China’s gradual relaxation of controls on its currency is playing out like a vast financial striptease, enticing bankers, companies and investors alike.
Treasurers can now use renminbi to settle trade deals and bankers enjoy greater access to the domestic bond market. These developments are most welcome, to be sure, but the authorities in mainland China are still keeping a tight grip on currency reform through the judicious use of regulations, quotas and caps, fearful of the twin menace of inflation and speculation. As a result, the market has been left tantalised and panting for more.
Patience will be needed. As Lisa Robins, head of treasury and securities services, China, J.P. Morgan, pointed out, no one save the regulators can know the time frame for further reform. “The method employed by the Chinese authorities seems to be to try something, iron out the kinks and move it forward. Now we are in the moving forward stage,” she said. “Banks are now able to invest in the interbank bond market, which is a great step for corporates to invest surplus cash and is a move towards further opening up of the capital market. But how fast this process will happen is anybody’s guess.”
In Hong Kong, China has launched a pilot project that allows locals to deposit Chinese currency in their bank accounts, transfer their renminbi from one account to another and to buy renminbi investment products. The scheme has taken off with gusto. Local banks now claim roughly Rmb130 billion ($19.5 billion) on deposit, of which perhaps Rmb80 billion represent retail accounts (individuals can convert up to Rmb20,000 or $3,000 a day). The remainder is principally driven by cross-border trade settlement, which is likely to continue to grow rapidly. HSBC reported that between July 2009 and March 2010, it opened more than 11,000 renminbi trade settlement accounts. Meanwhile, Standard Chartered said its total number of renminbi accounts increased by three-and-a-half times between the end of June and mid-October this year.
However, finding a productive outlet for all these renminbi deposits is a challenge -- current regulations are more favourable towards renminbi outflow than inflow, so there is pressure for greater access to the mainland capital markets. For example, receiving renminbi from overseas counterparties for trade-related transactions is still limited to existing approved mainland designated enterprises (MDEs). Some companies are holding long renminbi positions to meet their working-capital needs or in anticipation of currency appreciation. Others look at the currency as a natural hedge for two-way trade with China or for investment opportunities. In any event, despite the mainland’s capital account and convertibility restraints, the pool of offshore renminbi is growing quickly, which is making it easier for Chinese companies to do business internationally and to raise funds from overseas investors.
According to Guenter Gerke, head of Asia cash management and international business at Commerzbank, the total number of renminbi transactions is not that significant yet, though interest is growing.
“Germany is one of the biggest trade partners in China with a total trade volume of about €92 billion ($128 billion) in 2009,” he said. “We expect the number of corporations in China and Germany switching their settlement currency to renminbi to increase substantially during the years to come.”
Meanwhile, reports that the Malaysian central bank has bought renminbi-denominated bonds highlights another avenue driving the outward flow of renminbi. Aside from a possible domino effect on other central banks, the significance of the bank’s move is more symbolic at this stage, reflecting a post-Lehman wariness of the US dollar. “If Malaysia can hold [renminbi] and trade it through the Hong Kong Monetary Authority, it puts the HKMA at the centre of the action, but it is also the first country to in effect acknowledge that it wants to hold the renminbi as an official reserve currency,” said J.P. Morgan’s Robins.
Mini-QFII boosts expectations
One of the problems with owning a stack of renminbi is finding something to do with it — the existing supply of renminbi-denominated investment products is woefully insufficient to meet the market’s growing needs. Sure, the currency seems like a one-way bet to many a taxi driver in Hong Kong, but how to earn some returns?
“It is quite obvious that each time a renminbi-denominated bond is issued, it is usually over-subscribed and investors want to hold it till maturity, so at the moment there is not a very active secondary market,” said Neil Daswani, Standard Chartered Bank’s managing director, transaction banking, North Asia. “The market is apparently looking for renminbi investment opportunities in China, but this is dependent very much on the regulations and pace of relaxation from the various regulatory authorities in mainland China.”
The next major fillip to renminbi liquidity growth in Hong Kong may well be a pilot scheme expected to be launched in the next few months. Mini-QFII, as it has become known, follows the eight-year-old qualified foreign institutional investor scheme, which allows approved foreign fund managers to invest up to a certain quota in domestic stocks and bonds. Mini-QFII will enable Hong Kong subsidiaries of mainland brokerages and fund managers to do the same, though using different quotas. Currently, Chinese investment houses are only allowed to raise funds domestically to invest in mainland financial markets.
Banks are gearing up for huge global interest in the scheme. But, as with all mainland currency reforms, regulators will keep the scheme under close control, with an expected cap set at around Rmb20 billion, split between 80% bonds and 20% stocks.
Elsewhere, and depending on regulators, banks are considering renminbi-denominated structured investment vehicles, such as foreign exchange-linked renminbi deposit products, index-linked vehicles and swaps and options, said Justin Chan, head of Hong Kong trading at HSBC. Banks are also looking at renminbi deliverable spots and non-deliverable forwards (NDFs) as potential foreign exchange products to meet demand. “There will likely be heightened demand for renminbi bonds in Hong Kong and, as recent issuances and the broad scope of distribution demonstrate, certificates of deposit (CDs) will continue to gain in popularity in Hong Kong. HSBC expects bond and CD issuance demand to cross the Rmb10 billion mark in 2010, and will only increase as funds and insurance companies launch more renminbi fixed-income related products in Hong Kong,” added Chan.
Once the market develops, Hong Kong will benefit from more sophisticated services, said Philippe Jaccard, Citi’s managing director of liquidity and investments for Asia Pacific, within the bank’s global transaction services team. One important driver of renminbi liquidity will enable clients to reuse renminbi deposits as a loan tied together in a notional pooling structure. “This would allow the company to reuse renminbi in any other currency, and would be very valuable for European or US companies,” he said.
Banks will also seek to encourage companies to use their renminbi cash more effectively. “This would be not just for the purposes of settling goods and services, but once renminbi is offshore, it could be used for the purposes of intercompany funding more effectively than keeping some legal entities with just excess cash. This is happening now though very slowly, but some clients are asking for it and I would expect it to pick up very quickly,” said Jaccard.
In the meantime, Hong Kong’s financial institutions and companies will welcome developments like mini-QFII, even if it is just another small step on the way to an internationalised currency.
