Engineering sufficient liquidity to foster RMB trading and settlement in Hong Kong is the city’s “greatest challenge, but also biggest opportunity”, its stock exchange chief executive, Charles Li, said yesterday.
Speaking to a rapt assembly at the Foreign Correspondents Club in the Central business district, Li stressed that the exchange, along with the Hong Kong Monetary Authority, would continue lobbying Beijing to improve its FDI regime as well as to seek approval for providing an interim pool of liquidity support.
Solving this liquidity riddle lies at the heart of convincing a sceptical western audience that Hong Kong can deliver on its aspirations to become a vibrant international trading hub for the RMB, given that China operates a closed capital account.
“This is a historical transformation that is going to be very difficult, very complex, particularly in the context of overall global changes, with trade controversies and many other things,” said Li.
“A lot of people are very sceptical about it. I don’t have a magic solution or a crystal ball. It is a decade-long process and it is going to take a lot of creative innovation, and a lot of trials and pilot programmes. But we believe it is possible.”
He noted that China’s trade account was fully open, allowing the free flow of renminbi in and out of the country, supported by large-scale swap arrangements in place between the central banks of trading partners.
“The problem is there is no water in the pipe because there is no RMB out there to pay for it,” he added. “Even though the swaps could provide the RMB for people who want to pay in RMB, trade partners have no incentive to do so because they don’t really have … a place to park the RMB. So at the beginning we have to do it [generate liquidity] artificially.”
At present Hong Kong has a rapidly growing liquidity pool of about Rmb100 billion, broadly in lower-yielding fixed income and banking products – which Li referred to as “the formation phase” (see graphic).“It is a great starting point,” he said. “We are starting to see insurance products and foreign fund management products. Many trading partners will begin to consider putting RMB into [the pool]. Their CFOs and treasury departments over time may want to begin to re-denominate some of their balance sheets into RMB if they are China’s long-term major trading partner.
“But we are saying that is not enough. We believe we need to begin to move into a higher yield curve. We need to do that to make sure that there are larger products and a greater number of products. As products begin to emerge, they are going to trade more actively.”
Li underlined that the city is now striving to move into “the growth phase” (see graphic), spawning the emergence of corporate bonds, interest rate products, stocks and index futures in RMB.
While he conceded that the upside for investors was still limited at present as Hong Kong continues to lobby Beijing to secure a more relaxed regime of controlling FDI back into China, the downside centres around the RMB's limited availability damaging demand for securities.
“The issuer would have every reason to say ‘I don’t want to consider this product unless I know that I am not going to suffer a valuation discount’ simply because there is not enough RMB out there,” said Li.
He pointed out that Hong Kong has lobbied for the opportunity to provide an interim pool of liquidity support to ease issuer difficulties for the launch and trading of designated products on a pilot basis.
“How it works is a little bit technical, but essentially you have a pool and the people who have RMB can continue trading [RMB products], while people who don’t have RMB but love the product for arbitrage or other reasons can go into the pool and participate in the deal, thereby minimising if not eliminating all the price discrepancies due to the availability of RMB.”
These Hong Kong dollar investors would be able to tap into the RMB liquidity pool, provided that when they trade out of the position, they exit with Hong Kong dollars, therein returning the pool to its original size.
“The integrity of the RMB level inside the pool gets preserved,” explained Li. “We do believe that this capital pool is something that is highly feasible and highly workable.
“The reason policymakers in China will potentially consider this favourably is because even though it requires some limited opening of the capital account, this capital pool is for limited purposes only and for a short period of time. When enough RMB has started to accumulate naturally, then eventually the need will be phased out.”
Li described the potential market in offshore RMB flow as very substantial, adding: “Hopefully a portion of that RMB will become permanently stationed [in Hong Kong], creating an indigent and native growth market that will also begin to have yield. Ultimately the Holy Grail is that one day Chinese investors will begin to come here en masse.”
He listed Hong Kong’s priorities as setting up RMB infrastructure, expanding its mainland market data business, developing renminbi products, facilitating mainland connectivity, and pursuing OTC clearing.
"When the RMB [market] gains sufficient critical mass offshore, there will be a huge amount of interest rate swaps, hedging and risk management opportunities. We want to make sure that we are there," Li concluded. "This is a very exciting potential transformation. It is going to be easier said than done, but I do think we have a very bright future ahead of us.”
