anothertwo 25bp symmetric rate cuts in 2015 and three RRR cuts, coupled with furtherrelaxations of provident fund usage, tax cuts and possibly a partial relaxation of homepurchase restrictions (HPRs) in tier-1 cities, should cushion the downside.

b) Supply imbalance starts to unwind gradually

New land sales (volume terms) declined significantly in 2014, by 16-51% in the top 100cities. Even in the 43 good cities, with no oversupply, land sales dropped 36%. That

said, oversupply remains acute in most cities and may need two to three years tounwind. A dual-speed bottoming out should occur as the first batch of cities recovers in2H15E.

c) 27 cities could see property prices rise in 2H15 & transactions volume rise 10-20% in 2015

Nationwide, Wee Liat expects volume growth to improve to 0 to -5% compared to -9% in2014, but 20-30 cities could see volume growth of 10-20%. As transaction volumesrecover gradually, we forecast moderate property price growth in 27 cities in 2H15.

Construction starts and projects under construction enter a new era of single-digit growthas developers and cities focus on de-stocking

d) Sector valuations trend higher; mid-cap, low-end P/E, good landbank stocks

should outperformi) Wee Liat expects two key trends: 1) the valuation should tick moderately higher; and 2)the range should narrow, with lower-end P/E stocks re-rating and outperforming themore fully valued stocks.

ii) Mid-size developers with good quality landbanks in cities that we deem good willoutperform on better sales prospects. Our top picks are Shimao, R&F and KWG; weupgrade Longfor and Country Garden to BUY, and raise target prices for COLI (5%) andCRL (8%).

Mortgage rates for first home buyers % of banks offering mortgage rates at a discount tothe PBoC benchmark for first home buyers

6.63 6.67

6.82

6.99

7.03 7.03 76.97

6.856.75

6.58

6.126.00

6.20

6.40

6.60

6.80

7.00

7.20

Jan-14 Apr-14 Jul-14 Oct-14

(%)

13

7 6 5 5 57.5 7.3

13

26

31

0

5

10

15

20

25

30

35

Feb-14 May-14 Aug-14 Nov-14

(%)

Sources: Rong360.com (based on a study of 86 cities, a sample of 35 citiesand 525 banks); BNP Paribas Sources: Rong360.com; BNP Paribas
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Nationwide transaction volume vs. PBoC benchmark rate

(25)

(5)

15

35

55

75

95

115

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

J a n - 0

6

A p r -

0 6

J u l - 0 6

O c t - 0

6

J a n - 0

7

A p r -

0 7

J u l - 0 7

O c t - 0

7

J a n - 0

8

A p r -

0 8

J u l - 0 8

O c t - 0

8

J a n - 0

9

A p r -

0 9

J u l - 0 9

O c t - 0

9

J a n - 1

0

A p r -

1 0

J u l - 1 0

O c t - 1

0

J a n - 1

1

A p r -

1 1

J u l - 1 1

O c t - 1

1

J a n - 1

2

A p r -

1 2

J u l - 1 2

O c t - 1

2

J a n - 1

3

A p r -

1 3

J u l - 1 3

O c t - 1

3

J a n - 1

4

A p r -

1 4

J u l - 1 4

O c t - 1

4

J a n - 1

5

A p r -

1 5

J u l - 1 5

O c t - 1

5

(y-y %)(%) PBoC > 5 yrs lending rate (LHS) Nationwide resid. sales vol. (RHS)

Transaction volume bounce60% y-y in both 2008 and2012 epsiodes of rate cut

1Q15:interest ratecut by 25 bpts

Resid. sales vol.:From -9% y-y in Nov 2014to 0% y-y by 4Q15

3Q15:interest ratecut by 25 bpts

0

Sources: PBoC; NBS; CEIC; BNP Paribas estimates from Jan 15

Potential policy measures to support property market in 2015

Interest rate cut Two symmetric interest rate cuts of 25bp each in 2Q15 and 3Q15, on both deposit andlending rates

RRRs cut Three RRR cuts in 1Q15, 2Q15, 4Q15, 50bp each

Further relaxation in provident fund use1) shorten the period for approval of provident funds2) Combine several provident funds - including those of parents for purchase of property.3) use of provident fund for purchase of second property

Partial relaxation of HPR in Tier 1 cities 1) Relax HPR for high-end properties. 2) relax HPR for non-city centres projects

Exemption of business tax & capital

gain

Business taxIf holding period < 2 years (previously 5 years), then it is 5.5% of the sales amount. If theholding period >2 years, it would be exempt from business tax.Capital gains taxLess than 20% of the capital gain from selling the property (vs. 20% previously)

Source: BNP Paribas

BNP Paribas China Properties Consensus valuations and BNPP target pricesCode Name Mkt Cap

(HKD b)Last(HKD)

PE (x)FY15


TargetPrice (HKD)

Upside (%)

Chinese Properties2777 HK Guangzhou R&F 33.4 10.28 4.3 0.8 6.2 BUY 13.9 34.8%1813 HK KWG Property 17.1 5.83 3.9 0.7 6.5 BUY 7.5 28.6%813 HK Shimao Property 67.0 18.92 5.4 1.2 5.0 BUY 22.0 16.1%688 HK China Overseas Land 209.7 25.25 7.9 1.8 2.1 BUY 26.7 5.5%2007 HK Country Garden 69.2 3.38 4.7 1.0 6.7 BUY 3.5 3.3%

960 HK Longfor Group 65.6 11.18 6.4 1.2 2.8 BUY 11.2 -0.3%Sector Average 5.4 1.1 4.9 14.7%

Sources: Bloomberg, BNP Paribas; closing prices as of 5 January 2015

A shares gaining momentumSupported by a substantial improvement in market turnover, China A-shares momentumis growing. It reflects the shift in domestic retail investor sentiment as they follow closelypolicy stance changes. The average daily turnover on the Shanghai Stock Exchangesurged 40.6% m-m in November to USD39.8b (from USD28.3b in October) and thenrocketed 105% m-m to USD81.7b in December. Shanghai A shares (SHASHR Index),rich in financial stocks, rallied 34.9% following the rate cuts, while the Shenzhen A-shares Index rose only 7.4%. Compared to historical valuations, Shanghai A sharesremain undemanding. We witnessed investors selling the expensive Shenzhen A sharesto buy the relatively reasonable Shanghai A shares. Shanghai A is trading at 12.7x P/E, 1.72x P/BV and 2.3% dividend yield in 2015 Shenzhen A is trading at 21.3x P/E, 2.73x P/BV and 0% dividend yield in 2015


11/100

NOT For


Shanghai equities are supported by strong volumes Shanghai A-share valuations remain reasonable

2000

2200

2400

2600

2800

3000

32003400

3600

0

20000

40000

60000

80000

100000120000

140000


Shanghai Stock Turnover (LHS)SHASHR Index (RHS)

(USD m) (Index)

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

(x) Shanghai A - PE Shenzhen A - PE

HSCEI - PE


Domestic retail investors turned active on equitiesThe total number of new accounts opened in Shanghai and Shenzhen Stock Exchanges

jumped to a peak of 891k during the week of 12 December (expanded 4.2x since theinterest rates cut). Thereafter, it collapsed 65% to 310k during the week of 2 January.For margin trading, the leveraged buying balance of Shanghai Stock Exchange alsorocketed 2.7x to RMB715b on 7 January from RMB263.7b at end-June; this raisedspeculative activity concerns and the China Securities Regulatory Commission (CSRC)warned investors of potential downside risk.

