Second Wind for Offshore RMB Market

According to the Hong Kong Monetary Authority (HKMA), offshore deposits of renminbi (RMB) (the offshore currency is denoted as CNH to distinguish it from its domestic equivalent, CNY) grew 87% last year to CNH588.5bn. The volume of so-called ‘dim sum’ bond issuance trebled to more than CNH100bn. Despite a pick-up in volatility in the US dollar (USD)/CNH market last autumn and a subsequent sell-off in dim sum bond prices, several factors are expected to give the market a renewed boost in the coming year.

“The offshore RMB market continues to evolve rapidly. The volatility in September and October 2011 owed much to the unwinding of a large speculative short position in USD/CNH and the sharp rally of USD due to the global flight to quality,” says Cindy Chen, head of securities and fund services for Citi Hong Kong.

“As result, the CNH-CNY spot spread widened to as much as over 1200 pips and at one point the USD/CNH [which normally trades at a premium over USD/CNY] sank into a steep discount against the spot USD/CNY. Since January 2012, the USD/CNH spot rate has been stabilised and the CNH-CNY spread has narrowed close to parity in light of reduced RMB appreciation expectation and signs of slowdown in China,” she adds.

Despite the recent slowdown, the developments of the past year have come at a rapid pace. For a start, there have been major breakthroughs in the opening up of China’s capital account:

  • Foreign direct investment (FDI) and inter-company or direct bank loans can now be made in RMB. FDI denominated in RMB last year is estimated at CNY90.7bn, according to Rani Gu, RMB senior product manager, Citi Transaction Services.
  • The RMB Qualified Foreign Institutional Investors (RQFII) programme, rolled out in December 2011, was lifted from CNY20bn (US$3.2bn) to CNY70bn in April (US$11.1bn), along with an increase in the QFII programme itself. RQFII allows Chinese fund managers and securities firms to launch funds domiciled in Hong Kong in RMB to invest in the Chinese fixed income and equity markets. The first batch of funds, with an agreed quota of RMB20bn, was required to allocate 80% of their money to fixed income securities. Those restrictions are being relaxed for the second batch of funds.
  • Securities firms have been seeking approval for an RQFII exchange traded fund (ETF) that will invest in the China A share market. The launch of a first equity offering is also being talked about.

“A variety of other drivers are expected to drive growth in the offshore RMB market in the coming months,” says Gu. She draws particular attention to four factors:

  1. Wider circulation of RMB, particularly through the development of a deeper market in London.
  2. Expansion of the dim sum bond and RMB loan markets as more global corporates look to borrow in RMB.
  3. Moves by central banks and sovereign wealth funds (SWFs) to shift a portion of their reserves into RMB.
  4. Redenomination of an increasing percentage of China’s imports and exports into RMB.

Growing Role in Trade

The adoption of RMB in offshore payments may be a recent phenomenon but it is a rapidly growing one. Both Japan and Russia have signed bilateral agreements to use their national currencies for cross-border trade settlement with China, while the Australian and Chinese central banks have signed a currency swap agreement that will allow RMB200bn (US$32bn) of local currencies to be exchanged between the two countries over three years. Data from SWIFT show the RMB now ranks as the number three currency – after the USD and euro – for global issuance of letters of credit (L/Cs), with a 4% market share.
 
Surprisingly, perhaps, the biggest contribution to RMB payments now comes from Europe. According to SWIFT, Europe’s share of international RMB payments grew from 36% in Q111 to 47% in Q112. “Europe has been quick to adopt RMB in settlement, which now makes up 6.7% of its total payment volume with China/Hong Kong compared with 2% a year ago,’ says Camille Liao, Europe, Middle East and Africa (EMEA) liquidity and investments, Citi Transaction Services. “London has become a key offshore RMB trading centre. In Q411, 30% of RMB payments and 46% of RMB foreign exchange [FX] conducted outside China and Hong Kong went through London,” she adds.

