Professional Documents
Culture Documents
China onshore
CNY
Exchange traded bonds CNY DF
Bert Gochet
(852) 2800 8325 bert.j.gochet@jpmorgan.com
Corp
Exchange traded shares
Yen Ping Ho
(65) 6882 2216 yenping.ho@jpmorgan.com
PBOC
Corp
FDI
Corp
Interbank bond mkt pilot program
Jason Mortimer
(852) 2800 8329 jason.j.mortimer@jpmorgan.com
Corp
BoC
QFII
Grace Ng
Corp
Conversion quota
ODI
Investor
Simon Song
(86-21) 5200 2833 simon.p.song@jpmorgan.com
Corp
Corp
HKMA
BoC(HK)
Corp
Participant bank
CNY NDF
CNH
Investor
Corp
CNH DF
USD
HK bank
Hong Kong
Offshore
Source: JP Morgan Legend: Financial product Central Bank Corporate Bank Investor CNH market
www.morganmarkets.com
The certifying analyst(s) is indicated by the notation AC. See last page of the report for analyst certification and important legal and regulatory disclosures.
J.P.Morgan Securities (Asia Pacific) Ltd The CNH market January 26, 2011
Asia Markets Research Simon Song (86-21) 5200 2833 Bert Gochet (852) 2800 8325
How the CNH market fits into the internationalization of the renminbi
China is carefully building up avenues for circulation of renminbi between offshore and onshore The CNH market in Hong Kong is the most visible result of this process. We show how all the pieces of the CNH and CNY market fit together.
Details pilot program first launched in Shanghai and 4 cities of Guangdong province, for cross-border trading with Hong Kong, Macau, and ASEAN.
Pilot program expansion previous pilot program expanded to 18 additional provinces, for cross-border trades with all countries. Also, the scope now covers services trade. Amended Clearing agreement Pilot program for opening bond market Pilot program for RMB ODI settlement PBoC amended the Clearing Agreement with BoC (HK), expanding the scope of RMB business and increasing flexibility in RMB-denominated financial services. PBoC lauched another pilot program of opening China interbank bond market for three kinds of overseas institutions. PBoC announces another pilot program which allows qualified corporates to settle in RMB in overseas direct investment (ODI).
Asia Markets Research Simon Song (86-21) 5200 2833 Bert Gochet (852) 2800 8325
China onshore
CNY
Exchange traded bonds CNY DF
Corp
Exchange traded shares
PBOC
Corp
Corp
Interbank bond mkt pilot program
Corp
BoC
Conversion quota
QFII
ODI
Corp
Investor
Corp
Corp
HKMA
BoC(HK)
Corp
Participant bank
CNY NDF
CNH
Investor
Corp
CNH DF
USD
HK bank
Hong Kong
Offshore
Source: JP Morgan Legend: Financial product Central Bank Corporate Bank Investor CNH market
FDI
3
J.P.Morgan Securities (Asia Pacific) Ltd The CNH market January 26, 2011
Asia Markets Research Simon Song (86-21) 5200 2833 Bert Gochet (852) 2800 8325
For the last six months, any retailer or corporateregardless of its country of domicile- has been able to do RMB business in HK, as long as they simply open a settlement account with BoC (HK). All their transactions are closely monitored by HKMA. But there is a restriction on clearing - banks can only square open positions of RMB with BoC(HK) for settlement of cross-border trade, subject to a quota (which was CNY8bn last year, and 4bn for 1Q11). Meanwhile, non-trade related transactions can only be squared in the CNH inter-bank market. This raises the important point that CNY can freely leave China and enter the CNH market as long as it is backed up by trade documents, but the reverse is not true. Say for example, a mainland based importer can pay in CNH for as many imports as he likes. This flow of CNY out of China into CNH happens without quota, and is the main reason why CNH deposits in Hong kong have picked up so strongly in 2010. But a non-China based buyer of Chinese goods is not necessarily guaranteed to be able to obtain CNH to pay for his purchases. After all, he will need to purchase the CNH in the market or from his banker, and eventually that position will need to be squared via BoC(HK) subject to the conversion limits set by PBOC. These limits were the topic of discussion late last year when it turned out that the CNY8bn conversion quota for 2010 had been exhausted ahead of year-end. Effectively, there had been more demand for CNH from non-China based corporates than authorities had expected, and the quota had already been filled. The quota for this year has been increased, with CNY4bn for the first quarter. It is believed that this will be sufficient for now. Over time though, the CNH liquidity in the Hong Kong market will become self sustainable and the quota approach will eventually be scrapped.
