Hong Kong was given a major boost in its desire to be an offshore settlement centre for renmimbi (RMB) in July 2010 when the People’s Bank of China (PBOC) and the Hong Kong Monetary Authority (HKMA) agreed to the following expansion of business:
- All corporates and financial institutions are able to open RMB accounts (i.e. no longer restricted to trade-related accounts).
- Removed restrictions on RMB fund transfers between personal and wholesale accounts within Hong Kong.
- Allowed RMB denominated financial and investment products in Hong Kong subject to approval from the HKMA on the banks’ internal controls and management processes.
- Foreign exchange (FX) open position resulting from personal conversions and trade-related transactions can be squared with either the Hong Kong RMB clearing bank or China agent banks, while non trade-related transactions must be settled through the Hong Kong interbank market.
This led to the birth and growth of the Chinese Yuan (CNH) off shore market. In conjunction with an earlier move to allow CNY-settlement-participating banks to develop CNY business (as long as CNY funds do not flow back to the mainland), the HKMA has allowed banks and other institutions not involved in CNY trade settlement to develop CNH products, and move CNH freely offshore – outside of mainland China. This spurred the development of RMB deliverable forwards, certificates of deposit (CDs), bond issuances and other structured products in the Hong Kong market.
Figure 1: Offshore RMB Business in Hong Kong
Source: Standard Chartered
Hong Kong continues to grow from strength to strength in RMB settlement. Trade transactions settled in RMB through banks in Hong Kong increased from a monthly average of about RMB5bn in the first half of 2010, to over RMB57bn in the second half of 2010, and RMB100bn in the first quarter of 2011.
In 2010, RMB trade settlement handled by banks in Hong Kong amounted to RMB369bn, which was equivalent to 73% of mainland China’s total RMB trade settlement. This ratio increased to 86% in the first quarter of 2011, suggesting that Hong Kong is becoming the prime platform for RMB trade settlement, serving both local and overseas banks and companies.
Despite rapid market development, there are still differences between RMB trade settlement and the non-trade related. CNH settlement. Banks acting as counterparties to non-trade related conversions are not allowed to automatically net out their positions with the Hong Kong RMB clearing bank (but are permitted to do so with other participating banks). In contrast, the clearing bank can be freely used as counterparty for trade-related CNY conversion.
In this way the Chinese authorities have been able to broaden the number of institutions and individuals who can hold CNH, without in effect opening up its capital account. This different treatment for trade-related and non-trade-related CNY conversion is one of the ways the onshore and offshore markets have been kept distinct, and this has led to pricing differences between the two.
This lack of a single CNH FX market and the fact that China’s capital account is still largely closed results in the fungability between CNY onshore and offshore being limited.
- US dollar/CNH quoted for purposes of a trade-related transaction is quoted with reference to the onshore market, both in terms of similar pricing and similar liquidity.
- US dollar/CNH for non-trade-related purposes (such as purchasing a CNH-denominated structured product) has its own pricing and liquidity, reflecting specific demand and supply conditions for CNH deliverable in Hong Kong.
Banks, and particularly the trade settlement banks, will probably need to maintain separate accounts to manage their trade-related and non-trade-related exposures. This has cost implications both at a systems and operational level. Banks also have the additional consideration of how best to support their underlying corporate clients: do they site accounts in the client’s location or look to support through their offices in Hong Kong or China using the services of a third party correspondent?
For corporates, the picture is simpler as a single CNH account can be maintained which can be used for what are termed ‘general purposes’ or for a trade-settlement transaction given the appropriate documentation.
The success of Hong Kong and CNH is ably demonstrated by the explosive growth of CNH deposits. As of February 2011, there were some CNH408bn of CNH deposits in Hong Kong and this is expected to grow rapidly in the next few years.
