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Asia-PacificApril 2 2012

London bids to play renminbi strong suit

As China has moved to speed up the internationalisation of its domestic currency since the financial crisis, the UK has made no secret of its willingness to play a role in this process. But much work still needs to be done with regards to trade settlements between the two countries, as well as improving transport links and communications.
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London bids to play renminbi strong suit

When Chinese vice-premier Wang Qishan visited London in September 2011 to attend the fourth annual China-UK Economic and Financial Dialogue, he gave formal backing to moves by UK banks to develop the city as an offshore centre for renminbi trading in Europe. Both Chinese and UK representatives saw London's potential to complement Hong Kong’s offshore renminbi trading role in Asia.

In a joint statement both sides “welcomed the private sector interest in developing the offshore renminbi market in London and the growth of the market to date”, and, following the visit, UK officials were keen to talk up the UK’s unique status in Europe as the only country to discuss economic and financial services at top ministerial levels.

"China is committed to moving towards greater exchange rate flexibility and a more open capital account and London can play a really important role in supporting this process," says one UK government official who was close to the negotiations. "There is a growing understanding that the renminbi will eventually be one of the world's major global currencies. This is an enormously important opportunity for London and we are keen to support the private sector in responding to it."

Ongoing process

From a Chinese point of view, the decision to look to London was the latest step in the internationalisation process of the renminbi which started in 2009, when People’s Bank of China governor Zhou Xiaochuan expressed concern that over-reliance on a weakening dollar had led to what he saw as unhealthy imbalances in the global financial system and unpleasant effects on China’s mountainous foreign currency reserves.

In July of that year China initiated the process of building pools of liquidity abroad, first by relaxing rules on cross-border trade settlement in renminbi, and then with the expansion in 2010 of Hong Kong’s offshore bond market to Chinese and foreign companies. Fast-food giant McDonald's became the first foreign issuer of a Chinese currency bond in September of that year.

Beijing, meanwhile, established a clearing system between Bank of China HK and the People’s Bank of China, and signed a cross-currency swap agreement, giving Hong Kong access to Chinese renminbi. The renminbi became deliverable offshore in Hong Kong in July 2010.

To distinguish between the tightly controlled mainland market and Hong Kong’s flourishing alternative, a new abbreviation for the offshore deliverable currency was coined – CNH, which signified the legally distinct version of CNY, or onshore renminbi. Although CNH and CNY are ostensibly the same currency, they operate separately and have traded at a premium to one another.

With CNH-denominated accounts proliferating in Hong Kong during 2010 and 2011, local banks were flooded with renminbi deposits, which rose from less than Rmb100bn ($15.7bn) in January 2010 to about Rmb680bn in November 2011, according to HSBC.

As current accountant restrictions fell away, trade-related remittances of renminbi rose sharply, reaching Rmb240bn in December 2011. About 10% of all Chinese trade is now settled in renminbi. At the same time, Hong Kong-based banks started to offer spot foreign exchange products, alongside deliverable forwards, swaps and options out to two years.

Natural step

With the CNH increasingly established as unit of trade settlement, Beijing was last year ready to move to the next stage on the path to full convertibility, which was to establish the renminbi as an investment currency. With the UK already a leading centre for derivatives and foreign exchange (accounting for 37% of global foreign exchange trading, according to the Bank for International Settlements [BIS]) it was in an ideal position to take advantage.

However, policy-makers are under no illusion that if London is to reap the benefits, market-based initiatives must be supported through official channels.

“We think London has tremendous strengths and can play a crucial role developing the offshore renminbi market in the Western time zone, but there is also a strong common interest with Hong Kong in sharing a platform spanning issues such as settlement arrangements,” the UK official says.

UK government officials moved quickly to co-operate with their counterparts in Hong Kong, and those efforts bore fruit in January with a joint announcement from the Hong Kong Monetary Authority (HKMA) and UK Treasury for the launch of a private-sector forum to enhance co-operation on the development of offshore renminbi business. The forum, which will hold its first meeting in May 2012, is expected to focus on the technical challenges in expanding London’s role in renminbi trading, particularly in respect of clearing, settlement and development of new products.

