For the Chinese offshore market to develop in London, there needs to be a critical mass of RMB in the city," says Chi Lo, CEO of HFT Investment Management Ltd in Hong Kong. "The key avenue for RMB into London is through trade, but this is limited at the moment. [As a result], the amount of RMB accumulated in London is small. This will restrict the size and pace of development for London into an offshore market for China.
Recently, some prominent media reports, such as one from the BBC, stated: "Talking to bankers and lawyers, there is growing optimism that the City of London will join Hong Kong as an offshore centre where the Chinese currency can be traded... and that an announcement on all this may not be far off. British banks and financial institutions have been pushing for London to become an offshore trading centre for the Chinese currency. London sees a multitude of opportunities in trading RMB, as it is a rapidly growing market in foreign exchange and bond issuance.
Hong Kong was the logical choice for China to begin its offshore RMB project in July 2010. With a predominately independent economy, the special autonomous region is still part of Chinese sovereign soil and thus China has direct control of what happens there. Trade channels between China and Hong Kong are long and well-established, and Hong Kong exports to China account for 16% of all Chinese imports.
Comparatively, the UK lags behind Hong Kong. The UK only accounts for 0.6% of total Chinese imports. This has been the average for the last five years.In Hong Kong, there were a lot of Chinese importers paying exporters based in Hong Kong in RMB," says Chi. "This meant that trade in Hong Kong was settled in mainland currency. This was a key avenue to accumulate RMB in Hong Kong. In London, a similar channel does exist but on a much, much smaller scale. Trading RMB outside of China has a lot to do with the amount of RMB products that are available.
RMB product development will need to be stimulated, says Chi. Until then, there will be little incentive to hold RMB beyond trade needs, and ... will generate lower returns than other international currencies. Developing more products will take a long time, but Beijing is not in a rush. Moreover, there has been little concrete discussion between Beijing and London. London is the largest foreign exchange hub in the world with one of the most sophisticated financial systems, [and] its not controversial to consider that the RMB would be fully traded and settled in the city at some point in the future, says Daniel Hui, senior FX strategist at HSBC in Hong Kong. "[But] all there is in terms of hard facts is that there was discussion between London and Beijing officials last autumn."
And while internationalization of the currency is on the agenda in China, pertinent political developments and domestic economic concerns will precede it. Beijing still has a lot of things to sort out before this comes to the forefront of the agenda," says Chi. "Most of the next year will be taken up by the handover in leadership. The political agenda will be very busy and RMB internationalisation will not be the only economic task.
Like with most economic policy, China will be taking slow and measured steps.
The march to convertible RMB is there, but there is no rush, says Paul Bakunowicz, Asian trader at Citi in London. Corporates will need time to adjust, and Beijing will need the time to control such a big animal. True convertibility of the offshore RMB is a long way off."
The process in London might, indeed, be preceded by other economic developments, drawing out the process longer than expected. And although London becoming an offshore hub for China will speed up the process of RMB internationalization, this is not the only route that can be taken. Once the offshore RMB market [CNH market] has been built up and fully understood, the CNH will eventually replace the Hong Kong dollar. When this market becomes bigger, and the CNH market is more flexible, then the currency will be on its way to being fully convertible and internationalized, says Bakunowicz. "This is a longer-term development something that we will perhaps see happening in the next 10 to 12 years."
The offshore currency market is relatively new and still unpredictable. Volatility due to plummeting investor sentiment amid the eurozone crisis in September and October last year raised questions about how the offshore market will develop. Although things are moving forward in Hong Kong, some are beginning to question its success, says Chi. "RMB deposit growth and trade settlement are both slowing down. This will play on peoples mind when starting similar ventures elsewhere."
It will be a while before London becomes an offshore market for China, but the process is inevitable. London is hindered in its limited ability to accumulate RMB, but this does not act as a deterrent, says Chi.
It just might take longer than expected.