RMB internationalisation: a new world order

Published: Nov 2014

It is unlikely to have escaped your notice that China is on the verge of becoming the world’s biggest economy. In fact, it may be already. In October International Monetary Fund (IMF) projections showed that China’s GDP for 2014 would marginally exceed that of the US for the first time (at least based on purchasing power parity). And while there is debate as to whether, according to what measure of GDP you use, the US is still the world’s top economy, it is nevertheless indisputable that China has become a veritable economic powerhouse.

However, despite the country’s economic rise, the prevalence of its currency internationally has failed to keep pace with the growth of China’s global influence – as of October 2014, RMB was only the seventh-most traded currency in the world. But of course, things take time. And we cannot expect internationalisation to be meteoric – we must look to the medium-term for redback domination.

What this means is that treasurers must start thinking now about the rise of the renminbi and how they may need to integrate the currency into their treasury risk policies much sooner than they had anticipated if its internationalisation continues at its current pace. After all, RMB volumes across Thomson Reuters’ Matching and FXall in the first quarter of 2014 reached record highs, and the dollar-renminbi entered the top ten traded currency pairs on FXall in March 2014 and is typically one of the top four traded pairs by volume on Matching.

“The renminbi has gone from the 20th most traded currency just two years ago to the seventh most traded today – a very substantial improvement,” says Janet Ming, Head of China Desk at RBS. “As China continues to strengthen its position in global trade, RMB will further improve its position.”

The steps to internationalisation

The RMB’s rise is not a serendipitous occurrence, but part of a concerted plan. Its progress marks one of the early steps on a path that Beijing hopes will result in the RMB becoming widely held in reserve by foreign central banks. In ‘RMB Roadmap’, a whitepaper published in May by Asia Securities Industry and Financial Markets Association (ASIFMA), Standard Chartered, and Thomson Reuters, the authors set out five milestones along this path:

  1. Becoming a deposit currency internationally.
  2. Being used increasingly for trade.
  3. Becoming an investment currency.
  4. Central banks agreeing bilateral swap agreements with the People’s Bank of China.
  5. Being accepted globally as a reserve currency.

The majority of industry insiders that Treasury Today has spoken to recently believe the renminbi will be a fully convertible currency by 2020, and that the redback has made significant progress in that direction to date. “Although not yet fully convertible, we know that around 40 central banks are already diversifying some of their reserve currency in RMB. If this redenomination continues, and the investment flows keep multiplying, RMB should become a G4 currency, alongside the dollar, euro and sterling, by 2020,” says Carmen Ling, Global Head RMB Solutions for Corporate and Institutional Clients at Standard Chartered.

Foreign governments are not standing idly by watching the RMB’s rise to prominence, either. In October, the UK became the first Western government to issue a renminbi-denominated sovereign bond. The RMB three billion bond was the largest ever RMB bond from a non-Chinese issuer, and has been seen as a strong statement of intent by the UK to build up RMB reserves (prior to the issuance of the bond, Britain only held reserves in US dollar, euro, yen and Canadian dollar).

“The UK’s decision to issue a sovereign bond in RMB was certainly a strong symbolic gesture,” says Evan Goldstein, Global Head of RMB Solutions at Deutsche Bank. “When other central banks start to build up RMB deposits and diversify their currency holdings, then Beijing will have achieved its objective. But the currency will only be truly global after major capital account reforms take place, and there is convergence between the off and onshore market in terms of interest rates, FX rates, and pricing mechanisms.”

The renminbi’s progress along this path has been accompanied by a nascent two-way volatility in the USD/CNY exchange rate – earlier this year, after three and a half years of appreciation against the dollar, the RMB experienced a spike, going from 6.05 in January to almost 6.26 in May, before recommencing its path of appreciation once again (see Chart 1). “As the RMB becomes a more international currency, its exchange rate will also be more liberalised and market-driven – it is no longer a one-way bet,” adds Standard Chartered’s Ling.