The 2009 pilot program for cross-border trade kicked CNH deposits up a notch. Since then, holding RMB in HK became meaningful for exporters and importers. Deposits increased on the back of cross-border trade. From chart 2 you can tell how deposits picked up pace from mid 2009. The pace of deposit growth over that period was broadly in line with the growth of China net imports settled in RMB. In other words, goods and service trade in the current account were the main source of RMB in HK over that period. During this initial stage, Bank of China (HK) started to play a special role in controlling the flow of RMB in Hong Kong. It was appointed as the clearing bank for all transactions in the territory, ie. a de facto central bank for RMB in Hong Kong. BoC(HK) thereby became the lender for all RMB transactions, and also all RMB held by other banks was to be deposited with BoC. In the days after the pilot progam announcement the access to RMB in HK was only available to a limited amount of counterparties, and for a well defined set of purposes: retail customers (for RMB deposits and bonds), corporates (for trade settlement), and depository institutions (for attracting deposits). Since mid-2010, the pace of development stepped up another notch. In July, PBoC amended the Clearing Agreement with BoC (HK), expanding the scope of RMB business. As part of that amendment, corporates were now allowed to open RMB accounts and transfer funds across accounts for any purpose, regardless of whether or not they relate to trade settlement. In addition, banks were allowed to introduce RMB-linked products, such as CDs, deliverable forwards, mutual funds, and insurance products. Interbank CNH deposits and CNH deliverable forwards started trading in the market. At the same time, CNH deposits started ballooning.
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Asia Markets Research Simon Song (86-21) 5200 2833 Bert Gochet (852) 2800 8325
The Mini QFII is a program would allow CNH funds flow back into capital markets in China (including A shares) through the channel of financial products provided by HKbased Chinese security firms and asset managers (Note that Mini QFII is different from the plain QFII: in the latter, USD gets echanged for CNY and invested in mainland exchange traded products). Chinese media have reported on Mini QFII several times since last year. But an official approval has been delayed by concerns about hot money flows. Last week, Shang Fulin, the Chairman of CSRC again said that Mini QFII will be launched soon, but on a trial basis. HKMA officials have also hinted that this program is pending Chinas top leaders approval. The second approach is letting selected offshore institutions buy CNY bonds in the onshore interbank bond market. Under this scheme, three kinds of overseas institutions will be allowed to buy bonds onshore: (1) central banks who are already in cooperation with PBoC (such as through a currency swap line), (2) the RMB clearing banks in HK and Macau, and (3) overseas participation banks ie. those banks who are the participants in RMB cross-border trade settlement. The central banks and clearing banks would be able to access the Chinese interbank bond market directly or go through an agent bank such ICBC or BOC. The participation banks will have to go through an agent bank and cannot access the interbank market directly. But even for this limited amount of institutions restrictions apply, as one would perhaps expect. First, the bond investment needs an approval from PBoC. As far as we know, only HKMA, BNM and ICBC (Asia) have received an approval so far. Secondly, a quota will apply. In our
understanding, this would not be more than a few billion CNY to start. Third and perhaps most important, the source of RMB funds for the bond investment should be either (1) from currency swap lines with PBoC (note PBoC has opened up a total of CNY 800bn of swap lines with eight central banks since 2008. They are unused so far, but will be used for small size soon to kick off this program ), or (2) cash from RMB cross-border trade by participation banks, or (3) from proceeds from investing in RMB business. Fourth, each overseas institution can open only one RMB nostra account with one of the eligible onshore banks to do bond trades. The impact of this pilot program on the onshore markets (spot, forward, bond, etc) is limited in the near term, since time is needed for application, approval and setup of operations. In the future, however, this program will improve the circulation of RMB between onshore and offshore, and link together the RMB markets in the Mainland and HK. This channel can be considered the first tentative step toward an eventual opening of the capital account.
J.P.Morgan Securities (Asia Pacific) Ltd The CNH market January 26, 2011
In practice, an international currency has to play the roles of store of value, medium of exchange and an unit of account, for both residents and non-residents, both the private sector and public sector. At the official, public sector level, China has signed a number of bilateral swap arrangements, denominated in RMB, with central banks from other Asian and emerging economies, including Korea, Hong Kong, Malaysia, Russia, Indonesia, Argentina, etc, since the onset of financial crisis, with the total amount of swap arrangments accumulating to more than 800 billion yuan.
