At a Glance
- An increasing number of Chinese companies need to manage exchange rate risk
- Says Renminbi reserve currency status could affect capital flows
As the world adjusts to China’s new economy – one focused on consumption and more normalized growth – the country is advancing its markets in several key areas. Investing is now more about corporate acquisitions, its currency has received reserve asset status and China is now the world’s largest oil importer. As the 11th China International Derivatives Forum begins this week, we spoke with Christopher Fix, Managing Director and Head of Asia Pacific for CME Group, to see how these and other major shifts are impacting China, and how China is impacting world markets,
As China shifts from a manufacturing economy to a consumption-based one, how can derivatives markets help businesses and investors navigate that shift?
China’s economy is clearly now rebalancing towards services and consumption and away from its traditional drivers of export manufacturing and fixed-asset investment. This is also leading to a change in financial priorities and the business landscape, where derivatives are needed to manage new exchange rate risk. An important trend is that authorities are no longer targeting foreign exchange reserve accumulation and have instead encouraged outbound acquisitions by Chinese corporates – both private and state-owned. In May last year, rules were changed so that Chinese firms looking to invest less than $1 billion in overseas firms no longer needed to seek government approval, a significant help in removing the often up to four month wait for deal approval from the regulator.
The results are plain to see. So far this year Chinese acquirers have announced a total of $486.1 billion in mergers and acquisitions, which is up more than 50 percent on the same period last year, according to Dealogic.
This internationalization means an increasing number of Chinese companies need to manage exchange rate risk as they own businesses overseas and conduct cross-border financing. This also comes at a time of heightened exchange rate volatility, with not just more two-way movement in the RMB, but also considerable exchange rate volatility related to quantitative easing by G3 central banks. Derivatives can play an important role to manage the risk of unexpected exchange rate movement for businesses and lock in revenues in foreign currencies.
While China’s switch from fixed-asset investment growth will reduce its growth in demand for various hard commodities, it is quite different for crude oil. Here, China is set to play a bigger role in dictating the future of the oil industry and we can also expect derivatives to play an increased role in managing risk.
This year, China surpassed the United States as the world’s biggest oil importer and this trend is likely to become more entrenched. Demand tends to be consumption-driven and Chinese import demand is likely to be increasingly influential in setting international crude prices. This is one reason why China plans to launch a crude futures product in Shanghai later this year, which could become an important benchmark if it is freely traded. At the same time, Dubai Mercantile Exchange’s Oman Crude Oil Futures Contract is becoming more influential, with China already consuming 50 per cent of the Oman blend – the deliverable grade on the contract.
The IMF has now confirmed that the Chinese Renminbi (RMB) will be included in its basket of reserve currencies. Where do you see this having the greatest impact for China and for the currency?
The inclusion of the RMB into the IMF’s Special Drawing Rights (SDR) basket gives prized reserve asset status for China’s currency. Our view is that SDR inclusion is important symbolically for China as an affirmation and important vote of confidence in the process of internationalizing the RMB. It is also joining a select group with currently just the U.S. dollar, the Euro, the British pound, and the Japanese yen included in the SDR basket.
Where this could have a significant impact over time is on capital flows, if China can attain the goal of having the RMB widely used as a reserve currency. But for this to happen, more needs to be done by the Chinese authorities to open up its capital account. This would need to go hand-in hand with further liberalization of financial markets, bond markets and interest rates.
SDR status is not a shortcut or quick fix as China will still have to convince global central banks of the long-term purchasing power and liquidity of RMB reserve assets. But it is entirely reasonable that over time, an economy the size of China’s should be deserving of reserve currency status as well as being included in the IMF’s SDR basket.
China’s One Road One Belt initiative has garnered worldwide attention with its immense potential economic impact. What does this mean for China’s trade partners and the various countries along the proposed new Maritime Silk Road and Silk Road Economic Belt?
China’s One Belt One Road initiative is clearly highly ambitious in its scope and promises to have a significant economic impact, albeit over an extended time frame. To put it in perspective, the overall area covers about 50 percent of global GDP, some 4 billion people and over 60 countries. It should be noted, however, that China is already the top trading partner to over half the countries on the route. We expect it will lead to an increase in the cross border flow of commodities, currencies, and financing tools needed to support the initiative.