SH+SZ Stock Exchange new account openings Shanghai Stock Exchange leveraged buying

050

100150200250300350400450500

2012 2013 2014

Shanghai New A-shares Account

Shenzhen New A-shares Account

('000 account)

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

24-Apr-13 24-Oct-13 24-Apr-14 24-Oct-14

End of day leveraged buying balance - SSE(CNY b)

Sources: Bloomberg; BNP Paribas; weekly data as of 2 January 2015 Sources: Bloomberg; BNP Paribas; data as of 7 January 2015

China A shares (a proxy play FTSE China A50 XIN9I Index) rallied 54.1% andoutperformed the HSCEI by 30.9% since the rate cuts. The Hang Seng China AHPremium (HSAHP) surged to a peak of 132.4 on 7 January 2015, implying A shares onaverage traded at 32.4% premium over their corresponding H shares (a sharp reversalfrom its low of 88.97 on 23 July).

Investors accumulated China A-share ETFs: A50 Tracker (2823 HK) AUM expanded by HKD32.9b (+58.6%) to HKD88.9b

on 6 January 2015 (from end-June); ETF underwriters can use the Stock Connect quota to purchase A shares; Due to a stronger rally of the onshore market, both 2823 HK and 2822 HK are

now trading at discounts to their NAVs; 2823 HK is more liquid and linked to more structured products, options and

warrants activities.


12/100

NOT For


Foreign investors started to participate in the recent A-shares rally via the FTSE China A50 Index Futures, listed in Singapore. The December futures contracts had been activesince the rates cut and the average traded volume shot up by 47.6 times (to 323kcontracts between 24 November and 31 December, from 6.8k contracts in the first threeweeks of November).

BNP Paribas is ready to underwrite structured products on Shanghai A shares (via StockConnect). We selected 50 very liquid stocks on the Shanghai Stock Exchange to servehedging purposes better. In the starting stage, only simple products, such as CertificatePlus, Fixed Coupon Note and ELN, will be considered. Since short sell is prohibited inChina, traders can only buy delta to hedge, thus, the OTC option activity is likely to be aone-way flow in the initial stage.

A-shares outperforming; HSAHP surged to 132.8 2823 HK and 2822 HK AUM

859095

100105110115120125130135

2012 2013 2014 2015

(Index)

30

40

50

60

70

80

90

100

17-Jul-14 17-Sep-14 17-Nov-14

2823 HK AUM 2822 HK AUM(HKD b)

Stock Connect launched


A-shares ETF are now trading at discount to NAV FTSE China A50 Index Futures (Dec-14 maturity)

-8%

-6%

-4%

-2%

0%

2%

4%

6%

17-Jul-14 17-Sep-14 17-Nov-14

2823 HK NAV premium (discount)2822 HK NAV premium (discount)

Stock Connect launched

0

100

200

300

400

500

600

0

100000

200000

300000

400000

500000

600000

8-Oct-14 17-Nov-14 17-Dec-14

Volume (LHS)Open Interest (RHS)

(Contract) (' 000 Contract)

Sources: Bloomberg; BNP Paribas; data as of 6 January 2015 Sources: Bloomberg; BNP Paribas; data as of 31 December 2014

Potential development of Chinas capital market in the next decade

Under Xi Jinpings leadership in the next eight years, banking sector reform, RMBinternationalisation and opening of Chinas capital account are key components of theagenda. The Shanghai-Hong Kong Stock Connect is a key milestone which indicates acrucial start; it will be followed by progressive moves such as i) the Shenzhen-HongKong Stock Connect, ii) increasing foreign participation by gradually expanding foreigninvestment quota to the abolishment of quota, iii) moving from B shares to H shares andmerging B shares with A shares, and iv) developing the futures and options markets andallowing short sell activity.


13/100

NOT For


EDS Asia remains positive on A shares

Initial through-train market volumes were disappointing, especially for the Southbound.However, its smooth operation was a positive. Northbounds accumulated positions areRMB86b (28.7% of the quota), while Southbounds are RMB16.4b (6.6%).

Northbound position Southbound position

0%

5%

10%

15%

20%

25%

30%

0

102030405060708090

17-Nov-14 1-Dec-14 15-Dec-14 29-Dec-14

Accumulated Northbound positions (LHS)

% Used of aggregate quota

(Rmb b) (%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

0.0

2.04.06.08.0

10.012.014.016.018.0

17-Nov-14 1-Dec-14 15-Dec-14 29-Dec-14

Accumulated Southbound positions (LHS)

% Used of aggregate quota

(Rmb b) (%)


Foreign participation to increase

Foreign institutional investors are involved in the Northbound as existing qualified foreigninstitutional investor (QFII) and Renminbi qualified foreign institutional investor (RQFII)quotas are not enough for them to invest in domestic A shares over the medium to longterm.

The combined QFII (USD64b), RQFII (RMB300b) and Through Train (RMB300b) quotasamounted to RMB996b (USD161b) as at end-October, allowing investors access to thedomestic A-shares market. Foreign participation in the domestic A-shares market

remains low, at about 3% of its total market cap. We believe there is room for expansion.A progressive MSCI A-shares inclusion in the emerging market universeThe A-shares inclusion in MSCI emerging markets universe will be progressive: even ifMSCI welcomes A-shares inclusion in its emerging market universe in June 2015, it willbe effective in May 2016 and an initial 5% cap factor should be applied to A shares.China A shares are likely to contribute less than 1% to the MSCI EM Index at thebeginning. Although this initial inclusion is regarded as small, it represents a large steptoward A-shares internationalisation. A full inclusion will take time, and requires 1) theabolition of quota systems, 2) the easing of capital mobility restrictions, and 3) thealignment of international accessibility standards.

Shenzhen and Hong Kong Stock Exchanges may connect in 2015

A Shenzhen-Hong Kong Stock Connect programme is underway. According to ChinaDaily Asia, dated 26 August 2014, an application to link the Hong Kong and Shenzhenbourses has been submitted for approval. Shenzhen will further cooperate with HongKong in the financial industry, talent exchange and mutual fund recognition. However, asmore small-to-mid cap companies are listed on the Shenzhen Stock Exchange,valuations are more expensive than Shanghai-listed big caps.

