The RMB eurobond market was born on July 7, 2010 with the launch of the Rmb1.3 billion ($190 million) eurobond of Hopewell Highways Infrastructure. In a client alert after the launch, we posed a question: HHI issues first RMB Eurobond – What next?. That bulletin was published only three months ago, but answers to our question have come with surprising speed.
In a number of further bond issues, the development of, and the constraints on, the new market have begun to take shape. Although the bonds have stolen the headlines, developments in the usually sleepy Hong Kong certificates of deposit market have in fact been even more rapid. A bilateral loan market and the beginnings of a syndicated loan market are stirring. The first deliverable renminbi derivatives have appeared, and investment products denominated in offshore renminbi are being designed. There is even talk of RMB-denominated IPOs being listed on the Hong Kong stock exchange in the near future. What is most striking about the past three months is the way in which the authorities in Beijing and in Hong Kong have quietly and effectively continued to develop and clarify the framework for the internationalisation of the renminbi.
A noteworthy feature of the internationalisation of the renminbi has been the absence of black letter regulatory change or reform. In Hong Kong, the shift in policy which launched the offshore currency was the February “Elucidation” letter from the Hong Kong Monetary Authority (HKMA) to authorised institutions. The full ramifications of the Elucidation only became clear with the HHI eurobond, and perhaps were not really believed or absorbed by the market even then. Further clarifications and regulatory developments have followed thick and fast.
A regulatory timeline
June 2009: The RMB trade settlement pilot scheme is established, allowing settlement in offshore RMB for the first time, but limited to transactions between exporters and importers in five mainland cities and counterparties in an Asean nation.
February 2010: HKMA Elucidation suggests that banks “can develop RMB businesses based on the regulatory requirements and market conditions in Hong Kong, as long as these businesses do not entail the flow of RMB funds back to the mainland.”
June 2010: Mainland authorities announce an expansion of the RMB trade settlement pilot scheme. The scheme is now available worldwide for trade settlement with Chinese entities in 20 provinces and cities which cover most of the PRC.
July 2010: HKMA issues further guidance to the market on “RMB Business in Hong Kong”, explaining and clarifying the impact particularly of the expansion of the trade settlement pilot, and spelling out banks’ ability to open RMB accounts for corporate customers and to conduct conversion and lending business within prudential guidelines, but otherwise without regulatory constraint.
August 2010: The People's Bank of China (PBoC) promulgates a new pilot scheme for eligible banks and institutions to access the mainland RMB interbank bond markets (subject to quotas to be determined).
August 2010: Hong Kong's Securities and Futures Commission (SFC) advises intermediaries to prepare themselves operationally for the introduction of listed investment products to be denominated in offshore RMB.
September 2010: HKMA publishes a circular on the selling of RMB deposit, investment and insurance products, covering appropriate risk disclosure.
September 2010: The Hong Kong stock exchange publishes guidance to brokers on what they can and cannot do in relation to trading and financing listed RMB products.
September 2010: Mainland authorities put out revised “Interim Measures on the Issuance of RMB-denominated Bonds by Multilateral Agencies” allowing the issue of panda bonds in the PRC domestic market by supranationals and the use of the proceeds outside China.
October 2010: As China Development Bank launches another retail RMB bond in Hong Kong, HKMA confirms relaxations from some of the selling and distribution restrictions applicable to publicly distributed investment products.
Accompanying these developments have been a series of speeches, interviews, seminars and other market communications from the mainland and Hong Kong governments and regulators, all aimed at clarifying and explaining what can, and in very few cases still cannot, be done with the new offshore currency.
Sure it’s offshore?
The outlines of what can and can't be done are relatively easy to draw. But what is the legal nature of this offshore currency? Is it different in some way from the “normal” onshore RMB, and if so in what way? Can the offshore currency be defined? The moniker “CNH” is gaining acceptance, a contraction of CNY (for Chinese yuan) deliverable in Hong Kong, but does it mean anything?
The parallel with the growth of the offshore US dollar, or eurodollar, market in the seventies and eighties has been drawn and it is in many ways illuminating, both as to the nature of the currency and as to its vast potential. But the parallel can also be rather misleading.
Illumination first. Eurodollars became so called because they were US dollars which circulated outside the United States, initially in London and other European financial centres, hence the prefix “euro”. These days the eurodollar market is worldwide, making the “euro” redundant, and has been joined by other widely traded currencies too.
What happened originally is that European banks and companies held US dollars in accounts at banks in London or elsewhere. At its most basic level this was simply a matter of a bank in London opening a record on its books that of the dollars in the London bank’s account with its correspondent bank in New York, USD was held for a corporate customer in the UK. That customer might then specify its London account for settlement of its exports to a firm in the US and the eurodollar pool expands.
Normal banking principles then take over. The London bank has the idea that it may as well lend out its US dollars to other corporate customers in the UK (subject of course to London prudential reserving requirements); those customers deposit the US dollars they have borrowed with their own preferred London bank, who onlends again. An expansion in the offshore supply of eurodollars takes place – roughly by a multiplier of 1/reserve requirement. This is very like what is now happening with offshore RMB (what a pity we still don't have a handy name like "eurodollars”!)
