Over the past four years, China’s currency, the renminbi (RMB), has increasingly made its presence felt in global foreign exchange markets as China continues its efforts to internationalize its currency. In the most recent BIS Triennial Central Bank Survey, the RMB has become the ninth most traded currency in the global market. Efforts to internationalize the RMB have continued apace, ranging from new RMB clearing arrangements around the world to the opening of the Shanghai Hong Kong Stock Connect Scheme.
In October 2014, Malcolm Baker, Senior Director, Interest Rates & FX Products, CME Group, chaired a panel at a Treasury Markets Association (TMA) luncheon in Hong Kong, discussing what the prospects are for growth of RMB products and where the currency stands in its goal of joining the G3 currencies.
- Jack Cheung (JC), CEO, Treasury Markets Association
- Patrick Law (PL), Managing Director, Head of North Asia Local Markets and Co-Head of Asia NDF Trading, Bank of America Merrill Lynch
- Michael Ng (MN), Head of EFX Trading, Rates Trading, Global Markets, Bank of China (HK)
- Jiong You (JY), Managing Director, Head of FX and Local Markets Trading, China Region, Citi
Here is an abridged version of the panel discussion.
Malcolm Baker (MB) – What does the future hold for the RMB? And is it positioned to become a G3 currency?
Patrick Law (PL): In the early days of CNH (offshore-traded renminbi) development, flows were driven primarily by trade-related business. Over the past couple of years since 2011, we started seeing more professional players in the market coming in, including a significant pick up from asset managers. Additionally, we have noticed a significant pick up in participation from other time zones, especially from Europe and to a certain extent in the US. I expect this trend to continue in the years ahead.
Jiong You (JY): From my point of view, the first stage is for the RMB to become a trade currency with China. The next move hence is to become an investment currency, and we have seen a lot of interest especially with investments in the CNH market and in the local domestic market through QFII and RQFII. The final stage is really to become a reserve currency. Earlier in October, the European Central Bank is reported to be looking to add CNH as a reserve currency. This is a significant move. The International Monetary Fund is also expected to be debating in its October meeting whether to add the Chinese currency to its Special Drawing Right, its composite reserve currency used in official financing. I think this is quite an exciting process and the outlook for RMB development is very optimistic.
MB – Can you quantify how big trading is now in RMB?
JY: By our observation, there were a few days when trading volumes of CNH in Asia time zones were even greater than Australian dollar (AUD) trading volumes. I may add to that, currently on the electronic trading system, spreads on the CNH are actually as tight as the major G10 currencies, so it shows the liquidity on the platforms.
MB – How international is the actual yuan trading?
Michael Ng (MN): The latest numbers from some of the electronic trading platforms suggest that total turnover during the pure Asian session now will be around 40-45 percent, whereas London will potentially account for almost 50 percent, with the rest from New York. In terms of notional growth, certainly the European pickup has been the most pronounced, which is not surprising given that the Euro bloc is China’s largest trading partner.
MB – Given the CNH is still loosely pegged to USD – What is the main risk?
JY: The USD/CNH as a new currency pair has just been around offshore for a few years, so that biggest risk is actually liquidity risk. We have experienced a few times where there was a risk specifically on the USD/CNH topside. Two years ago we also had the experience when onshore /offshore was trading at almost 2 percent spread. So I think the two key risks for participants are price liquidity and money market liquidity risks. With the imminent launch of the Shanghai-Hong Kong Stock Connect, the market is now expecting the onshore and offshore flows to eventually create some volatility in CNH liquidity. That is why the Hong Kong Monetary Authority (HKMA) has introduced the PLP (Primary Liquidity Providers) and also some liquidity products into the system to ensure that expected liquidity may be manageable offshore.
MB – Are clients taking further action to manage RMB exposure given the moves in the U.S. Dollar?
MN: On one side, youhave abroad dollar move, on the other hand, China continues to have a positive trade balance. These two trends will keep swaps largely anchored until there are significant developments one way or the other. Onshore liquidity remains pretty tight, and offshore is very tight especially on the short end. This is an intrinsic risk for any emerging market products, and certainly for USD/CNH. In the last couple of months, we have seen some extremely painful squeezes in short-term funding. Even though the CNH market has been growing substantially, the total unencumbered free CNH liquidity that sits offshore has not been growing at the same pace. A lot of the liquidity and capital actually gets committed back onshore.
PL: Firstly, more and more clients increasingly believe that there is actually two-way risk in the currency – so it’s no longer a one-way bet. At the same time, others are actually sanguine about China’s policy in terms of how they manage the economy into a slower growth trajectory, and have pretty high confidence that the currency will become more stable and internationalized.
At the moment the level of volatility does not justify hedging for many. If the currency becomes more two-way, moving in the range of 3-4 percent a year on both sides, you need to pay like 2.5 percent to hedge per annum.
MB – How would you rate progress towards the RMB becoming a reserve currency?
MN: For asset managers and reserve managers, there is still a comparative lack of high quality investment products to deploy CNH capital.
JY: The pace of the capital account opening will be key for CNY to become an international reserve currency. We are seeing an acceleration in the opening of the capital market. QFII took 11 eleven years to reach a scale of $50 billion (U.S.); it took RQFII two years to reach the same level. Now, Shanghai-Hong Kong Stock Connect will allow a scale of $50 billion to access the offshore market.
MB – Do you expect Hong Kong to take the lead in new RMB products?
Jack Cheung: I think Hong Kong retains an advantage for offshore RMB development as we can provide market-driven price discovery here. We also see an appetite for new products in our recent survey on the RMB of major banks in Hong Kong and to the major corporations. Amongst the 179 replies anticipated products in the near future, they mentioned futures, forward rate agreements , overnight indexed swaps , interest rate options, swaptions, caps and floors. They were also interested to trade RMB interest rates futures and 20 respondents indicated interest to become market makers.
MB – One test for the RMB achieving G3 status is achieving liquidity at the long end – how is this progressing?
MN: I think the growth of the liquidity profile has mirrored that in many other commercial market currencies in that liquidity improves most significantly in the short end, and it slowly propagates out as the market becomes more comfortable taking that of long-dated risk.
JY: I think it is also part of the credit mitigation process especially for long-dated products. Other things like clearing and infrastructure are also key for long-dated derivative trading liquidity.
To read the full version of the ‘Globalization of the RMB: The Path to Becoming a G3 Currency’ white paper, please click here.