Rethinking the menu

The offshore renminbi market is pricing in a depreciation of the currency against the US dollar over the next year, putting the brakes on breakneck growth. Politicians, however, are determined to press ahead.

When China issued the first sovereign bond in US dollars in the international markets two decades ago, the country needed a lot of capital to build its economy. Today, the purpose of the Ministry of Finance’s latest offshore fundraising is very different – helping the renminbi become an international currency in terms of trade, investments and, eventually, a reserve currency.

“We don’t need money, but just want to help the internationalisation of renminbi and to build Hong Kong into an offshore renminbi centre,” said Sun Xiaoxia, Director-General at China’s Ministry of Finance, at a seminar in Hong Kong ahead of China’s third Dim Sum offering of sovereign bonds.

Sun’s comments pretty much sum up China’s grand plan. In other words, the tremendous amount of work put into promoting the offshore renminbi – or Dim Sum – bond market in the past two years has been simply one part of a bigger goal.

The pace of progress, however, has slowed in recent months. With China’s economy cooling, investors no longer expect the renminbi to appreciate against the US dollar. At the same time, monetary easing in China has reduced the appeal of Dim Sum debt for Chinese companies.

These challenges threaten to put the brakes on the internationalisation of China’s currency – something China has no intention of allowing. In fact, policymakers, such as Sun, have doubled their determination to develop the market, with a series of regulatory measure designed to promote Dim Sum deals.

With Dim Sum yields more than doubling for some tenors in the past year and more rate cuts looming in China, it may soon be cheaper for mainland companies to borrow money onshore.

The supply glut of over Rmb30bn from Chinese banks and SoEs later this year alone is likely to send yields even wider in the Dim Sum market, which has already been struggling as hopes of an appreciation of the renminbi fade. The figure does not include the Rmb23bn paper the MoF issued in late June.

To make matters worse, demand for the renminbi is on a downtrend. At the end of April, renminbi deposits in Hong Kong fell 2.1% month on month to Rmb552.4bn.

While the dynamics of the Dim Sum market point to wider yields, the onshore market is going in the opposite direction. The widely speculated new economic stimulus package or expected onshore rate cuts in China may well erase quickly any savings from the Dim Sum bond market.

Nevertheless, it is still desirable for multinational corporations with operations in China to tap the Dim Sum bond market, as Veolia Environment showed with its Rmb500m trade in late May.

Boosts from the mainland

In early May, the National Development and Reform Commission has released a new set of rules to set up an approval framework for domestic Chinese companies to sell offshore renminbi bonds. The move makes the approval process more predictable and smoothens the way for Chinese issuers to come to Hong Kong more easily and regularly.

On April 3, the China Securities Regulatory Commission announced that it would substantially expand quotas for both US dollars and renminbi qualified foreign institutional investor (QFII) schemes to US$80bn from US$30bn and to Rmb70bn from Rmb20bn, respectively. This is another example of the recent acceleration in moves to liberalise cross-border capital flows.

“We don’t need money, but just want to help the internationalisation of renminbi and to build Hong Kong into an offshore renminbi centre”

We believe that the real reason for the accelerated moves to liberalise cross-border restrictions is to take advantage of the current lack of strong speculative pressures on either side of the currency as a window of opportunity to liberalise these channels at a time when the flow response is likely to be at its most orderly … which reinforces more flexibility of the regime overall, according to a HSBC research report..

Hong Kong is the testing ground or, in some sense, a springboard for offshore renminbi activity on its way to becoming the first offshore renminbi centre in the world. Other offshore renminbi centres are bound to emerge, but Hong Kong is striving to main its leading position.

The latest Hong Kong Monetary Authority effort was the launch of a cross-border collateral management service, which allows international financial institutions to borrow renminbi and other currencies with securities held by Euroclear Bank or JP Morgan as collateral in tri-party repo transactions with members of HKMA’s Central Moneymarkets Unit. The operations began on June 25.

The new arrangement will serve as useful infrastructure to support, among other things, renminbi repo transactions with a wider array of international securities.

One important function of renminbi repo transactions is that they help set the short-term benchmark rates in the CNH market.

Hong Kong loan bankers have longed for CNH Hibor rate as the preferred floating-rate benchmark for the fledgling offshore renminbi market.

Hong Kong’s Treasury Markets Association is initially publishing CNH Hibor rates from eight banks and has invited more of them to contribute.

“We would like to see the quotes being transactable, as supported by repo transactions,” emphasised a banker, referring the current turnover in the money market.

