1. The Offshore Renminbi Market in Hong Kong
The RMB has traditionally been a non-deliverable currency, convertible on the current account but considerably limited on the capital account. Cross-border capital account flows are limited to FDI, QFII, and QDII as well as through informal channels. Hong Kong is the first jurisdiction to allow accumulation of RMB outside China mainland. The RMB became officially deliverable in Hong Kong on July19, 2010 when the PBOC and HKMA issued a joint announcement clearing policy obstacles.
Hong Kong is a special administrative region of China, and maintains separate legal and financial systems. Given its close link with China mainland and its open economy, Hong Kong is considered an ideal testing ground for assessing the impact of capital account liberalization and RMB convertibility. Even though RMB can be accumulated in other jurisdictions (such as Singapore or London), Hong Kong is the only jurisdiction to date where RMB is officially sanctioned and regulated, and where there is also a RMB clearing bank. Combined with the fact that Hong Kong has been the traditional center of offshore RMB deposits and liquidity, Hong Kong has become the de factor CNH market. Generally speaking, CNY is referred to the currency within China mainland traded in the onshore market, while CNH is referred to offshore RMB market, traded primarily in Hong Kong.
The offshore RMB market in Hong Kong started in 2004, after the PBOC and HKMA agreed that Hong Kong banks could conduct personal RMB business on a trial basis and BOC (HK) was designated as the RMB clearing bank. Under the arrangement, the Hong Kong resident is allowed to convert up to RMB 20000 daily in Hong Kong. On July 19th, 2010, the PBOC signed with HKMA the “Memorandum of Cooperation on RMB Business”, which substantially expands Hong Kong’s capacity to conduct RMB transactions. It allows a rich menu of RMB trading activities, including spot and forward RMB trading. Under the Memorandum, financial institutions could offer deliverable forward, in addition to non-deliverable forward (NDF) that already traded in market. The offshore market experiment started mainly with a RMB retail deposit market, followed by institutional bond issuance, RMB trade settlement and RMB (sport and forward) trading. The current and planned cross-border channels include:
Cross-border trade RMB settlement, now fully rolled out to all domestic and international jurisdictions.
Interbank bond market investment scheme, allowing the clearing bank, trade settlement banks, and central banks to invest RMB accumulated offshore into the onshore interbank bond market.
RMB FDI, a program allowing ODI (outward direct investment) and inward FDI. Currently the ODI is working on a pilot scheme and inward FDI is still waiting for the green light from Chinese central government.
RMB QFII was rolled out last year, allowing Hong Kong fund managers to invest offshore RMB into onshore market under a QFII scheme. Earlier this year, the quota has bee expanded to RMB 70bn from RMB 20bn initially allowed.
The CNH has obvious advantage in that investor can access a rapidly growing universe of real underlying assts and derivative products. Beyond access to RMB denominated assets offshore, CNH will increasingly be vehicles to access RMB assets onshore as the authorities continue gradually opening up cross-border capital flow channels.
2. Governmental Objectives, Policies, and Timeline
China has traditionally instituted a stable foreign exchange policy by maintaining substantial controls on its currency Renminbi (RMB) and restricting the use of RMB overseas. The Chinese government used to maintain that convertibility of RMB will be the ultimate goal and it will take a gradual process. However the stand has changed markedly with China’s quick rise in the global GDP ranks. Based on the measures introduced in the last few years, it is reasonable to conclude that China is keen to press ahead with the development of an offshore RMB market, which will facilitate the internationalization of the RMB. This is generally seen as a precursor to the eventual launch of the RMB as a fully convertible global currency.
China has repeatedly affirmed that liberalizing its capital account is its ongoing official policy. The general sequencing policy appears to be strengthening domestic financial institutions, opening capital accounts, and managing the currency. When in 2009 Dr. Zhou Xiaochuan, the Governor of PBOC commented on the super-sovereign reserve currency and implicitly challenged the dominance of the US dollar, he implicitly suggested that RMB should join the elite club of reserve currencies. As the first step, expanding use of the Special Drawing Right should be a priority. The inclusion in the SDR basket is an official recognition of a currency’s status in the global economy. In the 2012 Joint Spring Conference of IMF and World Bank in Washington, Mr. Yi Gang the Deputy Governor of the PBOC and Administrator of SAFE, stated that RMB should be one basket currency of SDR and even indicated the proper weight of RMB should be 10%. All the statements indicated the Chinese government is very positive about RMB’s convertibility.
It is widely believed in China that eventual convertibility of RMB will offer enormous benefits, including efficiency gains from use of RMB in international transactions, removal of currency mismatch on balance sheet, and less reliance on US dollar, etc. Chinese scholars believes that the international role a currency depends on the following attributes of its issuing country, namely, the size of the economy and the trade sector, the size of the financial market, capital account openness, and the stability of the economic and political conditions. These attributes are necessary but no sufficient conditions for an international currency. The biggest challenge is lying with capital account openness.
