*This proceedings report is based on The Asian Banker’s RenminbiWorld Conference on “Building sustainable renminbi-based assets globally” in Shanghai, China

As China seeks to fund its own growth there is a real need to create transparent and liquid cross-border flow capability for the remninbi. China has set out to do this by establishing an offshore market for renminbi with the aim of protecting its domestic financial system as it establishes the currency internationally. It has been progressively setting up financial infrastructure, initially through Hong Kong but increasingly in Europe too where an enthusiastic welcome has been given by financial centres keen to carve out a role from the opportunities that the remninbi appears to offer.

Current and future plans for European Rmb hubs

Although the financial centres in Europe could be considered to be in direct competition with each other for renminbi business, in fact their roles are currently more complimentary as each financial centre builds on its own unique positioning and strengths. Jochen Metzger, head of payments and settlement for Deutsche Bundesbank, Germany’s central bank, explained that since June 2014 the People’s Bank of China (PBoC) has nominated Chinese banks as offshore clearing banks in Frankfurt, London, Paris and Luxembourg and that more will likely be designated in the near future, including Switzerland.

Bank of China became the nominated clearing bank for Germany and began offering services in November 2014 but, according to Metzger, this is only the beginning as there is already an agreement in place for the clearing bank to become a renminbi clearing house in the future. Although a clearing house in reality does little more than a clearing bank, its ownership structure will change so users can become co-owners and policy makers, circumstances likely to be of keen interest to other German and Chinese banks operating in Germany due to the future profit potential, assuming there are large economies of scale from the venture.

As such this will lay the foundations of STP payments between China and Germany, initially as a bridge between euro clearing and remninbi clearing, used for end of day liquidity clearing and liquidity sweeps. The bridge will rely on the China Foreign Exchange Traded System (C-FETS), operated by the interbank trading and foreign exchange division of PBoC and introduced at the end of September 2014, to set the CNY (onshore traded remninbi)/ euro exchange rate. This in turn will likely be the base for Rmb/ euro clearing at the clearing bank.

As the infrastructure develops, further consideration for direct links between the euro and CNY environments are likely to be made. For example PBoC is developing its second generation clearing and settlement system including a new RTGS, SIPS. This new infrastructure, assuming it is based on the international standard, ISO20022, will be able to link to Target II, Europe’s RTGS, when it too migrates to ISO20022 in November 2017. At that point it will be possible to settle Rmb and euro payments in central bank money, on the books of the respective central banks. A memorandum of understanding (MOU) already exists for this to occur.

Another European Rmb hub is being established in Luxembourg; ICBC was established as the designated clearing bank in September 2014 following the signing of an MOU between Luxembourg and PBoC in June 2014. Luxembourg’s strengths rest in the asset management industry; it is an international fund centre and the largest European fund centre for Rmb denominated funds whilst its stock exchange is the preferred hub for Rmb denominated bonds.

It was pointed out that in Europe renminbi will be able to cross national European Union (EU) country boundaries without the establishment of further clearing banks in each individual country due to the financial institution passporting rules that exist in Europe; EU rules permit a bank to set up a branch in any other EU nation should it so wish. However Metzger took the view that even though the passporting system permits the establishment of branches and subsidiaries throughout Europe potentially enabling many European financial institutions to pursue a renminbi based strategy, the real issue was establishing the relationship with corporates and SMEs to meet their needs and this was likely to pose the greater challenge. It is here that Germany has a strong advantage as it is China’s largest European trading partner.

The role of Hong Kong

Renminbi liquidity is an issue for all financial centres where renminbi is cleared and traded. Early on in the process of remninbi internationalisation, Hong Kong realised that this would be a concern and introduced repo facilities making use of a currency swap facility between HKMA and PBoC. By doing so Hong Kong has been able to position itself, up to now, as the link connecting all overseas renminbi offshore financial centres. HKMA continues to take liquidity very seriously ensuring market confidence.