According to some bankers, the more banks the better because the narrowing gap between the published CNH Hibor rates of banks was a promising sign for a more uniform rate.

The lack of an accepted benchmark has been a big hurdle to the growth of the Dim Sum loan market as benchmarks necessary to justify the absolute yield or cost on loans.

Another move related to renminbi liquidity was the HKMA’s creation of a facility effective June 15 to provide authorised institutions in Hong Kong with short-term renminbi liquidity. Among other characteristics, the new facility could help sustain the burgeoning market for offshore renminbi bonds in Hong Kong.

“We expect improved liquidity to support the performance of Dim Sum bonds and cap deposit rates,” said Becky Liu, fixed-income strategist at HSBC.

Similarly for loans, banks can tap the new facility to meet short-term needs while releasing their own renminbi funding for other businesses, such as purchases of Dim Sum bonds.

As some Dim Sum bonds are eligible for repo transactions, banks can also make use of such holdings to obtain liquidity.

The HKMA will use an existing Rmb400bn currency-swap arrangement with the People’s Bank of China to operate the facility. It will provide renminbi term funds against eligible collateral.

Partners and competitors

More importantly, the HKMA decided in late May to allow authorised financial institutions to determine their own renminbi net-open-position limits on a case-by-case basis – in other words relaxing the existing 20% restriction. The move, while not a sea-change, is expected to create more liquidity in Hong Kong’s developing offshore renminbi market.

Each bank can now set up its own NOP – the difference between on-balance-sheet assets and liabilities – as long as the HKMA is informed and endorses the proposed limit. The relaxation is the third since the NOP rule was introduced in December 2010 at 10% and, subsequently, raised to 20% in January 2012.

In the long run, however, the new rule will enhance the risk-management practices of financial institutions and their ability to expand further. The case-by-case approval process will also help the regulator keep renminbi speculation in check.

It is a welcome development in Hong Kong, more so because competition among several offshore markets for the Chinese currency has been heating up of late. Market participants have been calling for a revision to the rule, in part, because a number of Hong Kong’s rivals in the CNH market, such as Singapore, do not have limits.

The NOP rule change coincided with the first Hong Kong-London forum held on May 22 in the SAR to promote co-operation in the development of international renminbi business between the two cities.

London-based banks have been actively exploring the opportunities in the offshore renminbi market. Lately, one popular way has been to bring renminbi-denominated products, such as London-listed Dim Sum bonds and CPs, to the market. This boosts in London’s quest to become an offshore renminbi centre with increased liquidity and leverages on the city’s product capacities and infrastructure.

“We expect improved liquidity to support the performance of Dim Sum bonds and cap deposit rates”

In fact, London hopes to take fuller advantage of the extended operating hours of the renminbi real time gross settlement system in Hong Kong (from 08:30 to 23:30, Hong Kong time) and expand cross-market interbank funding activities between the SAR and English city.

“Trade finance is key to building liquidity in an offshore centre. Close collaboration between London and Hong Kong will help interlink liquidity between the two offshore centres and further support the growth of renminbi-denominated global trade finance, including those originated in Hong Kong,” said Ben Hung, CEO of StanChart (Hong Kong) .

According to SWIFT, international trade settlements in the renminbi amounted to Rmb580bn in the first quarter of this year. Most of that went through Hong Kong, while Europe accounted for around 10%.

Another not so obvious, albeit important development with far-reaching impact was that China and Japan started directly trading their two currencies on June 1 in an effort to cut costs and boost bilateral trade and investments.

The move will help internationalise the renminbi and lessen China’s reliance on the US dollar. Bilateral trade between the two countries totalled US$345bn in 2011.

The new arrangement also boosts Tokyo’s ambition to become an offshore outpost for renminbi trading. In particular, it opens up a lead over London, which has yet to seal a direct-trading partnership with China.

The trading will also result in each holding large pools of the other’s currency. The extra liquidity will also provide capital to invest in each other’s financial markets, as China gradually opens its doors to the world.

Singapore is also not shy about its ambition to be an offshore renminbi centre. It has recently been tipped to launch a renminbi real estate investment trust on the Singapore Exchange.

Taiwan is also holding talks with the mainland government to establish a renminbi clearing and settlement system, while cross-strait renminbi activity has received a boost from the setting up of branches on opposite sides of the strait.

Additionally, more countries like the UAE, Australia and Turkey have set up currency bilateral swap agreements with the PBoC.

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