On 5 January 2015, Premier Li Keqiang visited Shenzhen and mentioned that theShenzhen-Hong Kong Stock Connect should be established.

Chief Economist of Shenzhen Stock Exchange, Ji Mengzeng said during an interviewthat the SZ-HK Stock Connect could be launched as early as May 2015, with the initialquota limit set at the same level as the SH-HK Stock Connect. The daily turnover quotawill be gradually increased and eventually eliminated.

Given the previous experience on SH-HK Stock Connect and Shenzhens geographicproximity to Hong Kong, we believe Northbound buying will create the major flows in theSZ-HK Stock Connect.


14/100

NOT For


BNP Paribas EDS 2015 index targetsIn recent years, US equities have been supported by i) upward earnings revisions, ii)share buybacks and iii) quantitative easing. At the same time, Chinese equities, undertight liquidity conditions, suffered valuation contractions, while earnings continue to

improve. Investors have been concerned by potential Chinese bank NPLs.EDS Asia published a Sniper CHINA EASING STARTED , on 2 December, reiteratingour bullish stance as a result of policy makers change in monetary stance. EarlyDecember, the HSCEI index did follow the correction in US equities; however, we didntsee any significant liquidity outflows; the HKMA interbank balance has been stable atHKD239b (level observed since August) and HKD eased to the mid-point of its tradingband.

HSCEI Index vs. EPS HSCEI valuation contraction

400

600

800

1000

1200

1400

1600

3000500070009000

11000130001500017000190002100023000

05 06 07 08 09 10 11 12 13 14

HSCEI (LHS)

HSCEI Bloomberg Estimated EPS (RHS)

(Index) (HKD)

0

5

10

15

20

25

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%30.0%

35.0%

40.0%

05 06 07 08 09 10 11 12 13 14E

EPS Growth (LHS)PE (RHS)

(y-y %) (x)

Sources: Bloomberg; BNP Paribas; data as of 2 January 2015 Sources: Bloomberg; BNP Paribas; data as of 31 December 2014

HSCEI 2015 target at 12,600 and HSIs at 27,620On 2 December, EDS Asia introduced the 2015 index targets for the HSCEI and HSI. Its

base case target for the HSCEI Index is 12,600 (based on consensus FY15 EPS and aconservative P/E of 8x) and the HSI index target is 27,620 (12x), corresponding topotential upsides of 5.1% and 17.6% respectively. Our high case targets are based onslightly higher P/E assumptions, 8.5x and 12.5x respectively, and we believe theprobability of it occurring is 30%.

Thereafter, the HSCEI rallied about 10% to 12,245 on 2 January which is getting close toour base case target. Meanwhile, SHCOMP surged 21.3% to a recent peak of 3,351 on6 January. We agree it is hard to gauge the irrational behaviour of mainland investors,but a fair value of SHCOMP at the 3,500 level (4.5% upside) seems reasonable. This isderived from the Gordon Growth Model (the fair level is similar to its peak in 2009 whichis at 13.2x consensus FY15 P/E). Once mainland investors turn more cautious on Ashares, the H-shares rally is likely to decelerate.

HSCEI 2015 Index target HSI 2015 Index targetHSCEITarget 2015 PE (x)

HSCEILevel

ps edownside

(%)

Probability(%)

Consensus 2015 EPS = HKD1575.05Current 7.61 11,991 -

Low 6.00 9,450 -21.2% 10%

Base 8.00 12,600 5.1% 60%High 8.50 13,388 11.7% 30%

Expected return 4.4% 100%

Bloomberg consensus bottom-up index target12,773 6.5%

HSI Target 2015 PE (x) HSI Level

ps edownside

(%)

Probability(%)

Cons ensus 2015 EPS = HKD2301.7Current 10.20 23,485 -

Low 9.00 20,715 -11.8% 10%

Base 12.00 27,620 17.6% 60%High 12.50 28,771 22.5% 30%

Expected return 16.1% 100%

Bloomberg consensus bottom-up index target26,828 14.2%

http://rss-globalmarkets.bnpparibas.com/r?t=AisgAHoOPllTz007EM6HXhttp://rss-globalmarkets.bnpparibas.com/r?t=AisgAHoOPllTz007EM6HXhttp://rss-globalmarkets.bnpparibas.com/r?t=AisgAHoOPllTz007EM6HX


15/100

NOT For


HSCEI high, base and low targets HSI high, base and low targets

5.0

6.0

7.0

8.0

9.0

10.0

2011 2012 2013 2014 2015

(x) HSCEI - FY15 PELow case 6x PEBase case 8x PE

High case 8.5x PE

7.0

8.0

9.0

10.0

11.0

12.013.0

14.0

2011 2012 2013 2014 2015

(x) HSI FY15 PELow case 9x PEBase case 12x PE

High case 12.5x PE


HSCEI Bottom-up Index target Upside to HSCEI Bottom-up Index target

80009000

1000011000120001300014000150001600017000

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

HSCEIConsensus Bottom-up Index Target

(Index)

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%


mean

+

-


Will RMB enter the currency war? The CNY currency has been the most resilient among Asian and EM currencies. Thedevaluation of its trading partners and export competitors currencies is definitely puttingpressure on the CNY: the Chinese currency has already weakened 1.6% from its recentpeak. The 12-month CNY NDF is now trading at 1072bp above spot, indicating anexpectation of 1.7% depreciation against the USD in the next 12 months.

CNY spot weakened 1.6% from its recent high 12-mth NDF of CNY is trading at 1072bp above spot

6.00

6.05

6.10

6.15

6.20

6.25

6.30

Jan-13 Jul-13 Jan-14 Jul-14 Jan-15

USDCNY(USDCNY)

6.0

6.5

7.0

7.5

8.0

8.5

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

USDCNY USDCNY - 12M NDF(USDCNY)



16/100

NOT For


Significant CNY depreciation unlikely

China has the worlds largest foreign reserves and can withstand external shocks.Chinas foreign direct investments (FDI) were up 22.2% y-y in November from 1.3% y-yin October and 1.9% y-y in September. Unlike portfolio flows, foreign inflows in the form

of direct investment should be relatively long term. BNPP China Economics teampredicts CNY to reach CNY6.15/USD in 2015, implying a marginal appreciation of 1.2%.

Chinas foreign reserves peaked at USD3.99t in June FDI jumped to 22.2% y-y in November

0

500100015002000

2500

30003500

40004500

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

(USD b)

(40)

(20)0

20

40

60

80

100

04 05 06 07 08 09 10 11 12 13 14

(y-y %)

Sources: Bloomberg; BNP Paribas; monthly data as of September 2014 Sources: Bloomberg; BNP Paribas; monthly data as of November 2014

Derivatives dynamics distressed skew After Chinese authorities cut rates on 21 November, HSCEI 3M realised vol rose 8 vol-ptto 25 vol-pt during the market rally, while 3M implied vol moved in tandem with realisedvol, minimising the volatility premium. Due to the combined effect of Chinese stockssurging and commodities sell-off, the implied correlation of HSI has fallen by over 10correl-pt since October 2014, whereas HSCEI, which is less balanced but rich infinancials, remained largely unchanged in implied correlation.

