As trade denominated in yuan continues to rise at a phenomenal rate, its significance to global markets is quickly increasing. But even as the IMF considers adding renminbi to the basket of SDR reserve currencies and China’s global political clout rises commensurately, the country has yet to fully liberalize its markets—or its currency.

Author: Tom Leander

JUST A DISTRACTION

In some ways the focus on the SDR may be distracting from the real issue, which is the pace at which China is opening its capital account. HSBC’s Cheung says the high uptake rate of renminbi for cross-border transactions reflects the fact that the payments side is a first phase—and perhaps the easiest one. Full convertibility would require market openness that is only just evolving in China.

Full convertibility—meaning China would completely open its capital account and users would be free to trade the currency cross border with little in the way of barriers—would also require an independent central bank and liberalization of interest rates. China’s bond market—now the third-largest in the world at 35.9 trillion yuan ($5.8 trillion), according to Goldman Sachs—is huge, but corporate issuance is still small. For domestic corporate issues, lack of transparency in corporate reporting can keep lenders away. Panda bonds—foreign corporate issues in the domestic market—have been a dud since they were first touted, with German auto giant Daimler the only non-
financial-institution issuer.

In contrast, the dim sum—or offshore, yuan-denominated bond—market has grown rapidly since its launch in 2007. But issuance slowed this year as China’s central bank slashed interest rates. Issuance in the first four months of 2015 dropped 52% to 79 billion yuan, according to Thomson Reuters.

The sheer attention that liberalization efforts gain in the media belies the currency’s openness. Regulators issued rules allowing cross-border pooling in the Shanghai Free Trade Zone as recently as November 2013. Shanghai‒Hong Kong Stock Connect is an exciting development, but it took off just this April, when regulators opened the door to southbound investment by mutual funds into Hong Kong stocks.

The number of renminbi offshore trading centers has ballooned to 14 in a short time. In 2014, Doha, Frankfurt, London, Luxembourg, Paris, Seoul, Sydney and Toronto joined the club. Bangkok and Kuala Lumpur signed on this year. But outside of the major centers of Hong Kong and Singapore, only Luxembourg and London were named by a sizable percentage of multinational CFOs and treasurers in the Allen & Overy study as attractive locations for offshore renminbi liquidity management over the next five years.

Offshore liquidity shortages, in fact, still prevent some corporates from developing renminbi trading relationships. Cheung notes that trade settlement may take only seconds longer in Hong Kong than for a US dollar trade. But to a corporate treasurer, the difference reveals a lack of depth in trading markets even in Hong Kong, the biggest offshore center. 

Technical hurdles also stand in the way of the currency’s global advancement. The China International Payment System, now under development, will be the global “highway” for yuan transactions. Technical problems forced a delay of its launch in 2014. Reuters has reported that unnamed government officials say the target date is now September of this year. The promise of CIPS is substantial. Cross-border clearing in renminbi currently requires a bank in an offshore trading center or a correspondent bank in China. Post CIPS, trades will be settled with a counterparty in China directly. 

Then it will be up to corporates to hone their renminbi skills. Both the Allen & Overy survey and a recent HSBC survey found that many corporates see lack of internal familiarity in handling the yuan as slowing companies’ usage of the currency.

Bankers, meantime, are adding new corporate renminbi solutions. Deutsche Bank structured an option for China-based milk producer Mengniu Dairy last year—the first-ever non-vanilla, yuan-denominated option to hedge cross-border exposures.

With China waiting in the wings for an IMF decision on SDRs, renminbi “noise” is getting louder by the day. Mark Austin, chief executive of industry trade body the Asia Securities Industry & Financial Markets Association, argues that China’s desire to be included in the reserve currency basket will have the residual benefit of prompting the government to keep up its momentum in opening its capital account, in such areas as interest rate liberalization and the creation of new free-trade zones, and in easing restrictions on the use of some financial instruments. “It’s about what China does over the next year to actually accelerate the reforms. Because China seems to want to be included in the SDR basket, and they don’t want to wait five years,” notes Austin.

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