In 2009, the State Council decided to build Shanghai into one of global financial centers by 2020. Recently Shanghai aspired to become one international RMB clearing center by 2015. RMB convertibility should be a prerequisite to achieve those goals. Based on that, many scholars have argued that RMB should be convertible by 2015. However the Chinese government has never endorsed this claim. Dr. Zhou Xiaochuan has refused to give a clear timeline of RMB convertibility, only stating that it is up to the market. However, in February 2012, a taskforce led by Mr. Sheng Songcheng, Director General of PBOC’s Statistics and Analysis Department released a report, claiming that the situation now is ripe for opening China’s open account. Many government officials and scholars believe that RMB could be fully convertible with 5 years. At present the official standing is that China will promote RMB convertibility and take positive measures to facilitate the process, but the Chinese government will not commit a timeline.
So far, the Chinese government has adopted a multi-pronged platform to attain the goal of RMB’s convertibility, using RMB as the invoicing and settlement currency for cross-boarder trade, bilateral currency swap agreement with other central government, expansion of Dim-Sum products and encouragement of high capital inflows of portfolio investment. Those policies are largely carried out in Hong Kong. Policy is now focused on building the offshore market’s size, setting up the infrastructure for scalability, and broadening the scope of those who can take part. To further develop CNH market in Hong Kong, more policy initiatives are on the horizon, including offshore RMB loans, RMB-denominated ETF, and RMB-denominated stocks, among others.
In 2004 China started its experiment with convertibility and financial liberalization by establishing an offshore RMB market in Hong Kong. In July 2009, China initiated a pilot scheme to settle cross-border trade in RMB. The State Council approved Shanghai and 4 cities within Guangdong Province for the experimental RMB settlement of cross-border trade with Hong Kong and Macau. On August 23rd, 2011 the program has been expanded to cover the entire nation for trade with corporation globally. RMB-settled trade accounted for 10% by 2011, compared to only 2% in 2010, although the figure is still far below the one-third marline expected by Chinese scholars. China’s total CNY trade settlement volume recorded strongly in the first quarter of 2012, coming in at CNY 580bn, 10.7% of China’s total trade, according to the PBOC data.
RMB deposit in Hong Kong has been increasing dramatically since the start of 2010. By January, 2012, the total deposit reached RMB 576 billion, standing at 9.2% of the territory’s total deposit (lower than a peak of 10.4% in September 2011).
So far, China has signed bilateral currency swap agreement with over 18 economies with a combined value of RMB 1600 billion. These arrangements have a three-year duration and are renewable. They allow the economies to offer RMB trade financing to the local importer to buy Chinese goods.
The RMB has made marked progress in global foreign exchange market. According to BIS 2010 triennial central bank survey, RMB’s share of trading increased to 0.9% in 2010 from 0.5% in 2007 and 0.1% in 2004. The average daily surged to 29.2 billion in 2010 from 14.6 billion in 2007 and from 1.7 billion in 2004. However, RMB trading volume still lagged far behind other currencies. According to a BIS estimate, daily CNY spot market turnover is just USD 8 billion, compared to USD 1.2 trillion in the US dollar. With 2.4% market share, even HKD is much more prominent than RMB.
The Dim Sum Market also develops very quickly. The market so far is dominated by Chinese entities including Ministry of Finance, Bank of China, and China Development Bank. In 2011, the market size is about RMB 30bn.
3. The Latest Developments
The PBOC announced in mid-April that a new CNY clearing and settlement platform, named as the China International Payment System (CIPS), would be set up. It appears that CIPS will be similar to the US Fed’s CHIPS, allowing international banks to connect directly with appointed participating banks onshore. CIPS is a key part of Shanghai’s aspiration to become an international CNY clearing centre by 2015. When it is up and running, it should provide an alternative channel for CNY to enter and exit mainland China, complementing the existing channels (the clearing bank in Hong Kong and onshore agent banks). The result will be a larger global RMB pie.
The Renminbi is heading overseas it is going worldwide. CNY-denominated trade flows between China and the rest of Asia are increasing, CNH trading is picking up in London, and China has announced the creation of a new international CNY payment system. It is now easier for corporates to invoice in CNY, and keyholes in China’s capital account such as the R-QFII scheme, which allows offshore holders of CNY to invest in equities, are being carefully expanded. CNH trading volumes are up to USD 2bn a day in Hong Kong.
The new CNY trading band of +/-1% and the removal of short-dollar limits for banks herald a new phase of CNY market development. The PBOC is expected to reduce its FX intervention and allow market forces to drive increased CNY movement. Implied volatility in the options space has fallen, creating a good opportunity for corporates to buy protection.
CNH bond issuance has had a great start to the year, and liquidity has improved. Upward pressure on yields will remain.
One feature of CNH system is the clearing bank, Bank of China (Hong Kong). BOCHK is one of two offshore banks designated by the mainland authorities to settle and clear cross-border RMB FX transactions for various authorized activities. Equally important is the ability of clearing banks to take CNH deposits on custody for other Hong Kong banks and place them with the PBOC to earn a benchmark deposit rate. In this way, the RMB clearing bank plays some central bank functions, i.e., to offer a window for CNH liquidity and to set benchmark rate on CNH deposits.
According to HSBC’s research, by September 2011, the total market liquidity in CNH spot has grown to USD 1.5bn per day, while liquidity in the CNH forward and swaps market is now at USD 2.7bn. Adding up, the total CNH liquidity stood at USD 4.2bn, much large than the figure of USD 0.5bn at the start of 2010. It is expected that the CNH market liquidity will continue to rise as participants globally gain familiarity and access to the CNH market.