Offshore renminbi spreads beyond Hong Kong

Talk of the renminbi is often littered with references to water: there are lakes and rivers, bridges and pipes, valves and dams, and pools and puddles. And the project to make the Chinese currency international requires some highly skilled plumbers to make sure that the money does not flood into, or out of, mainland China. 

The Chinese authorities have put the renminbi on a path to internationalisation and are gradually allowing the currency to become more available offshore. For now, strict controls remain in place but one day the controls may be removed so that there is no distinction between onshore and offshore renminbi and the currency will be used as freely and easily as the US dollar. As the project moves into the next stage of transition, there is debate about the best way to bring new financial centres into the plumbing system. 

Making a splash

“The underlying policy objective of the mainland Chinese government is to not have any financial accidents – it wants to maintain control. The whole approach has been to relax restrictions piece by piece to see what happens. It always wants the control mechanisms so it can understand what is going on,” says Peter Cox, a partner at consultancy Bourse Consult. 

John Laurens, head of global payments and cash management for Asia-Pacific at HSBC, explains that the Chinese authorities want to build up renminbi transactions and create pools of liquidity outside mainland China in order to encourage the use of the currency beyond its borders. 

Hong Kong, as the global centre for offshore liquidity, has developed a pool of liquidity with a dam wall that China uses to manage its capital account. With offshore markets developing in Taiwan, Singapore or London, explains Mr Laurens, this will create other pools of liquidity with their own barriers. One day enough liquidity will be built up in the offshore pools so that the water will rise to a level where the is no need for the control mechanisms. 

“Eventually these dam walls will be removed as and when the renminbi becomes fully convertible, allowing liquidity to flow across borders unimpeded by exchange controls," says Mr Laurens. “The creation of these offshore pools is important in facilitating a managed transition to a fully convertible renminbi.” 

Global link

As an international financial centre, Hong Kong was a natural choice for the first stage of this project as it already has the mechanisms to introduce offshore renminbi to the world, and also link the flow to the mainland. Francis Edwards, partner at law firm Clifford Chance, uses a different water analogy and describes the Hong Kong clearing arrangements as a tap for releasing renminbi and accepting it back into China. Mr Edwards says that from a political perspective, as Hong Kong is part of China it makes sense to have the main part of the renminbi plumbing in Hong Kong.

As other pools of liquidity join the grand plumbing project there is debate about the best model to connect the flows to the mainland. Mr Edwards points to the issue of whether it is necessary to establish separate clearing banks in other financial centres, such as Singapore and London. 

Hong Kong is the offshore renminbi hub and main gateway to China’s central bank. Much discussion focuses on whether the new offshore centres should opt for the bicycle-wheel model of spokes that feed into the Hong Kong hub, or whether they need to create hubs of their own. 

There are currently two ways of making renminbi payments offshore to the mainland: through the correspondent banking network, or through Hong Kong’s real-time clearing system. With trade settlements there are no restrictions to control the flow between the offshore and onshore market, if there is the right paperwork to prove there is genuine trade underlying the transaction. Mr Laurens explains that if an importer in Brazil, for example, is paying a supplier in China, the payment can take place in renminbi in the same way as any other international currency, ie. through a correspondent bank in mainland China. 

The newer model, explains Yang Jiewen, senior strategic planner at the Bank of China Hong Kong (BoCHK), is Hong Kong’s real-time gross settlement (RTGS) system, which was established in 2004. 

Banks from all over the world can become members and link into this system, which is overseen by the Hong Kong Monetary Authority. “We are the settlement institution so the members will open a settlement account with us,” says Mr Yang. The advantage of this system, he explains, is that the payments can be settled in real-time. The Hong Kong RTGS is connected to the mainland’s real-time China National Advanced Payment System (CNAPS) so payments can flow from a bank in London, for example, to the mainland. 

London leads

As new offshore centres join the plumbing network, there is discussion about whether a similar system needs to be replicated around the world. So far, London has opted for the hub-and-spoke model whereby it feeds into Hong Kong’s platform and UK banks are members of Hong Kong’s RTGS system. 

There have been discussions about whether the People’s Bank of China – the mainland’s central bank – would grant a licence for a similar clearing bank to be established in London. Mr Cox at Bourse Consult argues that it is not inevitable that London will have its own clearing bank, and other industry observers comment that London did not feel it was necessary to create a new platform, especially since the operating hours of the Hong Kong platform were extended for London’s time zone.

Mark Boleat, chairman of the policy and resources committee of the City of London, says: “The general position is that London is quite content with the existing arrangements with Hong Kong,” adding that there has not been a proposal to establish anything new in the short term. “It is not on the agenda,” he says. 