Outwardly, the project seeks to extend Chinese diplomatic and economic ties through commerce and development. Beyond building infrastructure, One Belt One Road has the potential to stimulate demand in a range of related industries including aviation, rail, telecommunications and electricity generation where China has manufacturing expertise and capacity.
If this also leads to further urbanization in many of the less developed countries involved, this could lead to yet further growth linkages. There is also the possibility that trade will get a boost from these new linkages through shipping and cargo demand as planned infrastructure investments improve ports and open new markets to commerce. Investments in port, rail and road infrastructure typically boost cargo volumes as shippers have more options for carrying freight.
How would you rate the overall enthusiasm for financial firms to do business in China? As China continues to liberalize and open up its markets, where do you see the opportunities for overseas firms looking to gain a foothold in China?
It appears that we have now reached a new chapter in China’s financial liberalization and capital account opening, which is prompting many foreign financial firms to increase their China focus. I would highlight as key the recent announcement of mutual recognition of funds between Hong Kong and China, which has led many international wealth managers and fund management firms to beef up operations.
The scheme also appears less bureaucratic than earlier schemes, as it starts with an initial RMB300 billion (U.S. $48.4 billion) and does not require fund houses to apply for a quota for a specific fund or for a company. Instead, when northbound or southbound sales reach the RMB300 billion quota, the State Administration of Foreign Exchange (SAFE) will publish this information on its website. It will help global managers to access Chinese wealth, and Chinese managers seeking mandates from global investors looking for Chinese opportunities.
CME Group recently launched futures in the FTSE China 50 index. What can you tell us about the contract, and what will it give investors that was not available before?
This contract gives market participants access to 50 of the largest and most liquid Chinese stocks listed on the Stock Exchange of Hong Kong (HKEx). The FTSE China 50 index is closely correlated to the Hang Seng China Enterprises Index (HSCEI) as the HSCEI is also trying to replicate a similar exposure to the Chinese market.
The benefit of taking an exposure to the China market through the Hong Kong market is that the component shares are subjected to many clearing regulatory rules. Trading the FTSE China 50 Index futures on CME Group provides the security of clearing, and virtually around the clock trading around the globe. Another important advantage of listing the FTSE China 50 Index futures on CME Group is that it offers margin efficiencies for our clients who wish to arbitrage the FTSE China 50 index against other popular indices such as the Nikkei 225 or the S&P500.
Korea’s economy has slowed, in part due to fewer exports to China. Meanwhile Japan, Singapore and Malaysia are looking to the Trans-Pacific Partnership to help boost growth. How do you see these events affecting CME Group’s business in those countries, and what does this mean for China?
The TPP is one of the most extensive trade agreements ever produced with not just market access and tariff removal but also setting minimum standards of conduct across issues ranging from workers’ rights to environmental protection. Assuming the deal is eventually approved, it will create a new free-trade bloc across 12 countries that includes almost 40% of the world’s gross domestic product (GDP) – about US$25.7 trillion.
For the financial services industry, the TPP should be particularly positive as it allows for improved access to domestic financial service sectors for foreign businesses by reducing discriminatory barriers, such as limitations on ownership and expansion by foreign financial institutions. This should be especially the case for Japan and Malaysia where foreign financial institutions have less penetration. For Singapore, the TPP should help solidify its leading position in wealth management, although it is already a highly open economy with many existing free trade agreements in place.
While China was invited to join the trade group, it is understandable that it was not ready to sign up to all the restrictions that would have been placed on its financial sector and state owned enterprises. Beijing very much has its hands full managing its own reform program and currency internationalization.
But the TPP does provide an incentive for China to sign up to a set of fair-play rules of trade. Among the requirements of the TPP are to establish enforceable labor standards, environmental protections and to curb unfair advantages for state-owned enterprises. Many of these reforms have been discussed by China in the past and inclusion in the TPP might just give an additional external trade incentive to make progress on stalled domestic reform.