Chart 1: USD/CNY 2010 – 2014
Chart 1: USD/CNY 2010 – 2014

Source: Google Finance

The internationalisation process is being facilitated by Beijing’s capital account liberalisation plan. China took steps towards large-scale capital account opening in 2002 with its Qualified Foreign Institutional Investor (QFII) programme, which allows licenced overseas investors to trade in RMB-denominated shares. This was followed up in 2007 with the Qualified Domestic Institutional Investor (QDII) scheme, which allows capital raised from Chinese investors to be invested abroad.

In late 2012, China’s State Administration of Foreign Exchange (SAFE) took the first steps towards allowing foreign currency, two-way cash pooling, as well as centralised payment and collection on a company’s current account. It also technically allowed netting for trade settlement to take place. This was a huge advance for corporates with operations in China, who had previously experienced problems with trapped cash in the country, although that is not to say that the issue of trapped cash has been eliminated.

The role of the PBoC

One key factor dictating how rapidly internationalisation can progress is Beijing’s ability and willingness to encourage worldwide acceptance of RMB. “It has become increasingly apparent that the People’s Bank of China (PBoC) sees the internationalisation of the RMB as unfolding through the creation of a global network of offshore RMB clearing banks, currency swap agreements, integrated e-infrastructure, and related regulatory underpinnings,” says Jim Kwiatkowski, Global Head of Sales, FX, Thomson Reuters.

At the time of writing, there are seven official RMB offshore centres, in Hong Kong, Singapore, Taiwan, London, Luxembourg, Paris and Frankfurt. These financial hubs are able to concentrate offshore RMB funds in the country itself and in the neighbouring region. The centres can use a clearing bank for RMB activity, although this is not absolutely necessary; for example, ICBC Singapore is the clearing bank in Singapore, while in Luxembourg there is no RMB clearing bank, at the time of writing.

“The use of Chinese banks as designated clearing banks on the part of the PBoC has been the predominant method by which China has been trying to deploy RMB on the international market, as part of its current account reform process,” says Deutsche Bank’s Goldstein. “The appointment of more of these clearing banks in various markets around the world is a positive sign, and illustrates the greater degree of cooperation and coordination between the PBoC and other central banks. It has also allowed for the introduction of a local time frame for RMB clearing.”

Hong Kong was the first such hub to be established, and in May 2013 the daily value of RMB cleared through Hong Kong’s real-time gross settlement (RTGS) system exceeded that of HKD for the first time.

Goldstein says collaboration is key in the process. “China has been very active in working with other countries and market infrastructure organisations to understand how the RMB is being used in the offshore market and also the ways in which it can improve acceptance of the currency for investment,” he says. For example, through this collaboration, The Hong Kong Monetary Authority has started offering banks a RMB repo facility and extended local RMB clearing house times.

The Shanghai Free Trade Zone (FTZ) is a key part of this collaborative development of the currency. Launched in September 2013, the zone has allowed regulators to experiment with initiatives on a small scale before they are implemented more widely. “The FTZ serves as a holistic testing ground for financial reform,” explains RBS’s Ming. “The Government wants a fully market-driven environment with liberalised interest rates and exchange rates, and the Zone gives them some idea of the shape of things to come as the currency gradually becomes fully convertible. Anything being tested inside the FTZ is of strategic importance for companies outside the Zone because things happening there could very soon be happening outside it.”

Furthermore, the Shanghai FTZ is relatively easily replicable, meaning Beijing could expand its experiment before wider implementation. Guangdong and Tianjin, for example, could have their own FTZs before long. And as the implementation of reforms expands, within FTZs and beyond, corporates should be able to do more with the currency.

Cash management opportunities

For corporates, the range of RMB services on offer from banks is increasing in line with the internationalisation of the currency. A number of banks already provide basic onshore and offshore RMB trading solutions; furthermore, the provision of more advanced services is also on the up.

According to data from Thomson Reuters, dim sum bond issuance has grown considerably in 2014, and this looks set to continue to be a useful tool for capital raising. The amount of dim sum bond issuance between January and May this year was RMB 188.5 billion – more than the total for all of 2013 (RMB 186.9 billion). “The renminbi continues to be a strong issuance currency in 2014. As cross-border renminbi trade channels continue to embed further with China’s growing influence on international trade, coupled with tight credit conditions onshore, conditions for dim sum bond growth will remain favourable,” says Thomson Reuters’ Kwiatkowski.