Meanwhile, HSCEI skews reached new lows; on 5 December, 3M 90-110% skewplunged to an all-time low of -2.39 vol-pt while spot prices rebounded, with downsideskew crushed more than upside. In the past couple of weeks, we have witnessedinvestors accumulating cheap HSCEI skew positions; we believe current levels remainattractive (despite a marginal rebound).

We believe the extraordinarily low skew has been driven by structured product activities; Asia retail investors sold more downside volatility to collect the premiums during the bullmarket, while institutional investors (hedge funds) bought calls via the OTC market. Wedidnt witness any significant movement among the listed option market.

HSCEI implied vol in tandem with realised HSI and HSCEI implied correlation

10%

15%

20%

25%

30%

35%

40%

45%

Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15

3M Realized Volatility

3M Implied Volatility

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

Jan-14 Apr-14 Jul-14 Oct-14 Jan-15

HSI HSCEI

Source: BNP Paribas; data as of 6 January 2015 Source: BNP Paribas; data as of 6 January 2015


17/100

NOT For


HSCEI skew at low HSCEI call and put volume

(4.0)(2.0)0.02.04.06.08.0

10.012.014.0

2008 2009 2010 2011 2012 2013 2014 2015

HSI 3M 90-110% Skew

HSCEI 3M 90-110% Skew

(vol-point)

0

5000

10000

15000

20000

25000

3000035000

40000

Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15

Call Volume Put Volume(contract)

Source: BNP Paribas; data as of 6 January 2015 Sources: Bloomberg; BNP Paribas; data as of 6 January 2015


18/100

NOT For


Trade Idea 1: Chinese Equity Trades That We LikeThe below trades that we like are a combination of our fundamental views, marketdynamics analysis on China indices/sectors, while keeping in mind liquidity constraintsand risk parameter dislocations.

1. Vanilla Index Strategies Buy Mar-15 103/110% Call Spread on HSCEI at 2.07% (delta 19.5%) Buy Mar-15 105% Call on H-FIN at at 3.8% (delta 38.25%)

2. Single Stocks Soft-Exotic Options Buy Mar-15 105% Worst-of-Call on Chinese Banks (CCB [939 HK], ICBC

[1398 HK] and BOC [3988 HK]) at 2.5% (34.8% discount to the cheapestindividual call on ICBC at 3.835%, implied correlation offer at 93%)

3. Delta-One Basket Exposure Buy High Yield A-shares Basket and/or Buy China Properties Basket

4. Conviction Trade: Long/Short Strategies Buy Jun-15 105/115% Outperformance Call Spread on HSCEI ETF (2828

HK) over A50 Tracker (2823 HK) at 3.35% Buy Jun-15 105% Timer Outperformance Call on HSCEI ETF (2828 HK)over A50 Tracker (2823 HK) at 3.55% [with Vol budget at 17%]

Sell Mar-15 105% Call on A50 Tracker receives 5.4% and Buy 105% Call onHSCEI at 3.1%

Buy Chinese Banks & Insurers (or Buy H-FIN) and Short Chinese Brokers5. Short-term Hedging Tools

Sell Mar-15 110% Call and Buy 90% Put on HSCEI receives 0.33% (delta39%)

Rational and key charts1. Vanilla Index Strategies

Buy Mar-15 103/110% Call Spread on HSCEI at 2.07% (delta 19.5%) Buy Mar-15 105% Call on H-FIN at at 3.8% (delta 38.25%)

In the week following the PBoCs rate cuts announcement, short-dated volatilities spiked;the term structure wasnt as impacted and the back-end of the curve remained upwardsloping. As the A-shares rally gathered momentum, upside volatilities demandaccelerated. Retail investors chased single-stock upside via warrants and structuredproduct activities; they focused on selling downside volatilities on A-trackers andChinese financials.HSCEI Index upside skews remain at extraordinarily low levels (despite a marginalrebound from all-time lows). Bullish investors may choose to buy HSCEI Call Spreads;this implementation monetises the cheap upside skew and helps to reduce premium atrisk. We propose Mar-15 maturity to capture a potential rally in H shares, as volatilitiesremain elevated on shorter dated maturities.

Implied volatility term structure HSCEI Upside skews on the HSCEI remain low

14.0

16.0

18.0

20.0

22.0

24.0

26.0

28.0

1M 2M 3M 6M 9M 12M 18M 24M 36M

CurrentBefore rate cutsBefore LDR rules relaxed

(vol-pt)

(3.0)

(2.0)

(1.0)

0.0

1.0

2.0

3.0

4.0

5.0

2008 2009 2010 2011 2012 2013 2014 2015



(vol-point)



19/100

NOT For


2. Single Stocks Soft-Exotic Options Buy Mar-15 105% Worst-of-Call on Chinese Banks (CCB [939 HK], ICBC

[1398 HK] and BOC [3988 HK]) at 2.5% (34.8% discount to the cheapestindividual call on ICBC at 3.835%, implied correlation offer at 93%) Buy Mar-15 105% Call ICBC (1398 HK) at 3.835% (30.6 i.v.), CCB (939 HK) at4% (31.5 i.v.) and BOC (3988 HK) at 3.89% (30.9 i.v.)

We believe China is at the beginning of a monetary easing cycle; Chinese banks andinsurers should be key beneficiaries. Investors can also consider buying worst-of-call onthe three big Chinese banks (ICBC, CCB and BOC), which offers 34.8% discount to thecheapest plain-vanilla call. The breakeven of this structure requires the worst performerto rally by strike+premium, which is 7.5% for this WoC on Chinese Banks. In the latestChina Banks 2015 Outlook report, dated 5 December 2014, Judy has downgraded ABC(1288 HK) to HOLD but maintained the BUY rating on CCB, ICBC and BOC with highertarget prices at HKD8 (24.4% upside), HKD7 (22.6%) and HKD4.92 (11.6%).