London is clearly making a big effort to establish itself as an offshore RMB centre. In January, the HKMA and the UK Treasury announced a joint private sector forum to increase co-operation in promoting the offshore RMB market. One of the first visible effects of that agreement will be a five-hour extension to the HK RMB real-time gross settlement (RTGS) system to accommodate longer trading in London. The extension is expected to become effective at the end of June, widening the circulation of RMB in the western hemisphere. “The co-operation agreement also envisages improving CNH liquidity and the development of more CNH products,” says Gu.

Those products are already fast arriving. In May, Citi launched RMB-denominated bank accounts in the UK, together with a range of related services to support payments, trade, FX and hedging. “We are also looking at providing more liquidity structures as the Chinese continue to relax their cross-border concentration regulations, leveraging Citi’s global platform,” says Ms Liao. In other moves, there have been a series of RMB-denominated commercial paper issues out of London, while in May an RMB bond made its debut on the London Stock Exchange’s (LSE) order book for retail bonds.

Expansion of the Dim Sum Bond Market

In the past six months, sentiment towards the RMB has changed. Gone are the days when the Chinese currency was viewed as a one-way bet. “If institutions and big corporates take the view that the USD/CNY rate is going to remain flat over the medium term, more will look to borrow in CNH,” says Gu. The dim sum bond market has already seen a number of big international issuers, most raising relatively small amounts, including Unilever, McDonald’s and America Movil.

In March, Caterpillar was the first non-Asian corporate to launch a dim sum bond in 2012, employing Citi’s issuer services business to act as its lodging and paying agent.
Diversification of Central Bank Reserves

Japanese authorities have said they plan to start investing in China’s sovereign debt, making the country the first developed economy to hold reserves in RMB. Nigeria’s Central Bank governor, Lamido Sanusi, is also on record as saying the monetary authority wants to move between 5% and 10% of its US$33bn of FX reserves into RMB.

Import and Export Trade Flows in RMB

“Import and export trade flows with China play the most important role in driving the CNH liquidity pool,” says Gu. ‘In the past year, around 10% of China’s imports and exports have been redenominated into RMB. That compares with as little as 2% a year or so ago.”

More than 80% of China’s RMB cross-border flows are channelled through Hong Kong. In 2011, according to Gu, RMB trade volume achieved a month-on-month growth rate of 7.5%. Why then did the volume of RMB deposits in Hong Kong slip back after hitting a peak in November? “A deep dive into transaction levels shows a rebalancing of RMB import and export flows,” says Gu. The export/import ratio shifted from 0.18 at the beginning of 2011 to 0.6 at the year-end. “The message is that CNH liquidity in Hong Kong has been used for trade settlement with mainland exporters,” she adds.

One reason for that was a sharp change in CNH/CNY pricing in Q311, with the offshore currency moving to a discount. “This gave Chinese exporters more incentive to buy cheaper CNH via their offshore trading arms and then send the money back to China via the RMB cross-border trade scheme,” says Gu. The same factor encouraged importers to use the onshore rate where the quote allowed them to.

The relationship between the onshore and offshore currency moved back to normal in January. “CNH regained its premium to CNY,” according to Gu. “This will help Hong Kong retain more Chinese importers’ RMB flows and build up offshore liquidity.” CNH interest rates have since moved up and there are expectations that RMB bank lending may accelerate this year.

“We’ve already noticed some smaller and medium-sized banks starting to price aggressively to attract the offshore RMB deposit base,” she says. “The indicative offshore inter-bank lending rate remained high throughout Q112. No doubt the gap between the onshore and offshore markets will gradually converge but increased CNH deposit rates will provide more incentive to offshore depositors and investors.”

Chen concludes: “With strong support of the market regulators from China, Hong Kong and UK to expand the offshore RMB market, a good pipeline of new issuance of dim sum bonds and the expansion of RMB bank loan offshore, we believe the offshore RMB market could enter a new stage.”

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