As of November 2010, outstanding RMB deposit in the Hong Kong banking sector came in at 280 billion yuan, equivalent to 3.9% of of Hong Kongs total M2 money supply. Meanwhile, the Chinese authorities introduced the RMB trade settlement scheme in July 2009, which was then expanded in various stages to cover more than 67,000 Chinese corporates from 16 provinces and cities by December 2010. In addition, the PBoC introduced a pilot scheme in August 2010, allowing eligible institutions outside the mainland to use their RMB funds to invest in Chinas domestic interbank bond market. Given the notable progress on policy liberalization, and with growing expectations on yuan appreciation in recent months, outstanding RMB deposit in Hong Kong banks jumped by 212% since June 2010, to reach 280 billion yuan by November, equivalent to 4.6% of Hong Kongs total M2 supply.
GBP Others 0.3 0.8 0.0 0.1 0.3 0.6 0.2 0.6
J.P.Morgan Securities (Asia Pacific) Ltd The CNH market January 26, 2011
the long term potential scope of RMB trade settlement, for the medium term we have come up with more conservative scenario analysis regarding RMB trade settlement for the coming five years, with the focus on expanding RMB settlement on the import front at this early stage. Assuming the share of Chinas total imports settled in RMB will rise steadily towards 10% by 2015, and assuming average 10% annual growth in Chinas imports, along with a more modest share (up to 3%) of exports settled in RMB, the pool of total trade-related RMB deposits, most of which will likely reside in Hong Kong, could potentially rise to as much as 2,600 billion yuan in five years. This is a significant amount compared again the outstanding size of Hong Kongs M2 money supply at HK$ 7,111 billion as of November 2010. In an alternative scenario, if we assume that it is the group of emerging market economies, including non-Japan Asia, Latin America and Africa, that would see a notable rise in the share of their exports to China settled in RMB (given their closer economic ties with China, and the fact that China has in general held a trade deficit with this group), and assuming the share of Chinas total imports from this group to be settled in RMB will rise steadily towards 20% by 2015, the pool of total trade-related RMB deposits in Hong Kong could potentially rise to as much as 3,500 billion yuan in five years.
2006
2007
2008
2009
In addition, going further ahead, China could further open up avenues for domestic investors to invest overseas, which includes, but would not be restricted to, the Qualified Domestic Institutional Investor (QDII) program, in order to diversify the investment channels for the private sector. Part of this could be invested in RMB-denominated investment products offered in Hong Kong. The potential shift of every 1% of Chinas domestic deposit to RMB-denominated investment products in the Hong Kong financial market would amount to the equivalent of 700 billion yuan.
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Apr-12
off the 7-day repo, 1-year deposit, and 3-month SHIBOR) are traded onshore as well. For foreign investors, they are available in ND-form offshore.
Chart 2: Composite yield curves in Onshore CNY (green), Offshore deliverable CNH (blue), and Offshore NDF CNY (grey). Offshore CNH yields generally trade intermediate to Onshore CNY and Offshore NDF yields.
6.0 5.0 4.0 3.0 CNY T-Bill 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 0 2 4 6 8 10 12
9
% CNY Deposit CNY ND-IRS (7d Repo) CNY IRS (7d Repo) CNY Govt CNH
CNY ND Forward FX
J.P.Morgan Securities (Asia Pacific) Ltd The CNH market January 26, 2011
started trading around the same time. CNH deposit rates are based on quotes from BoC(HK), and given their one-way nature these rates are significantly lower than onshore deposit rates. The CNH interest rateswap market has gotten off to a false start: initial deals were based on (onshore) SHIBOR but this proved impractical and such swaps are no longer actively quoted. The dim sum bond market refers to CNH-denominated bonds that were issued offshore. The majority of dim sum bonds are denominated in CNH, but some other bonds are linked to CNY (but paid in USD). Chinas CNHdenominated benchmark sovereign bond curve is currently comprised of a single issue each of 3y, 5y, and 10y CGBs. These bonds were issued by the Ministry of Finance, in the Hong Kong market in December 2010. Their yields are significantly below mainland government yields, as they are commonly used as a CNY-appreciation proxy. Bond issuance in the CNH market has increased sharply since the lifting of restrictions on trading CNH in mid-2010. The current total of outstanding issuance is CNY59bi. The greatest issuers are banks (29%), government agencies (25%), and sovereigns (24%).
