The call from analysts comes after the City of London Corporation announced that a committee comprised of five banks will work with the city to strengthen London’s CNH capabilities and begin implementing protocols to facilitate greater CNH trade and deposits. This would create London as a second hub for the offshore renminbi, behind Hong Kong. “The potential for that exists because market prices can be impacted by the regulatory environment,” says Dariusz Kowalczyk, senior Asia economist and strategist at Crédit Agricole in Hong Kong.
“For, example if banks in London are required to keep much less of their renminbi assets in liquid instruments than Hong Kong banks are required to, its liquidity situation would be better. That means it would be easier for London banks to extend loans and it could materialize that renminbi is cheaper in London because of that.”
Kowalczyk explains that the offshore renminbi – which is classified as CNH in Hong Kong and CNL in London – is unique in its potential to price differently in separate trading centres because of the currency’s high level of regulation. Due to the scope and limited availability of the currency outside China, any additional liquidity can spark a price divergence between cities.
The market already sees a divergence of pricing for China’s onshore renminbi and CNH, due to the difference of supply and demand in the mainland and offshore, as well as investor perceptions of the China market and opportunity for the currencies’ appreciation against the US dollar.
To prevent arbitrage between the CNH and CNL, analysts predict that Beijing and Hong Kong regulators will advise London to adopt similar rules to Hong Kong, such as the implementation of liquidity ratios for banks.
For example, the Hong Kong Monetary Authority (HKMA) mandates that banks hold 25% of their CNH balance sheets in either cash or mainland bonds.
“In Hong Kong, you have requirements related to liquidity, and whenever the spot and offshore prices diverge a lot, there is regulation in place that puts offshore banks more in line,” Kowalczyk says.
“For example, Beijing allows Hong Kong banks to conduct foreign exchange spot transactions at onshore prices if they are related to a renminbi trade. This allows the convergence of onshore and offshore prices. There are also regulations on the asset liability balance of Hong Kong banks in terms of renminbi exposure. London may have similar rules.”
While it is possible that the currencies’ prices diverge, analysts agree the event is a long shot. Beijing, which predominantly dictates the availability and direction of the offshore renminbi, would want to avoid complicating the offshore currency market by creating arbitrage opportunities. It might put pressure on London to curb liquidity in the same vein as Hong Kong, analysts add.
According to a head of bond trading at a bank in Hong Kong, any potential sign of arbitrage will cause the market to immediately act on the pricing opportunities, thus minimizing the differentiation between CNH and CNL’s prices.
“This would depend on how efficient the market becomes, but if there are situations in which the offshore renminbi currency is trading differently in different cities, considering there are no barriers between Hong Kong and London, market investors would be quite quick to pick up the arbitrage opportunity,” the source says. “This is quite a new development and we’ll have to wait and see if such opportunities arise.”
However, the decision to adopt regulation that is either similar or dissimilar to rules in place in Hong Kong falls on London. Hong Kong, with its political ties to China, has less leeway to dictate its own rules on dealing with CNH, economists say, but London might have more autonomy.
“It seems that the two centres are developing different moulds,” says Raymond Yeung, senior economist at ANZ in Hong Kong. “Banking regulation is not driven from the Chinese point of view. It’s up to London. Banking regulators will assess their rules according to the stability of their own banking system. They can decide whether the renminbi market will have similar regulatory control as the euro/dollar market in the future.”