RMB Internationalisation: What Does it Mean for Treasurers?

It has become the world’s biggest economy. Economists and market analysts of all shades are agreed that China is approaching the next chapter of its growth story. International trade between China and the rest of the world has been growing at almost 20% per year for the past decade, and reached US$4.2 trillion at the end of 2013.

China represents perhaps the single biggest opportunity – and the single biggest challenge – for western companies. It is a massive export market; it has a vast, deep pool of skilled labour and enormous resources; and it is perhaps the most dramatic growth story of our age, recording an average 9% GDP growth over the past five years.

Rise of RMB

The latest data from the Bank for International Settlements (BIS) shows that by the end of last year the renminbi (RMB) had risen to become the second most used trade finance currency and the ninth most traded currency against the US dollar. Turnover has nearly quadrupled during the past four years, and annual growth of 15-20% can be reasonably expected for the near future. Offshore RMB markets in Hong Kong and other financial centres have helped to satisfy the sharp rise in demand, and now account for around two-thirds of the US$120bn worth of RMB traded on an average day.

It is therefore not surprising that there is so much demand for the RMB or that we continue to see accelerated growth in volume across our FX platforms: it is now typically among the top four traded pairs by volume on Matching and entered the top 10 traded pairs on FXall in March 2014. Recently Thomson Reuters worked with the Asia Securities Industry and Financial Markets Association (ASIFMA) and Standard Chartered Bank to set out the roadmap for the further internationalization of RMB. We agreed that the prevalence of China’s currency does not match the country’s global economic influence – but it will soon – and we set out five milestones on the roadmap:

  • It becomes a deposit currency internationally.
  • It is used increasingly for trade.
  • It becomes an investment currency – the development of the offshore market.
  • Central banks agree bilateral swap agreements with the People’s Bank of China (PBOC).
  • It is accepted globally as a reserve currency.

Clearly, the massive expansion of trade with China has also meant a massive expansion of currency requirements. Multinationals need RMB to buy raw materials and products, to pay suppliers and employees, or to hedge revenues of their Chinese operations. That, therefore, leads to consequent growth in FX products for investors who need to hedge their investments in RMB-active companies.

The PBOC sees the internationalisation of the RMB unfolding through the creation of a global network of offshore RMB clearing banks, currency swap agreements, integrated e-infrastructure and the related regulatory underpinnings.

The offshore RMB market was developed specifically to enable China to open up its capital account to international flows, while the onshore market can remain separate. The result is there are now three main markets for the RMB: the onshore RMB (CNY) market, the dollar-settled non-deliverable forward (NDF) market, and the offshore RMB (CNH) market. Each has its own demand and supply dynamics, therefore they also have differentiated FX and interest rates and securities pricing.

Meanwhile more trade corridors are opening up via bilateral swap line arrangements. In July this year Switzerland reached a bilateral currency swap agreement with the Chinese Central Bank that has already resulted in RMB growth in excess of 50%.

Impact on Treasurers

Corporate treasurers are now operating in a rapidly changing world where cross-border payments to Chinese companies previously settled in US dollars or euro can now be expected to be settled in RMB. The Chinese companies benefit from avoiding some hedging and transaction costs, while their overseas partners benefit from negotiating better pricing from counterparties by offering settlement terms in RMB.

With China focused on international trade and settlement with the UK, Australia and Canada among others, we should expect trading in these cross rates to develop, which will be more efficient for corporations to settle these transactions. In the FX markets, these cross rates are still developing, with most liquidity remaining in the US dollar cross.

What corporate customers tell us they need in their foreign exchange services globally are increasingly efficient electronic trading and the ability to comply with a changing regulatory environment. This is true in all countries in which they want to operate, but of course they hope the same will ultimately be true for RMB. There remains steady focus on foreign currency risk management, which in turn is driving corporate treasurers to adopt those electronic trading tools to manage their company’s bottom lines. Again, compliance with regulation is a significant influence here: since execution processes are more heavily scrutinised now, we are seeing a general trend to augmenting phone trading with electronic channels, where execution quality can be readily measured.

With China’s central bank talking about joining the International Centre of Clearing, more electronic RMB trading might be around the corner. Here too regulatory pressures are a driving force, increasing transparency and pushing the competitive pricing which electronic trading can enable. Electronic trading enables participants to easily discover the best price available to them for any trade from their available counterparties.

It is important to note that the Chinese economy is opening up to direct investment as well. Later this month, the Shanghai-Hong Kong Stock Connect initiative is expected to launch, enabling for the first time direct investment by qualified institutions and individuals between these exchanges. Investors in China and Hong Kong will be able to buy and sell shares listed on each other’s exchanges – the Hong Kong Stock Exchange (HKSE) and the Shanghai Stock Exchange (SSE) respectively. Integral to the success of this programme will be the further loosening of restrictions on capital flows in and out of China.

In other words, it represents another milestone on the roadmap to the long-awaited opening of China’s financial markets.

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