China financial consensus valuations and BNP Paribas target pricesCode Name Mkt Cap

(HKD b)Last

(HKD)PE (x)FY14

PE (x)FY15

EPSGrowth

y-y%


TargetPrice(HKD)

Upside(%)

Chinese Banks939 HK CCB 1,621 6.43 5.6 5.2 6.2% 1.0 6.3 BUY 8.00 24.4%1398 HK ICBC 2,173 5.71 5.8 5.5 4.9% 1.1 5.9 BUY 7.00 22.6%998 HK China Citic Bank 405 6.11 5.5 5.2 6.8% 0.9 5.1 BUY 7.10 16.2%3988 HK BOC 1,464 4.41 5.9 5.5 7.9% 0.9 5.8 BUY 4.92 11.6%3328 HK BoComm 576 7.03 6.4 6.1 4.8% 0.9 4.6 BUY 8.00 13.8%1988 HK Minsheng Bank 422 9.97 5.8 5.5 5.8% 1.1 3.1 BUY 10.80 8.3%1288 HK ABC 1,552 4.02 5.6 5.3 7.4% 1.0 6.2 BUY 4.03 0.2%3968 HK CM Bank 509 18.86 6.6 6.0 10.0% 1.2 4.3 HOLD 18.14 -3.8%Sector Average 8,722 5.8 5.5 6.5% 1.0 5.7 14.0%

Chinese Insurer s2628 HK China Life 1,073 29.7 20.0 17.1 17.1% 2.6 1.5 BUY 34.09 14.8%2318 HK Ping An 740 80.1 13.8 12.6 9.1% 2.2 1.1 BUY 105.68 31.9%2601 HK China Pacific Insurance 352 37.85 23.1 19.2 20.6% 2.5 1.4 BUY 46.88 23.9%1336 HK New China Life Insurance 167 40.7 14.3 12.9 11.0% 2.2 0.8 BUY 46.92 15.3%Sector Average 2,332 18.1 15.7 14.7% 2.4 1.3 21.6%


China banks performance China insurers performance

80

90

100

110

120

130


ICBC CCB BOC

(Index, Jan-14=100)

80

90

100

110

120

130

140


China LifePing AnChina Pacific Insurance

(Index, Jan-14=100)

Sources: Bloomberg; BNP Paribas; data as of 6 January 2015 Source: BNP Paribas; data as of 2 January 2015


20/100

NOT For


3. Delta-One Basket ExposureHigh Yield A-shares Basket

Buy High Yield A-shares Basket

While the hunt for yield has been a well-known process in the western world, we believeit just started in the domestic A-shares universe. Chinese high yielding stocks used tounderperform in a domestic market driven by retail investors. Considering that yieldhunting has been a major investment theme in the developed world and internationalequity markets over the past couple of years, foreign investors should focus on domesticChinese stocks offering attractive yields and depressed valuations. The basket rallied37.6% since the interest rates cut and outperformed the SHCOMP Index by 2.5%.

Additional returns will be generated from the yield, which is quite high at 3.9% in FY14and 4.1% in FY15. The basket offers decent liquidity at USD60m per day.

The saving deposit rate has more potential to decline; BNPP China Chief Economist,Xingdong Chen, expects two more interest rate cuts in 2Q and 3Q: the 1-year householdsaving deposit rate has the potential to reach 2.25% from the current 2.75%. High Yield

A-shares make sense given the basket is still trading at very undemanding valuations.

High yield A-shares basketCode Name Sector Price

(CNY)High Yield A-shares Baske t601006 CH Daqin Railw ay "A " Indus trial Trans por tation 12.18 28,161 340.6 2.2 12.1 10.6 4.2 4.8 10.5% 10.3600104 CH SAIC Motor Corp "A" Auto & Parts 24.67 43,173 243.8 1.9 9.7 8.5 4.8 5.5 9.2% 13.2600011 CH Huaneng Pow er "A" Electricity 9.09 20,334 150.7 1.9 10.5 10.1 4.9 5.3 9.9% 1.0600900 CH China Yangtze Pow er "A" Electricity 10.87 29,182 177.7 2.2 17.1 16.5 3.0 3.1 9.8% 2.9601088 CH China Shenhua Energy "A" Mining 22.86 70,354 381.7 1.6 11.9 11.6 3.5 3.6 10.1% 11.6600019 CH Baoshan Iron & Steel "A" Metals & Mining 7.17 18,784 214.6 1.0 17.5 14.8 2.6 3.1 11.0% 1.0600028 CH Sinopec "A" Oil & Gas 7 123,070 696.9 1.4 11.8 12.1 3.3 2.9 8.5% 6.0601857 CH PetroChina "A" Oil & Gas 11.69 326,758 450.8 1.8 16.5 16.7 2.6 2.3 10.0% 7.8601939 CH CCB "A" Banks 6.82 209,445 572.4 1.4 7.4 7.0 4.6 4.9 11.4% 0.1601398 CH ICBC "A" Banks 5.1 281,725 591.2 1.2 6.4 6.1 5.3 5.6 9.8% 3.9

Weighted average 1.7 12.1 11.4 3.9 4.1 100.0% 5.62823 HK A50 Tracker 1.9 9.9 7.1 2.8 4.0 2.3

Mkt CapUSD m

Est T/O(USD m)

P/BV(x)

% YTDDY (%)FY15

WeightDY (%)FY14

PE (x)FY14

PE (x)FY15


High yield A-shares basket (since 2012) High yield A-shares basket (since 2014)

80.090.0

100.0110.0

120.0130.0140.0150.0160.0170.0

Jan-12 Jan-13 Jan-14 Jan-15

High Yield A-shares A50 Tracker (2823 HK)

(Index, Jan-12=100)

85.095.0

105.0115.0

125.0135.0145.0155.0165.0175.0


High Yield A-shares A50 Tracker (2823 HK)

(Index, Jan-14=100)



21/100

NOT For


China Properties Basket Buy China Properties Basket

As discussed in Theme 1: Chinese Equities in 2015 A Reflation Story , Wee Liat,BNPP Head of Regional Property, believes the property sector is going to be re-rated.We suggest investors purchase BUY rating names in our China Properties coverage.Partnering with BNP Paribas Forward Trading desk, we have constructed an equal-weighted China Properties Basket. Investors could enter a swap with BNP Paribas andreceive positive total returns on the basket. Forward Trading provides the belowindicative pricing and terms on the swap for USD50m notional:BNP pays positive performance + net dividendsBNP receives Hibor 3M + 50bpCommissions: 15bp In & 15bp Out + stamp dutyOrder Execution: Best effortBreakable: Anytime

Historically, rate-cut policies have prompted industry wide re-rating for the properties sector

14.2

28.6

8.1

12.9

2.1

7.6

1.9

4.7

0

5

10

15

20

25

30

35

J a n - 0

9

M a r -

0 9

M a y -

0 9

J u l - 0 9

S e p - 0

9

N o v -

0 9

J a n - 1

0

M a r -

1 0

M a y -

1 0

J u l - 1 0

S e p - 1

0

N o v -

1 0

J a n - 1

1

M a r -

1 1

M a y -

1 1

J u l - 1 1

S e p - 1

1

N o v -

1 1

J a n - 1

2

M a r -

1 2

M a y -

1 2

J u l - 1 2

S e p - 1

2

N o v -

1 2

J a n - 1

3

M a r -

1 3

M a y -

1 3

J u l - 1 3

S e p - 1

3

N o v -

1 3

J a n - 1

4

M a r -

1 4

M a y -

1 4

J u l - 1 4

S e p - 1

4

N o v -

1 4

J a n - 1

5

Frwd P/E (x) Max Min

2008: Interest rate cut by 189 bpts

Max frwd PE expanded from14.2 to 28.6x in 2009Min. frwd PE expanded from2.1 to 7.6x in 2009

Jun-July 12: Interestrate cut by 50 bpts

Nov 14: Interestrate cut by 40 bpts

Max frwd PE expanded from8.1 to 12.9x in 2012Min. frwd PE expanded from1.9 to 4.7x in 2009

Sources: BNP Paribas.