Henry Yung, senior manager, financial infrastructure development, HKMA explained that Hong Kong’s experience had enabled it to understand what is needed to build an international global hub for which he identified three factors: policy headroom, a robust, clear and market-friendly regulatory regime, and thirdly, financial benchmarks.

In terms of policy headroom, Yung pointed to the formulation of policy milestones that have enabled the development of the offshore renminbi market in Hong Kong such as the 2009 renminbi trade settlement pilot scheme, the 2011 creation of channels for renminbi portfolio investment flows including the renminbi QFII, and most recently the Shanghai - Hong Kong Stock Connect. In terms of the regulatory regime, Yung advised that two main principles were established; cross-border flows of renminbi funds in and out of the Mainland should comply with Mainland authority rules whilst Hong Kong regulatory requirements would apply to offshore funds. Financial benchmarks have been established for financial products such as CNH hyper-fixing.

Early days

The establishment of international renminbi hubs creates many new questions for which the answers are not yet clear, partly because hub establishment is so new and large renminbi flows have yet to occur. For example, it was pointed out that Hong Kong maintains renminbi liquidity partly through the help of its swap arrangement with PBoC but it was not clear what liquidity arrangements have been put in place in Europe beyond existing emergency swap facilities between central banks. Metzger indicated that these swap arrangements could change if the need arose. This left the unanswered question about why China did not feel it necessary to show greater commitment to international renminbi hub arrangements by providing non-emergency swaps from the outset.

Yung, drawing on the experience of Hong Kong, pointed out that Hong Kong too started with only an emergency swap arrangement with PBoC. However the expectation was set that if there was a liquidity issue, the HKMA could be approached in an emergency but as renminbi activity in the market evolved, liquidity increased so today HKMA are more relaxed about approaches for additional liquidity.

Another issue thought to require clarification is the responsibility for liquidity of assets held in International Central Securities Depositories (ICSDs). Currently nobody is questioning the liquidity of ICSDs as very large flows have yet to occur, but a time will likely come when the liquidity will have to exist outside China and Hong Kong for renminbi assets to be managed by ICSDs.

The future of Hong Kong

Although Hong Kong has played a trailblazing role with the internationalisation of the renminbi, its future is brought into question once China opens up its current account. The history of clearing shows that clearing always comes back to rules of the home country where the real debt and liquidity exists; this would make the US though New York responsible for the dollar, the Eurozone through Frankfurt responsible for the Euro and China through Shanghai responsible for the renminbi.

Yung acknowledged this but pointed out that Hong Kong has been an established international financial centre for an extended period and continues to develop a portfolio of business beyond the remninbi. Examples include Sukuk business and as the development of the Eurodollar market shows (the Eurodollar market emerged for lending based in dollars outside of the US), a similar type of opportunity could arise in Asia, where demand for renminbi investment products is strongest, and Hong Kong could play a pivotal role.

Hong Kong’s currency is another factor that is thought likely to be impacted by the development of international renminbi hubs. The Hong Kong dollar is pegged to the US dollar and as such continues to act as a “vehicle currency” when required. Although many observers have begun to ask when will the Hong Kong dollar become pegged to the renminbi, Yung drew attention to the fact that the US/ Hong Kong dollar peg remains firmly in place and there is no pressure to make the switch especially as Hong Kong remains viable as an international financial centre developing a range of products and opportunities in addition to its renminbi business. It was acknowledged that Hong Kong’s future is not really thought to be bleak; there is a critical mass of talent and capital employed that could likely survive the opening of the capital account in China.

For now it is clear that the internationalisation of the renminbi is merely about creating opportunities. China’s approach shows no preference for partners or operators and the Chinese government is providing a back-stop for any liquidity requirements. This will likely continue to be the status quo as the market develops but will remain untested until liquidity becomes a problem. This is not thought to be anytime soon.

Categories:

China, Hong Kong, Rmb, Trade Finance, Transaction Banking

China,HK,Rmb,Trade Finance,Transaction Banking,

China,Hong Kong,Rmb,Trade Finance,Transaction Banking,

Keywords:PBoC, ICBC, Renminbi Hub, HKMA, ICSD