By Yijie Hu
China has embarked on an ambitious and carefully planned journey to make the renminbi more global—and more widely respected.
Lao Tzu once said, “A journey of a thousand miles begins with the first step.” So it is with the current travels of China’s renminbi (RMB). One of its first and most important steps was launched in July 2009 by the Chinese authorities’ “Pilot Program of RMB Settlement of Cross-Border Trade Transaction,” under which designated domestic enterprises were allowed to use RMB as the settlement currency.
Both the scale and scope of the program were expanded in 2010 soon after the initial launch, making Hong Kong the designated key offshore RMB financial center. The Pilot Program is expected to continue to be expanded and foster a geographical progression of RMB use over time.
Currently there are two channels for eligible foreign enterprises to conduct RMB cross-border trade settlement with their Chinese trading partners; both involve using qualified “participant banks” or PBs. With the first channel, any foreign bank serving an overseas importer or exporter can perform the role of a participant bank and approach a mainland correspondent bank (MCB) to conduct an RMB settlement transaction. MCBs consist of all Chinese incorporated banks which are permitted by the People’s Bank of China to conduct international settlement business. MCBs can sign an RMB settlement agreement with the participating bank and open an RMB nostro account to handle RMB settlements between their export/import clients; they can also buy and sell RMB to the participating bank within a certain quota set by the PBoC or provide RMB financing to the participating bank. As an alternative to MCBs, the participating bank can approach the clearing entity, the Bank of China HK, to settle in RMB.
new opportunities
The ongoing internationalization of RMB is bringing numerous business opportunities to foreign enterprises, including trading firms and banks, to hedge foreign exchange risks and benefit from strong RMB appreciation. For foreign sellers and exporters, including the flexibility of invoicing in RMB can extend their reach to the Chinese consumer, reduce supply chain costs, and optimize supply chain management. It can also provide exporters with pricing protection, as they can lock up their profits directly in RMB and lower the risks associated with receiving FX.
Direct RMB borrowings from banks and trade financing are cheaper in Hong Kong compared to the mainland, notes Rachel Wang from Citi Global Transaction Services in Shanghai. The offshore RMB market allows corporations to enjoy more channels of relatively low borrowing cost by raising funds from the offshore RMB market, also known as dim sum bond issuance. For multinational corporations (MNCs) with manufacturing and sales offices in China, additional benefits include leveraging the interest and exchange rate differentials between the onshore and offshore RMB market to maximize profitability.
Under the original and expanded Pilot Program, foreign companies with trade and non-trade relationships with onshore Chinese enterprises are able to engage in RMB-related financial transactions with qualified PBs, including placement deposits, FX, remittances, checking activities, and trade financing.
For foreign firms that look for returns on their RMB proceeds, there is still a rather limited but growing number of investment products that have been developed in Hong Kong’s offshore RMB market, including RMB-denominated CDs, bonds and other structured instruments. Corporations can also invest the proceeds of their dim sum bond issuance back to mainland China on a case-by-case basis (upon approval of Peoples Bank of China (PBoC) and State Administration of Foreign Exchange (SAFE)). For corporations that do not wish to repatriate funds back to the mainland, they may prefer to use their RMB proceeds to engage in products such as USD swaps.
Two years after the initial launch of the Pilot Program in 2009, it is estimated that 80 percent of the participants in RMB trade settlements are mainland Chinese importers, and a majority of the transaction flows are with neighboring ASEAN (Association of Southeast Asian Nations) countries. Both the value of RMB cross-border settlement and the volumes of RMB deposits parked in Hong Kong have seen spectacular growth since 2009, albeit from a very low level.
Last year’s settlements in RMB, which totaled about RMB 500 billion ($78.3 billion UDS) under the current account, constituted about 2 percent of China’s total foreign trade. As of September 2011, China’s central bank, the People’s Bank of China, has signed currency swap contracts worth RMB 841.2 billion ($131.8 billion UDS) with 12 countries and regions, the top three swap line partners are Hong Kong, South Korea, and Singapore.
Hong Kong Re-invoicing Center
For foreign MNCs with multiple subsidiaries in different countries, and with sales offices and manufacturing facilities in China, juggling different currencies for invoicing, payment, and other treasury functions can be complex, not to mention suck up resources. To save costs and improve productivity, leading financial services companies have stepped up their efforts to help companies navigate the complicated processes of RMB and FX cash management.