With the buildup of the CNH deposit base this raises the question of how banks and corporates can deploy this CNH on hand. Now that the CNH market has delivered the ability to trade, invoice and settle currency outside the mainland, offshore corporates and institutions can buy, sell, invest and actively hedge their exposures using the suite of CNH products which are increasingly becoming available in the offshore market. The development of an interbank CNH market, however, is probably sometime away in the future unless borrowing in CNH picks up speed and interbank market and banks in Hong Kong start building CNH loan books to drive a healthy CNH asset/deposit ratio.
Currently, corporates holding CNH have limited remittance options:
- Payment for underlying cross-border import trade settlement fulfilling the regulatory criteria.
- Capital injection subject to the approval of the Ministry of Commerce.
- Foreign debt; for mainland corporates and financial institutions having headroom in their approved caps for foreign currency borrowing.
In fact, SWIFTWatch Traffic Analyser, which was recently enhanced to carry currency and value denomination, shows a 25% decrease in CNY volume into China and a consequent increase of CNY volume into Hong Kong (3Q10 against 1Q11), although absolute volume numbers are still quite small.
Prospects for Other Offshore RMB Clearing Centres
Recent press speculation in Singapore has suggested that the PBOC and Monetary Authority of Singapore (MAS) are giving consideration to establishing Singapore as an RMB settlement centre to attract and settle RMB flows in ASEAN. Trade between Singapore and China has been growing rapidly in recent years, from US$10bn in 2000 to US$57bn in 2010.1
Some factors that would support settlement of RMB in Singapore include:
- Offshore demand for RMB continues to grow significantly, as RMB becomes increasingly liberalised and investors start holding RMB deposits and bonds.
- RMB cross-border trade settlement continues to grow since the launch of the pilot scheme in 2009.
- Hong Kong has already shown the way in establishing RMB settlement offshore with a dedicated RMB real-time gross settlement system (RTGS) in place since 2006.
- China is expected to liberalise even further over time.
- Possibility that Chinese companies may list in overseas exchanges and the consequent opportunity to promote Singapore as a regional financial centre for RMB settlement.
To this end, Singapore would do well to learn from Hong Kong’s experience. These are some areas worth looking into:
- Selection of one commercial bank as the settlement institution has resulted in major capacity issues for interbank placements for CNH deposits in Hong Kong.
- Counterparty limits come into play as the settlement institution is a commercial bank (the expected resolution here is a fiduciary account with PBOC which will change the risk profile to sovereign for interbank placements).
- Guidelines from supervisory bodies around capital concentration with one counterparty can be a factor.
- There is currently an extremely small demand for CNH lending in Hong Kong.
Continued growth can be expected for CNY in both its onshore and offshore forms. With up to 20% of China’s trade expected to be redenominated to CNY from US dollar over the next couple of years, banks are scrambling to accommodate client demand for RMB settlement.
The percentage of China’s total trade settled in RMB has been increasing rapidly, from only 0.7% in the first half of 2010, to 4% in the second half of 2010, and to 7% in the first quarter of 2011.
As the world’s biggest contributor to global trade alongside the US, the ‘transactional demand’ for CNY can potentially be as large as that for US dollar when CNY becomes truly internationalised. Considering further that China runs a huge trade surplus of US$180bn annualised (US$300bn at the peak in early 2009) in comparison to the US trade deficit of US$650bn, the world`s demand for CNY could be even larger than that for US dollar.
Arguably, at some point in the future, if China relaxes some of the current restrictions on offshore RMB, we might see the potential integration of the onshore and offshore RMB into a single freely convertible currency which could eventually serve as a global reserve currency. This will also mean dilution of the impact of monetary policies on CNY as mainland entities will then be able to tap offshore CNY pools. But until that happens, the jury is still out on this ‘one currency two markets system’ and investors will continue to increasingly hold CNH in deposits and bonds, as they see this as a store of value (and an appreciating one at that) with potential eventual deployment allowed into China.
1Source: Standard Chartered Bank Research.
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