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| By John McCormick, Chairman of RBS Asia Pacific |
In our opinion, central banks will adopt the renminbi as a major reserve currencyand markets will use it for the massive trade and investment flows in and out of China. Any company wanting to do business with China that is not primed for the change does so at its own peril. Not that the road to convergence will be straightforward. Any company that does trade with China, has FX exposure there, or just needs to raise cash in the current fragile global economic environmenthas a responsibility to its shareholders to be au fait with the fast-changing renminbi market and efforts to increase trading the currency outside the People’s Republic. Companies need to know how to raise RMB, how they can deposit it, make payments, borrow, exchange, invest and hedge it.
The rapid evolution of the offshore renminbi, known as the CNH, over the past four years highlights why corporates can’t afford to be out of the loop. Hong Kong, where the overwhelming majority of CNH trades take place, is now home to CNH500 billion of deposits from virtually nothing in 2008. An estimated USD1.8 billion is traded in CNH spot foreign exchange every day and there are more than CNH225 billion worth of outstanding bonds in Hong Kong, including issues from corporate giants Tesco and Macdonald’s. If this pace continues, as I expect it to, we could soon see even European governments issue RMB bonds.
With the backing of the City of London and HM Treasury, London is now poised to become the next big hub for offshore trading and clearing of the renminbi. Companies outside China will be able to deposit renminbi in London or use it there to make payments, borrow, exchange, invest or hedge. So, what is the latest on London’s RMB quest? Since British Chancellor George Osborne launched Britain’s push in April, known as the Initiative on London as a Centre for Renminbi Business, there has been a focus on analysing the challenges. One of the biggest is liquidity.
For London banks to be able to settle companies’ two-way trades in China, the volume of trade settlement activities needs to grow. In other words, they need more liquidity. Currently, liquidity flows across China’s borders under the current account and capital account through various offshore (CNH) and onshore (CNY) accounts. Trade and overseas direct investment (ODI) are the only channels that transfer liquidity from onshore to offshore. However, ODI flows tend to be inconsistent because China, which runs a trade surplus with its non-Asian trade partners, has several layers of controls and quotas to regulate outward investments. This leaves trade imports rather than exports as the only dependable source of liquidity. In March, it became even harder for London to get the business and liquidity it needs to launch products after changes to the CNY trade settlement scheme made it easier for mainland Chinese exporters to settle in RMB.
There have however been some recent developments to encourage liquidity in the offshore market and develop London as a centre of trading in the renminbi. A new cross-border arrangement to manage collateral has been introduced, and the system in Hong Kong that settles RMB trades – the Real Time Gross Settlement system – recently extended its operating hours to 08:30 – 23:30 to cater more for European participants. That has helped but not completely solved the time zone issue because the branch of China’s central bank where foreign banks hold fiduciary accounts hasn’t also extended its hours. Those of us behind the London scheme are working on other ways to solve the liquidity squeeze by investigating how to mitigate foreign exchange settlement risk in the international RMB market and analysing a tri-party repo system.
For London to thrive in renminbi trading, the People's Bank of China (PBOC) would also need to open a CNY swap line to the Bank of England (BOE). This swap line would effectively be used by the BOE to inject CNY liquidity in exchange for sterling, though not as a facility to defend the CNY should it come under pressure. Neither central bank has yet hinted at such a move and the BOE might find it tricky to extend its mandate to such a role. Nevertheless, it would be a huge boost to market confidence and a major milestone on London’s journey to becoming a RMB centre.
Another task for London is to provide direct foreign exchange quotes of RMB against GBP, EUR and other currencies so that corporates in the UK and Europe can easily manage trade settlement, financing and wealth management. I think this can be done but it depends on liquidity of any cross exchange rates, where the CNH is currently the weak link. London therefore needs to build its own pool of deliverable CNY liquidity as quickly as possible. Trade bodies and market makers need to improve pricing benchmarks and bond indices; work with inter-dealer brokers to boost the liquidity of existing and new products; and engage with the relevant regulators to ensure consistent global standards for RMB products.
Of course, the depth of any offshore, CNH, cross-exchange rate market ultimately depends on the depth of the direct USD/CNH market. Encouragingly, this has deepened tremendously for both spot and forward contracts in the past year, driven by the influx of companies in China taking advantage of the lifting of curbs on CNY settlement for their exports. This has enabled them to settle more cross-border CNY trades.
The secondary market trading of offshore CNY-denominated bonds – commonly called ‘dim sum’ bonds – has also improved, but it is unlikely to deepen much further until the market develops a short-end money market and a long-end interest rate swap market for funding and hedging. Market markers also lack a risk-free sovereign benchmark curve, which only China can set since the RMB originates in China. Until that happens, renminbi issuances by other governments can constitute sovereign issues and be used as benchmarks for banks or corporates originating from the same countries.
This year, discussions about this market have also focussed on the drop in non-bank CNY deposits in Hong Kong, which have fallen for five consecutive months. Are Hong Kong residents and foreign investors’ losing interest in the offshore renminbi? Are they diverting their deposits to other financial centres such as London or Singapore? Or, is this the result of a backflow of offshore CNY liquidity to the onshore market through imports or the changes to the CNY trade settlement? In fact, all these factors have probably contributed to the drop in deposits, but I am not too concerned. RMB trade settlement volumes and bond issuance are still growing, suggesting that any loss in interest in the CNY could only be a marginal factor contributing to the drop in deposits.
Many issues have yet to be resolved, but only corporates keeping a close eye on developments in the renminbi will be ready to seize the advantage.
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Disclaimer
Woon Khien Chia, Head of Local Markets Strategy, Emerging Asia, RBS, also contributed to the article.
The statements and opinions expressed in this article are solely the views of John McCormick and Woon Khien Chia and do not necessarily represent the views of The Royal Bank of Scotland.
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