One case in point: in 2011, an international manufacturing company established a re-invoicing entity in Hong Kong to actively manage settlement of cross-border trade flows between its China operations and other entities. Citi was able to help the client define and implement a solution, from concept, to discussions with regulators, to execution (including appointment as trade settlement bank for the company’s China-related supply chain flows), according to Ron Chakravarti, Managing Director at Citi Global Transaction Services.
The solution works like this: the MNC, with the help of Citi, set up a trading company that functioned as a re-invoicing center, and made the trading company the centralized counterpart for all China-related transactions; then the MNC opened an RMB NRA (non-resident account) in China and offshore RMB DDA (direct debit authorization) in Hong Kong, allowing for centralized international settlement in RMB.
Set up this way, the re-invoicing center, as a rapid response to regulatory changes to RMB’s exchange rules, allows the company to consolidate its foreign exchange risk in one more liberal jurisdiction, Hong Kong, rather than have each of its many mainland China entities handle it on an individual basis. The centralized shared-service center also reduces payments costs and introduces better liquidity management by allowing coordinated timing of transactions, with the additional benefits such as increased supply chain transparency. As the RMB gains more popularity as an international currency, undoubtedly there will be a rapidly growing demand for intercompany trade in RMB, making for easier and speedier settlement procedures.
Facing the fast-changing FX market, a few MNCs have taken the steps of getting close to the redback by issuing dim sum bonds and settling trades in yuan. In the meantime many are still waiting on developments a while longer, as they remain concerned about uncertainty and lack of clarity over shifting regulations and market benchmarks, as well as a lack of liquidity and investment vehicles. But a move by one of the industry leaders would surely send a signal of confidence and invite others to look more seriously.
RMB Plan for corp. Treasurers
As restrictions on settlement in yuan have been lifted in broader geographic regions, trading should become an area where corporates encounter fewer problems; more strategizing, however, may be put into determining what to do with the stash of Chinese currency accumulated through trading. On one hand, even in lieu of a smorgasbord of sophisticated investment instruments available in the RMB market, it has appreciated 3.6 percent so far this year vs. the dollar, offering a not-bad-but-not-significant return; on the other hand, presently it is still not convertible on the capital account, meaning corporate treasurers still have to go through steps that are both complex and tedious to change excess RMB into another currency, or to bring offshore RMB back to China, only with hard-to-get permission on a case-by-case basis.
For now, it may be too early for corporate treasurers at MNCs to go all red(back) in their cash management and trading, yet it is never too early for corporations to start contemplating their RMB plans. They should stay close to the policy development, analyze their resources and goals with their function group, as well as with risk-management managers, also stay in touch with their bank to discuss how to best play their RMB position to meet both investment and hedging needs, and to keep pace with the latest RMB products offered by the banks.
Next Steps
During his visit to Hong Kong in August 2011, current China Vice Premier Li Keqiang, widely believed to be the next Premier of China in 2013, made announcements promising to let foreign investors buy mainland shares and bonds, essentially opening the floodgates and allowing more yuan flow between China and Hong Kong. Although no exact launch date has been given for the scheme, Vice Premier Li said foreign owners of RMB can soon buy up to 20bn yuan ($3.1bn USD) worth of yuan-denominated stocks and bonds on the mainland. Markets reacted to this news by pushing up shares and brokerage stocks listed in Hong Kong, and analysts suggested that Beijing has become more comfortable with the swift pace of the offshore RMB market’s development, and is taking the yuan internationalization process to the next stage.
However, to reach the eventual status of a robust international currency, the yuan must be fully convertible. After the success of the Pilot Program and the gradual opening of partial convertibility of RMB, it is increasingly likely that China will liberalize its domestic market to pave the way for the convergence of offshore CNH and onshore CNY money. Although there has not been a firm timeline given by Beijing, the frequent releases of initiatives in recent years suggest liberalization could follow more quickly than broadly anticipated. Investors and participants in both the CNH market and Asia in general, should prepare for potential risks and outcomes of an eventual CNH/CNY convergence.
So, like the many massive projects undertaken in China over the past 75 years, the RMB’s journey is ambitious, largely driven by policy and governmental planning. However, this time, the project is moving rapidly as tech international companions and join the march.