BANK 29%
Graph 2: CNH bond notional issuance increased dramatically since August 2010
mln CNH 60,000
40,000
20,000
GOVT NATIONAL 24% GOVT AGENCY 25%
0 Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
10
Mainland capital account remains closed and RMB funds cannot flow freely from Mainland to HK and to global markets, the lack of free arbitrage should leave USD/CNH biased to a negative spread against onshore USD/CNY. While a move to a free capital account would allow offshoreonshore convergence, this is not expected anytime soon. Fundamentally, the PBoC remains extremely sensitive against allowing offshore investor (or speculative) demand to impact onshore spot. USD/CNH-USD/CNY converged late-2010, but move is temporary and event driven. While USD/CNH rallied into USD premium against USD/CNY late-2010, we view the move as a knee-jerk reaction to HKMA regulatory refinements. In particular, headlines surrounding position limits on CNH had triggered a one-off readjustment of USD/CNH exposures. That said, the details of the regulations do not alter the fundamental elements driving the USD/CNH-USD/CNY spread. They remain 2 separate markets (and arguably more so following the HKMA refinements). We would view USD/ CNH-USD/CNY spot convergences as potential opportunities to be short USD/CNH.
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J.P.Morgan Securities (Asia Pacific) Ltd The CNH market January 26, 2011
entities may also establish re-invoicing centres in Hong Kong, as a means to channel CNH payments to offshore subsidaries as an alternative for offshore financing. These suggest an underlying bid for offshore USD/CNH insofar as it trades at an USD discount to onshore. Conversely, corporates requiring RMB for payments to merchandise trade counterparties in Mainland, may find it cheaper to generate RMB cash via USD/CNH if it trades above the onshore rate. Overall, we still expect USD/CNH to remain biased to the downside against onshore spot. To be sure, convergence trades will anchor USD/CNH to the general trend of onshore USD/CNY, but in the lack of pure and unrestricted arbitrage offshore RMB will still be vulnerable to global demand shocks. This suggests offshore USD/CNH will tend towards a USD discount to onshore spot, as the 2 remain fundamentally separate markets. We would view USD/CNHUSD/CNY spot convergences as potential opportunities to be short USD/CNH.
USD/CNH forwards peeling off the deposit curve NDF USD/CNY depo implied CNH 6.65 CNH 6.60
6.55 6.50 6.45 6.40 spot 3M 6M 12M
USD. This means that participants cannot enter long USD/ CNH offshore DF unless they are already long CNH cash or can easily fund in CNH. The inability to transact in large enough sizes, unwind risks and wide bid-offers on CNH DFs also feature to some part. In addition, both forward curves roll into different spot rates. And this implies basis risk when trying to cover the delivery leg of USD/CNH. Trading the NDF vs CNH would hence constitute taking views on 2 different underlyings, which remains far from a risk-free arb. That said, there is technical appeal to being on the short USD/CNH side of the CNH vs NDF convergence trade given the tendency for offshore spot to trade below onshore. This is apparent particularly at the longer-end of the USD/CNH curve where forwards are in USD discount and substantially off implied pricing from the deposit curve. However, amid fixing risks, liquidity risks and wide bid-offers on USD/CNH
Chart 2: Summary of notable flows across USD/RMB curves (numbers correspond to the text)
USD/CNY
(4) "cross-border" hedging
USD/CNY NDF
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DFs, risk reward is attractive only on wide spreads of USD/ CNH against NDFs. To be sure, the curves could converge increasingly as offshore CNH liquidity improve in Hong Kong. However, trading volumes on the offshore DF have extremely thin. Even factoring strong growth, the market is not expected to achieve the threshold needed to anchor the offshore NDFs anytime soon. If anything, the market has so far been happy to acquire CNH via a lower USD/CNH spot, as CNH in HK can be deployed in positive return assets as opposed to negative carry in the NDF curve. Such demand dynamics may also leave a wedge between markets.
from trading counterparties constrain the scope to position in the NDFs. The recent regulatory changes by SAFE may also have reduced the ability of Mainland corporates to take on such trades. Given the depth of NDF trading liquidity offshore, onshore-offshore arb have had only limited ability to compress the onshore-offshore spread.
Summary
Current regulations ensure offshore USD/CNH remains a fundamentally different market from onshore. Convergence trades may narrow the difference. But in a world of unrestricted CNH access, CNH will remain susceptible to demand-side shocks, and USD/CNH will be biased lower against onshore. Leakages across the 3 forward curves suggest some scope for arbitrage or convergence across markets. See summary chart 2 (flows numbered as outlined by text in preceding pages).
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J.P.Morgan Securities (Asia Pacific) Ltd The CNH market January 26, 2011
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