Capital Risk Management… and the Rising RMB

As the world’s second largest economy, the largest exporter and second biggest importer, there is growing worldwide demand for China’s currency – the renminbi (RMB). The use of its currency will undoubtedly continue to grow, but until recently, the RMB was less accessible from the outside business world, making it difficult for trading partners to manage any risks associated with its currency. By KC Lam, CME Group.

KC LamThe rapid growth of the RMB only took off in 2010 when the People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE) started to internationalise it through trade settlement, bilateral currency swaps and the incubation of offshore centers. Since then, the RMB has experienced rapid growth in deposit and trading volume both on- and off-shore. The RMB is now being used for business transactions in multiple off-shore locations which include Hong Kong, Singapore, Korea, Australia and other areas around the world. Accordingly, a need for capital risk management tools for the Chinese currency has emerged.

Offshore RMB in Hong Kong (known as CNH) has been actively traded in the Asian market, but the liquidity and depth of the market quickly dissipates after Asian trading hours. In addition, market access is limited for participants outside of Asia. To move to the next stage of internationalizing RMB, trading in the currency needs to be global and accessible to a diversified client base, across hedge funds, proprietary trading firms, banks, as well as corporate and retail accounts.

In addition, the FX community trades round the clock, and for the RMB to internationalize and globalize, it has to be available not just during Asian hours, but in other time zones as well. In February, CME Group will launch its deliverable offshore CNH futures, offering close to 24 hours of trading, across more than 85 countries, with a T+2 variation margin that would greatly benefit traders outside Asia. This will give customers and clearing members time to fulfil their financial obligation to the exchange to meet variation margin calls.

Increasingly, we are getting end customer queries and requests for clearing NDF (Non-Deliverable Forwards) trades that are traded over the counter. Customers who are trading both futures as well as the over the counter NDF trades can benefit from capital efficiencies through margin offsets.

In this brave new world, one can expect more focus in the areas of clearing, mitigating counter-party risks, hedging, transparency, security and safety of customer transactions. All these will come into play and whether it is a regulatory push or whether it is just inherent risks in the market today, market participants have become more aware of all the various issues that could potentially arise.

The future trend is heading towards full internationalisation of the RMB, where we see the RMB becoming a global payment currency. However, before that can happen, China needs its currency to be fully convertible and it must be perceived to remain strong in value with deep liquidity. In the meantime, the listing and trading of CNH futures plays an important facilitating role in “globalising” the currency and can help China continue the push for greater acceptance of the RMB as an international and trading currency.

In 2010, the offshore RMB business experienced rapid growth in Hong Kong. To give an idea of the size and scope of this expansion, by the end of 2011, CNH deposits in HK totalled over 600 billion Yuan, an increase of approximately 317% versus 2010. Growth had significantly slowed by the end of last year, however, and CNH deposits in Hong Kong had dropped to about 570 billion yuan. By Vivien Deng, Newedge.

Vivien DengWhat was the reason for this slowdown? The lack of investment instruments for offshore RMB. The total amount of CNH bonds and other instruments is much lower than the CNH deposits in HK, with low liquidity. Therefore, there is an enormous demand for the launch of new RMB denominated products and exchanges have been taking action to address this. Last year, HKEX launched the first exchange-traded USD/CNH currency futures settled in Yuan and CME is soon to launch a deliverable offshore RMB futures product. HKMEX has been preparing to launch RMB denominated gold and copper futures contracts. It is now clear that exchanges are competing to catch the growing offshore RMB pool, as well as position themselves for the advent of RMB internationalisation.

On the other side of this equation, China is preparing to launch USD denominated products. For example, the Shanghai Futures Exchange is preparing to launch a Crude Oil futures contract, which will be denominated in either RMB or USD. The plan is for this to be the first commodity contract open to foreign investors. At present, these efforts are enjoying full Chinese government support, as illustrated by the fact that the CSRC has amended futures trading rules and has taken action to clear obstacles that may halt the launch of this contract. This currently is in a simulation stage to test settlement and clearing processes for both currencies, though concrete plans have not been finalised.

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