As the liquidity pool builds in London, Hong Kong will continue to be the valve to control the flow to the mainland. However, there is debate about what should happen next with other financial centres. Taiwan and Singapore are both in the process of establishing their own systems, which has spurred debate about whether it is necessary to create new hubs in the same time zone. 

Singapore has been preparing for a clearing bank of its own, and in July a memorandum of understanding was signed between China and Singapore that would give qualifying full bank (QFB) privileges to two Chinese banks that would give them greater access to the Singaporean market. One of them could become the renminbi clearing bank and there has been speculation whether the role would be given to Bank of China again, or whether a rival – such as ICBC or China Construction Bank – would become Singapore’s hub for payments to the mainland. 

A spokesperson at the Monetary Authority of Singapore (MAS) says: “Eligible Chinese banks that are interested in QFB privileges will apply to MAS. It is not appropriate to comment on which are the two likely banks, as that will be pre-judging the application and assessment process.” 

Diluting liquidity?

More recently, at the end of August, a memorandum of understanding was signed between China and Taiwan that would create another renminbi liquidity pool and establish Taiwan as an offshore centre. 

The details of the clearing and settlement model in Taiwan have yet to be announced, but there has been discussion of creating a separate currency code for the renminbi in the Taiwanese pool. Currently the offshore renminbi trades under the currency code of CNH. London uses CNH, with the ‘H’ denoting Hong Kong. Discussion about the creation of CNT for Taiwan, and possibly CNS for Singapore, focuses on whether this would dilute the liquidity in the existing offshore CNH market. The success of the internationalisation depends on the depth of liquidity pool in the offshore market, and there are concerns that the creation of many currency codes could create separate puddles of liquidity that are not easily traded. 

The project is a balance of control of the Chinese authorities on the one hand, and the need for market forces to take hold and build up the use of renminbi to create offshore liquidity on the other. Some observers say that the agreements with Singapore and Taiwan could be seen more as a political move to widen the internationalisation project, and thus encourage the use of renminbi, and for Singapore and Taiwan to position themselves as international financial centres. 

The creation of separate pools – with their own dam walls – could be viewed as diluting the existing pool of offshore liquidity, but it could also be viewed as the next step in creating new deep pools in the region. Singapore has already established itself as an international financial centre and gateway to south-east Asia and beyond, which would open up a new offshore market. Meanwhile, the Taiwan agreement comes at a time of increased cross-strait co-operation and the agreement allows Taiwanese companies to settle their trade with China in renminbi, bringing a new flow into the internationalisation plumbing project. 

It could be argued that it is not practically necessary to establish separate clearing platforms for these offshore centres. The creation of pools of liquidity, with their dam walls against the onshore pool, is part of the transition stage as renminbi moves along its path to internationalisation. Once the offshore liquidity has raised to the right level, the controls are removed and the currency is freely convertible, banks around the world should be able to connect directly with China’s central bank. 

Mr Cox at Bourse Consult points out that most international currencies do not have a central bank clearing system outside the home country of the currency. 

Statement of intent

For now, China’s payment infrastructure is not ready for internationalisation and the real-time CNAPS platform is a domestic system that only has Chinese banks as its members. Statements of intent have been made by the Chinese authorities to establish the China International Payment System, although the details of the infrastructure have yet to be revealed. 

Observers say that the system would be similar to the Clearing House Interbank Payments System, the US-based system for domestic and international large-value payments in dollars. 

The international Chinese system could eventually operate on a 24-hour basis to cover the time zones across the globe. London has so far opted to use the Hong Kong platform while the larger construction project is being built and is watching developments to see whether it would be necessary to create a clearing bank of its own that would function as a bridge to time zones in North America and Latin America. 

The pace of the internationalisation project depends on the depth of liquidity in the offshore market. Mr Boleat argues that the current stage of development is not about building more infrastructure, but getting more liquidity into the system. “We need more transactions – then the market will be more efficient,” he says. Mr Yang at the BoCHK echoes this point, saying: “You need liquidity to facilitate renminbi products and services.”  

Carmen Ling, head of Citi Transaction Services in Hong Kong, explains that a critical factor to the development of renminbi internationalisation is how fast and how willing China is to relaxing controls on its capital account. “It needs to have more renminbi-denominated investment instruments in the market, hence the increase in settlement needs to make bigger demand for the players,” she says.

Ms Ling adds that renminbi-denominated investment securities are not as attractive as they once were because the currency is now depreciating, which may affect the offshore market in developing its depth. “Last year, everybody wanted to hold renminbi or denominated securities because it was an appreciating currency,” she says.

Observers point to the current state of liquidity in the offshore market as being an indicator of the pace of internationalisation, rather than the particular mechanisms that are being planned in other financial centres. For now, as the internationalisation project is under way, the plumbers have a major task on their hands to create a system that on the one hand prevents any flooding, but on the other allows the flows to build up.