BNP Paribas China Properties Basket consensus valuations and BNP Paribas target pricesCode Name Price BNPP BNPP TP

HKD Rating (HKD)China Property Basket2777 HK Guangzhou R&F Proper ties 10.28 4,246 17.2 0.8 5.0 4.3 6.3 7.1 16.8% BUY 13.9 34.8%1813 HK KWG Property Holding 5.83 2,196 8.6 0.7 4.7 4.0 6.5 7.6 17.0% BUY 7.5 28.6%813 HK Shimao Property Holdings 18.92 8,499 30.2 1.2 6.0 5.3 5.1 5.8 16.5% BUY 22.0 16.1%688 HK China Overseas Land 25.25 26,192 99.1 1.7 9.0 7.8 2.2 2.5 16.4% BUY 26.7 5.5%2007 HK Country Garden Holdings 3.38 8,896 18.3 1.0 5.1 4.6 6.8 7.5 16.6% BUY 3.5 3.3%960 HK Longfor Properties 11.18 8,389 5.6 1.2 7.0 6.3 2.8 3.2 16.7% BUY 11.2 -0.3%Weighted average 1.1 6.1 5.4 4.9 5.6 100.0% 14.8%

DY (%)Cur Yr

PE (x)Cur Yr

PE (x)Nxt Yr

%Upside

DY (%)Nxt Yr

eightMkt CapUSD m

Est T/O(USD m)

P/BV(x)

Sources: Bloomberg, BNP Paribas; closing prices as of 5 January 2015

2015 PE comparison for China property developers China property developers performance

4.03.1 2.9

1.5

2.7

4.8

8.7

6.2

3.4

3.85.4

4.7

6.57.0

3.5

12.4

3.43.2

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

(x)

% of land bank which has rising ASP, good margins & sales volume

ShimaoRF

Shui On Land

Sunac

COGO

GreentownKaisa

Franshion

Poly

AgileCogard

Vanke

Longfor Sino Ocean

CRL

COLI

KWFantasia

70.090.0

110.0130.0150.0170.0190.0210.0230.0

Jan-12 Jan-13 Jan-14 Jan-15

China Property BasketHSCEI Index

(Index, Jan-2012=100)

Sources: Bloomberg, BNP Paribas; data as of 5 January 2015 Sources: Bloomberg, BNP Paribas; data as of 5 January 2015


22/100

NOT For


4. Conviction Trade: Long/Short StrategiesH-shares to outperform A-shares

Buy Jun-15 105/115% Outperformance Call Spread on HSCEI ETF (2828HK) over A50 Tracker (2823 HK) at 3.35%

Buy Jun-15 105% Timer Outperformance Call on HSCEI ETF (2828 HK)over A50 Tracker (2823 HK) at 3.55% [with Vol budget at 17%] Sell Mar-15 105% Call on A50 Tracker receives 5.4% and Buy 105% Call on

HSCEI at 3.1%Chinese Banks & Insurers to outperform Chinese Brokers

Buy Chinese Banks & Insurers (or Buy H-FIN) and Short Chinese Brokers

Buy H shares and Sell A shares

China A shares, supported by a domestic retail turnover improvement, had a strongermomentum than H shares driven by foreign investors. A domestic retail investorssentiment shift followed the changes in policy stance.It is worth noting that the HSAHP index traded at the 132.4 level on 7 January 2015; the

A50 Tracker (2823 HK) borrow cost rose from 0.5% in early December to over 4% in lateDecember when the A/H premium was at about 20%. Recently, the borrow cost fell to2% as speculators probably covered their positions after the A/H premium spiked further.In previous A-share rallies, the A/H premium index hit 140 in October 2011 and over 200in early 2008.

A50 Tracker (2823 HK) short-dated volatilities are substantially higher than those onHSCEI (from 11.0 vol-pt on 6M maturity to 18 vol-pt on 1M maturity). Investors interestedin arbitraging volatility discrepancies may consider shorting volatility on A50 Tracker andbuying volatility on HSCEI to receive premium. The near-term upside on A-shares vs. Houtperformance could be limited; one might consider that H shares should catch up andsell OTM A50 Tracker Calls to finance buying OTM HSCEI Calls.Shorting call on A-shares might be at risk as we cannot rule out the irrational behaviourof mainland investors to derive the onshore market to much higher level. We proposeusing the Outperformance Call Spread to capture the potential outperformance of H-shares over A-shares in which the downside will be capped at the premium.

An alternative strategy will be using Timer Outperformance Call that takes advantage ofa much lower implied volatility budget at 17%. On a daily basis, we compute the dailyrelative outperformance of 2828 HK over 2823 HK as R(t):

Then also on a daily basis, we observe the cumulated realised variance of R(t) as V(t):

On the day V(t) is above the square of the budget (17% x 17%), investor receives thepayout of the call on that date. If the V(t) has never reached the square of the budget,investor receives the payout on maturity date.


23/100

NOT For


HSAHP reached a peak of 132.4 on 7 January 2015 Implied volatility term structure

859095

100105110115120125

130135

2012 2013 2014 2015

(Index)

18

22

26

30

34

38

4246

50

1M 2M 3M 6M 9M 12M 18M 24M 36M

HSCEI A50 Tracker (vol-point)


Sliding 6M volatility of the strategy Backtest results

0%

10%

20%

30%

40%

50%

2006 2007 2008 2009 2010 2011 2012 2013 2014

Sliding 6-month volatility

0%

5%

10%

15%

20%

25%

2006 2007 2008 2009 2010 2011 2012 2013 2014

105-115% Outperformance Call Spread

105% Timer Outperformance Call

Sources: BNP Paribas Source: BNP Paribas

The domestic A-shares rally has been running ahead of the fundamentals andovershooting the consensus bottom-up index target by 13%. A-shares earnings are likelyto benefit from upward earnings revision especially for companies with cross holding. Weagree it is hard to gauge the irrational behaviour of domestic investors, but a fair value ofSHCOMP at 3500 level (4.5% upside) seems reasonable. As the rally was pretty strongover the past months, a short-term consolidation or pullback might be possible. Whereasthe HSCEI may have a bit more to go, with upside at about 6.5% to the consensusbottom-up index target, 5.1% to our base case scenario and 11.7% to our high casescenario.

