Investors' top ten questions about the renminbi

With the renminbi’s appreciation slowing, the focus of Chinese currency policy will shift increasingly towards internationalisation. We have thus compiled a list of the most important questions about how the offshore renminbi market works and what’s likely to happen next.

1. Why has the offshore renminbi rate been so volatile?
   

   Investors looked to liquidate short dollar-renminbi positions in the offshore deliverable market for reasons more related to general global risk reduction than any change in core views towards China or its currency. There was a similarly sharp position liquidation in gold, an asset generally perceived to be a safe haven.

   It essential to understand that the renminbi will not necessarily trade at the same rate onshore and offshore; the market is barely 18 months old and its participants’ lack of diversity has made liquidity and prices sensitive to changes in the global macro environment; and there is no central bank to smooth volatility.

2. Has the volatility been a challenge to long-term development of the onshore renminbi?
   While events in 2011 were surprising, volatility by itself is not unusual for an internationalised deliverable currency. Renminbi internationalisation will continue as one of the world’s largest economies and trading nations, China, will seek to transact with other economies in its own currency. Over time, the network effect from growing use of renminbi offshore will be self-reinforcing. The first step in this process will be the increasing use of the renminbi to settle global trade.

3. What would it mean if renminbi appreciation expectations disappear?
   There will be a point – possibly not too far away – where renminbi appreciation will no longer be a persistent consensus view. In fact, we expect appreciation will slow in 2012 as inflation fears fade. This shift may impact investors’ approach towards the offshore market but would certainly not undermine its development. Instead it would refocus market development in areas that may have been suppressed due to persistent appreciation expectations – the offshore renminbi lending market, for example.

4. How do trade settlement and the clearing bank trade settlement quota work?
   Trade settlement refers to the use of renminbi for cross-border trade activity, which has been allowed globally since July 2010 and throughout China since August 2011. This is different from the quota on foreign exchange transactions related to renminbi trade settlement handled by the clearing bank at the offshore rate. As most cross-border trade settlement occurs without a foreign exchange transaction, this quota does not limit the overall amount of renminbi trade settlement that can be done generally. The current quota is 8bn renminbi that can be bought and the same sum that can be sold each quarter by the clearing bank.

5. Who can trade in both onshore and offshore markets?
   Onshore participants generally can’t trade in offshore renminbi rate markets. Offshore, a company or investor can buy and trade at offshore rates. Generally they cannot trade in onshore renminbi rate markets but corporates can transact at the onshore rate through a clearing bank if the conversion is part of a cross-border trade settlement transaction. Corporates or investors outside Hong Kong can participate in offshore markets by opening offshore accounts in Hong Kong.

6. Corporates or investors outside Hong Kong can participate in offshore markets by opening offshore accounts in Hong Kong.

   Who regulates the offshore renminbi market?
   The Hong Kong Monetary Authority regulates the offshore market but has no mandate to intervene in the onshore market or to manage the currency and it generally takes a free market approach towards regulation.

   The People’s Bank of China and State Administration of Foreign Exchange regulate the onshore market but have no direct oversight on how the currency trades outside China. They are, however, the key bodies overseeing the opening of channels through which renminbi can flow between onshore and offshore.

7. Why does the US dollar trade at different rates against onshore and offshore renminbi – and what determines the spread?
   The flow between onshore and offshore renminbi is limited and closely regulated. Onshore parties cannot participate in offshore markets and only some offshore parties can participate in onshore markets – and only to a very limited degree. There can and will be different market-clearing rates at which the renminbi trades and large differences incentivise cross-border flows so that the long-term trend is towards convergence, even though significant divergence in the near-term is possible.

8. What is liquidity like in the spot and options markets?
   Liquidity, expanded rapidly through most of 2011, reaching around USD4.5bn daily turnover. However, this growth reversed when market sentiment changed in late September, along with broader volumes in financial markets. But once market sentiment improves and as the offshore market expands, we expect it to improve again.

9. Why is the forward market no longer regarded as an accurate indicator of renminbi appreciation?
   Historically the onshore renminbi non-deliverable forward market acted as a reliable indicator of future expectations of its exchange rate. In actuality, what was considered a ‘priced’ rate of future appreciation expectations was the premium charged to take long renminbi positions. Today, with a whole new renminbi-based currency and asset market for foreign investors, it is inevitable this has changed the way that the various renminbi forward markets behave.

10. What developments in renminbi internationalisation should we expect in 2012 and where is the next offshore renminbi centre likely to be?
    Since the establishment of the offshore deliverable renminbi market in Hong Kong in July 2010, much of the substantive growth has been organic. The main focus of regulation since then has been the gradual opening of cross-border channels. We expect this to continue in 2012. The deposit base should continue to grow steadily, as will the supply of offshore-denominated fixed-income and equity.

    There are also likely to be substantial moves towards expanding renminbi settlement beyond Hong Kong. Singapore would be a sensible first stop as it boasts deep, developed financial markets, has a close commercial and policymaker relationship with China, and is also a financial and trading hub for the rest of Asia. An expansion into London, the pre-eminent global hub for currency and metals, would signal an even quicker pace of internationalisation.

    This report must be read with the disclosures, analyst certifications and the disclaimer.