In a significant show of good will, the HKMA agreed to extend by five hours the running hours of its renminbi payments system, making it available until 3.30pm UK time, covering most of the London trading day. The change will take place in June.

Crossing continents

While the HKMA initiative has been welcomed, some doubters say that London cannot fully establish an offshore market without being able to offer renminbi settlement in its own time zone. However, those on the front line of foreign exchange markets argue that may not be the case.

“I am not sure the idea that if you do not have a clearer you cannot have a market makes much sense,” says David Bloom, head of foreign exchange strategy at HSBC. “It may be the case that you want to do a trade when most of the world is asleep but that is the sort of risk that banks are able and willing to take.”

The private sector, meanwhile, has been quick to take steps, forming an offshore renminbi working group under the auspices of transactions industry co-operative Swift to introduce straight-through processing protocols for offshore renminbi payments, treasury and securities. The guidelines were published in February.

“There is only one front-office settlement currency code for the Chinese yuan, whether it is onshore or offshore, and that is CNY,” says Wim Raymaekers, head of bank markets at Swift. “Industry participants, however, need to differentiate onshore versus offshore settled CNY in their internal systems and between counterparties, so we worked to introduce code words to designate place of settlement.” 

Potential problems

While London is seen as being best placed to offer an alternative time zone for CNH trading, there are several potential impediments to progress. Among these is the relatively low level of CNH trade settlement between the UK and China. While UK prime minister David Cameron has targeted a doubling of bilateral trade between the two countries by 2015 to $100bn, that pales in comparison with trade between Germany and China, which was $187bn in 2010.

“The trade element would be helpful to the UK because the key enabler is to get liquidity,” says Ian Tyler, a director of banking and capital markets at Deloitte. “Hong Kong gets it through a number of mechansims, such as the cross currency swap, which is an important function.” To support renminbi settlement, China has signed bilateral currency swaps with 14 countries, but not as yet the UK.

Banks in Hong Kong conduct some 86% of renminbi trade settlement, according to the Bank of China, while Hong Kong accounted for 78% of all payments sent and received in December last year, according to Swift.

Trading without trade

Given that it is unlikely to blaze trails in physical trade settlement, London’s next best hope of creating a liquid market is in foreign exchange, where it controls 30% of global financial trading. “We will make a price in any cross against the renminbi right now,” says Mr Bloom.

London accounted for 30% of renminbi payments outside China and Hong Kong in the fourth quarter of 2011, according to Swift, and 46% of renminbi foreign exchange trading, placing it on par with Singapore in renminbi payments and first in renminbi foreign exchange.

“Given that London is such a big centre for foreign exchange, you would expect it to take a larger share of that market,” says Mr Tyler. “However, it is a process and it is probably easier to talk in terms of direction of travel rather than absolute targets.”

The renminbi remains a minor currency in global trading terms, with average daily turnover in the renminbi foreign exchange spot market reaching the equivalent of about €8bn, according to BIS figures. That compares with €300bn in Japanese yen, €700bn in euros and €1200bn in dollars. Relative to the size of China’s economy, foreign exchange volumes should be in the region of €150bn a day, according to an analysis by JPMorgan.

Facing competition

Alongside the certainty of competition from Singapore and New York, as London forges ties with Hong Kong, one of the big unknowns is the future role of the city of Shanghai.

A statement by China's National Development and Reform Commission in late January said the government had designated Shanghai as a potential global centre for renminbi trading by 2015, with the city’s interbank offered rate becoming the benchmark interest rate for pricing renminbi-denominated assets at home and abroad.

“For the renminbi to become a true international currency, China will need to open its capital account and when that happens I see no reason why Shanghai cannot be an international centre for the renminbi,” says Candy Ho, head of renminbi business development at HSBC. “Hong Kong does not have exclusive rights to the pie.”

As London ponders the implications of the emergence of an alternative to Hong Kong, there are also pressing concerns at home, and in particular in relation to 'soft' issues such as the number of direct flights to China, in which the UK has fallen behind European competitors.

“It is important that as well as pushing financial services, we address issues such as transport links,” says Stuart Fraser, policy chairman of the City of London Corporation. “You cannot get a fast train to China – it would be a pity if issues such as communications and transport got in the way of strategic development.”

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