HSCEI Consensus Bottom-up Index target SHCOMP Consensus Bottom-up Index target

80009000

1000011000120001300014000150001600017000


HSCEI

Consensus Bottom-up Index Target(Index)

1800

2300

2800

3300

3800

4300


SHCOMP

Consensus Bottom-up Index Target

(Index)

SHCOMP overshotconsensus indextarget by 13%



24/100

NOT For


Buy Chinese Banks and Insurers (or Buy H-FIN) and Short Chinese Brokers

According to BNP Paribas Chinese financials analyst, Judy Zhangs latest sector reporton Chinese Brokers 2015 Outlook: Is this leverage-driven rally sustainable? (18December 2014), the leverage-driven A-share rally increases the cost of funding for

China; it may persuade the government to launch measures to control leverage. Whenthe A-share market momentum turns, we expect forced liquidations and panic selling.

Loan-related business contributed over 40% of H-share listed broker earnings in 1H14.In light of the accelerating integration of financial segments, banks may be allowed toenter the underwriting business dominated by brokers; the brokers investment bankingbusiness could be marginalised.

Brokers and banks are both benefiting by entering each others businesses. A-sharebrokers are trading at 3.68x FY15E P/BV, while H-share brokers trade at 2.4x. Brokervaluations look high compared to banks trading at 1.1x FY15E P/BV; discrepancies arehard to justify especially as brokers have shifted to more capital-intensive businessmodels with higher balance sheet risks. We think the risk/reward profile of Chinesebrokers is unattractive.

We suggest investors consider buying Chinese Banks and Insurers (or using H-FIN)while selling Chinese brokers as the funding leg. Borrow costs for Citic Securities (6030HK), Haitong Securities (6837 HK) and China Galaxy Securities (6881 HK) are all at40bp.

China Diversified Financials-Dec14.pdf: http://www.bnppresearch.com?E=deifhkbgff

China broker valuationsCode Name Mkt Cap

(HKD b)Last(HKD)

PE (x)FY14

PE (x)FY15

EPSGrowth

y-y%


TargetPrice(HKD)

Upside(%)

Chinese broker s6030 HK Citic Securities 476 29.1 31.1 25.2 23.7% 2.8 1.1 REDUCE 23.50 -19.2%

6837 HK Haitong Securities 277 19.44 23.7 18.6 27.6% 2.3 1.3 HOLD 16.80 -13.6%6881 HK China Galaxy Securities 79 10.14 19.9 16.1 23.4% 2.3 1.4 REDUCE 8.40 -17.2%Sector Average 833 24.9 20.0 24.9% 2.5 1.2 -16.7%


5. Short-term Hedging Tools

Sell Mar-15 110% Call and Buy 90% Put on HSCEI receives 0.33% (delta39%)

Investors kept chasing upside on A and H shares since the rate cuts and sent the HSCEIand A50 Tracker skews to extremely low levels. The extraordinarily low skews probablyreflect a lot of bullishness has been priced in. Also, EDS Asia believes Chinas policymakers do not feel there is an urgent need to pump liquidity into the financial system andthe next two rate cuts may be implemented in 2Q and 3Q. With the recent strongmomentum, A and H shares are likely to test their peaks in January or even in February(likely around the Chinese New Year when the financial system will be flooded withliquidity). Then, the market has the chance to enter a consolidation phase.

EDS Asia is rather bullish on China in 2015 overall but cannot rule out a short-termpullback, we will continue to monitor the market condition. Cautious investors canmonetise the extremely low skew environment to consider selling calls to fund buyingputs as a way to hedge. Both of their 3M and 6M 90-110% skews are at extraordinarilylow levels, making the strategy to receive premium.
http://www.bnppresearch.com/?E=deifhkbgffhttp://www.bnppresearch.com/?E=deifhkbgffhttp://www.bnppresearch.com/?E=deifhkbgff


25/100

NOT For


HSCEI skews at lows A50 Tracker skews dipped to negative zone

(4.0)(2.0)0.02.04.06.08.0

10.012.014.0

2008 2009 2010 2011 2012 2013 2014 2015



(vol-point)

(3.0)

(1.0)

1.0

3.0

5.0

7.0

9.0

11.0

2008 2009 2010 2011 2012 2013 2014 2015

A50 Tracker 6M 90-110% Skew

A50 Tracker 3M 90-110% Skew

(vol-point)



26/100

NOT For


Theme 2: Korean Equities 2015, the year of the catalystWinner Lee and Guillaume Derville Choinomics, monetary and corporate governance pressure as catalysts in 2015Last year Korean equities showed the worst performance in the Asia-Pacific region, withthe Kospi2 Index declining by 5.3% in 2014. While Japanese equities have been boostedby additional qualitative and quantitative easing (QQE), Chinese equities (especially inthe onshore market) reacted positively to the long-awaited interest rates cut.

The BoK (Bank of Korea) cut its benchmark rate twice (25bp each time) in August andOctober 2014 to 2%. Since then, the new Deputy Prime Minister and Minister of Finance,Choi Kyung-hwan, has been relatively quiet about the need for further stimulus. Recentfalling oil and commodity prices have eased the inflation pressure, providing more roomfor the BoK to implement easing. The latest headline CPI eased a further 0.8% y-y inDecember (from 1% y-y in November) below the BoKs 2.5-3.5% y-y target band.BNPP Regional Economist, Mark Walton, expects headline inflation figures to drop tobelow 1% by year-end: this should prompt the BoK to cut the policy rate by 25bp in thefirst quarter of 2015. Overall, Mark expects one more 25bp rate cut in 2Q to 1.5%.

South Korea's Target Overnight Call Rate South Koreas CPI vs. Commodity Prices

1.0

2.0

3.0

4.0

5.0

6.0

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

(%)

100

150

200

250

300

350

400

450

500

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

(%) CPI (LHS) CRB Commodity Index(Index)

Sources: Bloomberg, BNP Paribas; data as of 2 January 2015 Sources: Bloomberg, BNP Paribas; monthly data as of December 2014

Abenomics more or less priced inThe BoJs QQE drove the USDJPY currency above the 120 level. On 31 October, anearlier-than-expected BoJ move surprised the market the QQE programme wasincreased to JPY80t per annum from JPY60t-70t. The announcement had beencoordinated with a Government Pension Investment Fund (AUM of JPY127.3t) portfolioreallocation, and the domestic equity weighting target was raised to 25% (from 12%),while foreign currency-denominated assets were increased to 40% (from 25%). Also,Japans Prime Minister Shinzo Abe managed to postpone the consumption tax increase(10% from 8%). Abes political party Liberal Democratic Party (LDP) and its coalitionparty Komeito maintained 326 seats in the snap election held on 14 December. Thismeans that the ruling parties have retained their power. All these factors are likely toallow Abenomics more time to deliver its promises.Since July, the 15.4% JPY currency depreciation against the US dollar has been astrong dollar story on the back of potential Fed tightening in coming years and a weakJPY currency story to fight deflationary pressures. We believe the recent JPY currencydepreciation has put downward pressure on Asian currencies and a new round ofcurrency wars has now taken place.Since Abenomics began in 2012, the yen has depreciated more than 35% against theKorean won. The JPYKRW cross rate has broken the key support of KRW10 andreached a low of KRW9.099/JPY on 29 December. The cross currency rate almostreturned to pre-Lehman lows. The KRW strengthening against the JPY reduced Korean

exporters competitiveness and is putting pressure on Korean corporate margins. Webelieve a meaningful KRW depreciation might be necessary at some stage to restore itsexports competitiveness.


