By Matt Jamieson, Senior Director, Fitch Ratings and Sabine Bauer, Senior Director, Fitch Ratings.
The currency of China, the world’s second-largest economy, continues its ascent among global payments settlement, trade, and currency investment. Support is coming from a rapidly expanding network of offshore yuan clearing centres, which facilitate direct access to China’s onshore financial markets. We expect the proliferation of these offshore clearing centres to drive greater issuance of Dim Sum Bonds (DSB) by both Chinese and non-Chinese governments, financial institutions and corporates in 2015.
Expanding Yuan Financial Infrastructure
The pace of global yuan infrastructure expansion is flourishing, with eight offshore yuan clearing centres established in major financial centers in 2014 – London, Frankfurt, Seoul, Paris, Luxembourg, Doha, Toronto and Sydney – and an additional two so far in 2015 – Kuala Lumper and Bangkok. In total there are now 14 offshore yuan clearing centers, which started with Hong Kong and Macau in 2003 and 2004, followed by Taiwan in 2012 and Singapore in 2013. (The yuan, or renminbi, is abbreviated as CNY in the markets.)
Offshore clearing-centre banks convert local currency, directly into CNY (and vice versa) without the need to change it into U.S. dollars first, and thereby reduce associated time and costs to financial institutions and corporates trading/dealing with China. We expect the expansion of offshore clearing centres to support the international usage of the yuan for payments, trade, investment and reserve-currency holdings. A greater number of clearing centres enables greater usage of the currency in cross-border settlements, and these centres can develop a range of yuan-based financial services, help concentrate yuan pools, and allow the issuance of DSBs.
The amounts that can be repatriated back to China are restrained by the set quotas under China’s Renminbi Qualified Foreign Institutional Investor (RQFII) regulations. In this regard China has granted CNY270 billion to Hong Kong, CNY100 billion to Taiwan, CNY80 billion each to Germany, England, France and South Korea, and CNY50 billion each to Singapore, Canada and Australia.
Hong Kong continues to control the vast majority of offshore yuan flows despite the territory’s share declining to 70% at end-October 2014 from an average of 80% throughout 2012. We expect that the share of other countries excluding China could increase to 35% in terms of payment value by end-2015. According to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), 50 countries were using the currency for more than 10% of their payments value with China and Hong Kong at end-October 2014.
We estimate offshore yuan outside of Hong Kong currently stands at about CNY700 billion, with Taiwan, Singapore and Macau accounting for the bulk of it. Accordingly, it will take some time for the new offshore clearing centres to catch up to Hong Kong, which has by far the most established infrastructure and the largest offshore yuan pool with CNY1,128 billion in deposits and CDs at end-September 2014.
The key drivers for the accumulation of offshore yuan are settlement balances and conversions. In this regard the Hong Kong Monetary Authority’s (HKMA) removal of its CNY20,000 daily conversion limit with effect from 17 November 2014 will support the build-up of yuan deposits. Liquidity will also benefit from HKMA’s decision earlier in November 2014 to appoint seven banks as primary liquidity providers for their market making in certain yuan products. HKMA provides a designated CNY2 billion liquidity facility for each of these banks in return. There are additional liquidity arrangements in place under which banks can access intraday, overnight and next day liquidity from the HKMA.
China’s central bank, the People’s Bank of China (PBOC), appointed Bank of China’s Hong Kong subsidiary Bank of China (Hong Kong) Limited as the first yuan clearing bank. This role, which includes providing clearing, settlement and fiduciary account services to participating banks, still distinguishes the bank from its local peers. Initially, the PBOC gave the bank access to other banks’ deposits for squaring in the on-shore market. Given the depth of Hong Kong’s yuan pool the authorities have switched to offshore squaring for customer deposits in November.
Dim Sum Bond Issuance – No Longer Just Hong Kong
The rapid expansion of offshore yuan clearing centres in various locations across the globe underlines the potential for significant growth in DSB issuance in 2015 and beyond. The size of the DSB market has grown from an equivalent USD5 billion at the end of 2009 to approximately USD70 billion at the end of 2014, but is still very much at a nascent stage, representing a mere fraction of the USD5.8 trillion local yuan bond market as of end-2014. So far the vast majority of DSB issuance has been out of Hong Kong, given that Hong Kong and Macau were the only two designated CNH clearing centres until the end of 2012, and Hong Kong’s close proximity to China.
But in October 2014, the UK government became the first non-Chinese sovereign to issue DSB. Not long after London was designated as an offshore yuan clearing centre in June 2014, the UK issued DSBs worth CNY3 billion, a precedent followed by Australia’s New South Wales government, which issued CNY1 billion in DSBs two days after China designated Sydney as an offshore yuan clearing centre in November 2014. As the size of these sovereign DSB issues is insignificant compared to typical GBP or AUD denominated government-bond issues, the purpose is clearly more focused on developing the yuan market in their respective financial centres.
Accordingly, we expect other sovereigns with clearing centres to follow with their own DSB issuances over the next 12 months on the assumption that these sovereigns are equally desirous to be positioned as key trading hubs for the yuan going forward. As per the case of the UK and Australia, initial issuance volumes are likely to be small with the emphasis more on market development rather than funding.
For a related discussion on the growing usage of offshore yuan and its trade, payment and reserve-currency status, please see “Yuan Usage Gathers Pace for Payments, Trading & Reserves.”
Sabine is a senior director in Fitch Ratings’ financial institutions group. Matt is Head of APAC Research for Fitch’s Corporate Rating Group. This article was originally posted on The Why Forum. Like this article? Lets connect, join our Facebook, LinkedIn or Twitter. #DialogueTalk