Even the ability to extend offshore credit and effectively expand the offshore money supply is there: banks may extend credit in offshore RMB to their corporate customers, subject to normal prudential provisions, and, in a restriction which indicates an awareness of the runaway potential for credit growth and a degree of appropriate caution, subject to a relatively high reserve requirement of 25%. The eurodollar model also gives some idea of how this currency could develop – from its beginnings in the seventies, the eurodollar market has grown into the vast global capital market that exists today. Could CNH follow this trajectory?
So far, so enlightening. But analogising with eurodollars has limitations and can become misleading: more interesting now are the ways in which offshore RMB or CNH is unlike the eurodollar. The fundamental point remains that the renminbi is not a convertible currency. Offshore RMB (and for reasons which will become clearer, lets now start using CNH as the designator) exists in and is restricted by an offshore pool of available currency in a way which was never true of the eurodollar, which was (and still is) easily fungible with, and indistinguishable from, dollars held at banks in the United States. According to HKMA statistics, CNH deposits at the end of August 2010 (the latest available) amounted to CNH130 billion (up an astonishing 30% from the deposits at the end of June, just two months earlier). This is essentially the available pool of CNH and it can be measured accurately through HKMA’s reporting requirements.
There is indeed a defined offshore pool: CNH can swim freely within the pool (this was the nub of the Elucidation). To get into the pool, or to get out of the pool, however, involves swimming in or out through a bottleneck represented by Bank of China, Hong Kong branch, as the clearing bank appointed by PBoC. The bottleneck is controlled by clearing agreements between PBoC and BoC on the one hand and BoC and other participating banks in Hong Kong on the other. Positions in CNH resulting from permitted transactions such as trade settlement may be squared ultimately with PBoC, allowing CNY to swim in and become CNH; or CNH to swim out and become plain old non-convertible CNY again.
Is it a pool or a puddle?
So the nature of the offshore pool is clear, which means CNH does become capable of legal definition as distinct from CNY. What follows from this?
Adopting CNH as the designator for a new offshore currency has the very great advantages that it distinguishes the offshore currency from the onshore currency (they are not interchangeable in the way that eurodollars and dollars are interchangeable) and it makes clear the nature of the distinction: the pool and the ability to form part of it is defined by the fact that the currency is deliverable in Hong Kong. If you can receive it in a Hong Kong bank account, it's in the pool and freely transferable and deliverable in that pool; if you can't, it isn't!
Two further points must quickly be added. This does not mean that CNH is somehow limited to the Hong Kong market. It is already perfectly possible – in principle at least -- for institutions, banks, companies outside Hong Kong to open a CNH account with their bank in London, Bangkok or Sao Paolo, in just the way that a USD account may be opened outside the United States. The local bank does it by maintaining an account with a correspondent bank in New York (for US dollars) and with a correspondent bank in Hong Kong (which is, or which in turn has an account with, a participant bank in the clearing arrangements) for CNH. Through these means, CNH becomes a globally available and transferable currency, properly representing the internationalisation of the renminbi, while it remains, apparently paradoxically, non-convertible. And of course this means that Hong Kong becomes the global settlement centre for the internationalised renminbi (now properly called CNH).
The other point is that CNH exists because of, and is defined by, the clearing arrangement with PBoC. What if other clearing arrangements are established? This must be entirely within the power of PBoC to implement if it so chooses. So, will we get “CNL” for CNY deliverable in London? “CNJ” for CNY deliverable in Jakarta, anyone? Let's hope these developments, while possible, remain of only theoretical interest. Because if internationalisation proceeds in this way, we will end up with a series of local offshore puddles rather than a global offshore pool. Many bilateral clearing agreements with PBoC mean separately defined pools: CNL could not gain entrance into the CNH or the CNJ pool without swimming back into the mainland domestic pool and therefore out of the London offshore pool altogether. Perhaps it is possible, but it is not at all obvious how it could then swim out again into another offshore pool to settle a transfer instruction from a CNL account to a CNH or CNJ account.
There are clear signposts here for the development of legal documentation and definitions to deal with business day conventions, currency disruption events, payments clauses and so on. And there are clear advantages to issuers or borrowers and investors, not to mention regulators too, in having not only a clearly defined place of payment (and associated law of the place of payment) but a place of payment associated with the jurisdiction in which settlement of the currency, the means by which it derives its validity and value, takes place.
We will follow some of these signposts, and comment further on the legal ramifications of the CNH currency, in a later article.
Is it renminbi or Chinese yuan? RMB or CNY?
The lawful currency of the People’s Republic of China is referred to as the renminbi or the Chinese yuan, often interchangeably in the media. For the sticklers and pedants, one view (which we try but probably fail to adhere to) has it that “renminbi” properly refers to the currency itself, in the same way that the British currency is pounds sterling, or just sterling. Chinese yuan then refers to units of, or a quantity of, the currency – so CNY500,000 should be used rather than Rmb500,000. This is the position adopted by the Central Moneymarkets Unit in Hong Kong. “CNY” is the correct designator for the currency according to the International Organisation for Standardisation under its ISO 4217 standard for currency codes, although the 1998 FX and Currency Option Definitions published by ISDA allow both “CNY” and “RMB”. Confusing? Another reason to use CNH?
The author of this article, Andrew Malcolm, is a partner with Linklaters' capital markets group in Hong Kong.