27/100

NOT For


JPY/KRW broke the key support of 10 Kospi2 suffered from downward earnings revision

6

8

10

12

14

16

18

2008 2009 2010 2011 2012 2013 2014 2015

(JPYKRW)

100

150

200

250

300

350

10

15

20

25

30

35

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(KRW) Kospi2 Bloomberg Estimated EPS (LHS)

Kospi2 (LHS)

(Index)

Sources: Bloomberg, BNP Paribas; data as of 2 January 2015 Sources: Bloomberg, BNP Paribas; data as of 31 December 2014

Dollar strengthening against key global currencies KRW depreciated 7.3% in 2H14

-15.4%-13.3%

-11.6%-8.9% -8.2%

13.2%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

JPY AUD EUR GBP CAD DXY

% Change since end-June

-44.0%

-16.7%

-7.3% -5.6%-4.5% -2.9%

0.0%

-50.0%-45.0%-40.0%-35.0%-30.0%-25.0%-20.0%-15.0%-10.0%

-5.0%0.0%

RUB BRL KRW TWD INR ADXY CNY

% Change since end-June

Sources: Bloomberg; BNP Paribas; data as of 31 December 2014 Sources: Bloomberg; BNP Paribas; data as of 31 December 2014

Korea about to intensify the currency war

According to BNPP Chief Asia Economist, Richard Iley, in his latest report Asia:Currency wars, published on 7 November 2014, the BoJs recent aggressive monetary-easing campaign is going to impact Korea and to fight back Korea needs to make a casefor an additional BoK rate cut in early 2015. Richard highlighted that Korea is one of theregional markets most affected by the Japanese yen weakness as: i) the JPY has arelatively high weighting in the KRW REER (real effective exchange rate), and ii) Koreanexporters are in direct competition with Japanese rivals, as they share identical exportproduct baskets.

Asian Desknote-071114.pdf: http://www.bnppresearch.com?E=dedbakbgff3

BNPP Regional IR and FX Strategist, Mirza Baig, expects a response from Korea. Ratecuts, further FX intervention and acceleration of overseas investment for the NPS(National Pension Service) constitute potential options. Mirza forecast the KRW currencyto depreciate further to 1150 against the US dollar in 1Q15; this would be about 4.6%KRW devaluation.
http://www.bnppresearch.com/?E=dedbakbgff3http://www.bnppresearch.com/?E=dedbakbgff3


28/100

NOT For


JPY weightings in regional currency baskets National Pension Service asset allocation

20.518.7 17.9

16.3 15.9 15.713.1

11.8 11

5.3

0

5

10

15

20

25

TH TW PH KO CH ID MY HK SP IN

(%) BIS broad EER weight of JPY (based on 2008-2010 trade)

Domesticequities

19.1%

Overseasequities,11.3%Domestic

fixedincome55.1%

Overseasfixed

income4.2%

Alternatives9.3%

Cashequivalent

0.5%

Sources: Reuters Ecowin Pro, BIS, BNP Paribas Source: Bloomberg; data as of September 2014

Korean corporates downward earnings revision

The Kospi2 Index performance has been dragged by substantial downward earningsrevisions. The current years Kospi2 Index EPS has been lowered by 30.5% toKRW19.93, from KRW28.68, as of 31 December 2014. Samsung Electronics (20% to theKospi2 Index) suffered from smartphone sales slowdown and margins have been underpressure.

BNPP Korean Technology Analyst, Peter Yu, is turning upbeat on Samsung, although heagrees mobile business operating profits should stay low until 1Q15. He believes themost dramatic downward revision on Samsungs overall operating profits have beendone in 3Q14; semiconductor, display and consumer electronics earnings improvementfrom 4Q14 should lead to operating profits growing 16.6% q-q to KRW4.74t. He expectssemiconductor and display growth to drive 2015 operating profit growth. He raised his

Samsung Electronics target price to KRW1,550,000 (16.5% upside potential).

Samsung Electronics shareholder friendly move

On 19 December, Samsung announced its plan to raise its annual dividend payment in2014 by 30-50% and bought back USD2b worth of stocks.

Samsung Electronics- 151214.pdf: http://www.bnppresearch.com?E=deiedkbgff

Kospi2 suffered downward earnings revision Samsung Electronics vs. Kospi2

100

150

200

250

300

350

10

15

20

25

30

35

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(KRW) Kospi2 Bloomberg Estimated EPS (LHS)

Kospi2 (LHS)

(Index)

80

100

120

140

160

180

200

2010 2011 2012 2013 2014 2015

(Index, Jan-10=100)Kospi2 Samsung Electronics

Sources: Bloomberg, BNP Paribas; data as of 31 December 2014 Sources: Bloomberg; BNP Paribas; data as of 2 January 2015
http://www.bnppresearch.com/?E=deiedkbgffhttp://www.bnppresearch.com/?E=deiedkbgff


29/100

NOT For


Foreign investors negative confidence vote

Foreign investors were net buyers of Korean equities worth USD5.6b in the secondquarter and USD5.2b in the third. In the fourth quarter, they were net sellers (USD2.6b).Since 10 December, the selling has intensified (USD2.76b in 10 consecutive trading

days). Foreign investors loss of faith in Korean equities has been driven by the lack ofcatalysts combined with a global risk-off. In the fourth quarter of 2014, the KRWweakening hasnt been meaningful compared to the substantial JPY devaluation.

EDS Asia believes mid-to-late December flows were related to substantial portfolioreallocation. Deputy Prime Minister Choi will have to implement aggressive measures in1Q15 to reverse the current negative bias on Korean equities. We believe politicalpressure is going to play a major role, while BoK might be pushed to react aggressively.

Worth mentioning, Korean bond inflows amounted to USD35b in 2014; inflows offsetequity outflows. We believe the KRW weakness has so far not been flows driven butmore linked to monetary policy changes.

Foreign investors sold USD2.76b in December Korea bond vs. equity flows

120140160180200220240260280300

(10.0)0.0

10.020.030.040.050.060.070.0

2009 2010 2011 2012 2013 2014 2015

Accumulated foreign fund flow intoKorean equities (LHS)Kospi2 (RHS)

(Index)(USD b)

(10.0)(5.0)0.05.0

10.015.020.025.030.035.040.0


Accumulated Bond Inflow/

bnpp 01-15-15 asia research

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