It appears that treasurers are encouraged by the cash management opportunities the process will ultimately give them. “RMB internationalisation gives us comfort that we will be able to utilise the range of treasury products that we are ordinarily able to utilise in markets where there are fewer restrictions,” says Craig Weeks, Regional Treasurer, Asia Pacific at SABMiller. “This will allow us to raise capital more efficiently, with more transparency over the prices we are getting, whether for borrowing or for FX.”

Corporate users of RMB outside of APAC are also likely to experience improved cash management as a result of the aforementioned development of the offshore RMB clearing banks, particularly in Europe. “Having RMB clearing infrastructure in Europe will allow corporates in this part of the world to have more efficient RMB settlement, reduced transaction costs and better risk mitigation,” says Ming of RBS.

Beyond cash management, RMB internationalisation could also be a disruptive influence for good in trade finance for certain corporates. “By introducing an alternative trade settlement currency to the USD or euro, wider RMB use would help some users,” explains Standard Chartered’s Ling. “For example a Brazilian company that has traditionally traded with Chinese partners using USD, could eliminate this third element of currency risk by switching to RMB as the trade currency.” However, this switching would also require the corporate to fully understand the settlement risk and market risk of the RMB, too. “Once corporates start to redenominate their trades in RMB, the next challenge will be to distribute the benefits of the currency throughout the supply chain,” adds Ling.

Internationalisation will also mean a redrafting of treasury risk policies. “For treasurers, full RMB internationalisation would mean that the currency would play a role in corporate treasury policies, influencing their hedging and risk management,” says Deutsche Bank’s Goldstein. He adds that his bank is starting to see shades of this even now. “We have multinational clients in China that have been very successful in growing their onshore business through a subsidiary. The build-up of RMB on their books is significant enough that their head offices now want to manage that currency risk and the position itself offshore, because it has become a significant consideration for them in terms of their total book.”

Escaping isolation

Despite Beijing’s grand ambitions for the redback, it has its work cut out in spreading the reach of the renminbi across the globe. While China accounts for more than 10% of global trade, its currency is used for only 2% of trade. “At the moment China is not freely linked to the global financial system, and gaining more exposure and experience will be a gradual process,” says RBS’s Ming. “The pace of financial deregulation in China over the past two years has been the fastest of all APAC countries, but there is still a long way to go. China needs to make sure its financial system is mature and robust enough to face global competition.”

While the offshore RMB market was explicitly created to allow the RMB to internationalise, the onshore market remains separate from the global market. As a result the RMB is essentially fragmented at the moment into three main markets: the onshore RMB (CNY) market, the dollar-settled non-deliverable forward (NDF) market, and the offshore RMB (CNH) market.

“Each of these markets has its own demand and supply dynamics because of capital controls and the partial convertibility of the RMB as between the onshore and offshore markets,” says Thomson Reuters’s Kwiatkowski. “These conditions have resulted in the three separate, but related, markets with differentiated FX and interest rates and securities pricing.” However, he goes on to say that as capital controls ease and linkages grow, the level of difficulty in making cross-border transfers will drop, resulting in offshore/onshore convergence.

Addressing pricing differentials is a key factor here. “It is important to understand the difference in and the application of onshore and offshore pricing,” says SABMiller’s Weeks. “Further, establishing efficient liquidity solutions within the country is a target.”

Despite the remaining hurdles, RBS’s Ming is bullish. “This is a currency you cannot afford to ignore,” she concludes. “The question is how to maximise the benefits from a treasury perspective. While the internationalisation process is ongoing, treasury managers need to stay on top of the challenges, understand the implications for their business, and try their best to integrate their Chinese operation into the regional or global treasury system.”

So as the renminbi continues its march to worldwide adoption, treasurers would do well to start thinking about putting their own RMB plans in place.

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