Eyeing a slice of the renminbi pie

Inherent advantages help London pip other European rivals for offshore yuan business

Apart from its stature as a leading financial center, London is also known to have the largest offshore yuan market in Europe with total deposits exceeding 100 billion yuan ($16.3 billion; 12.5 billion euros).

The offshore yuan market is often seen as the test-bed for China's currency internationalization moves. In June, the UK became the first G7 country to sign a yuan currency swap deal with China.

Swap lines typically allow banks to access foreign currency in times of crisis. Under the deal, valued at 200 billion yuan, the central banks of UK and China can undertake currency exchanges and lending activities in cases of emergency.

"Britain has shown its confidence in the growing internationalization of the renminbi and wants to be the first offshore renminbi center in the Western world," says Fang Wenjian, CEO of Bank of China (UK) Ltd.

"Public sector involvement will help speed up the development of London offshore renminbi market and instill greater market confidence."

London has the right credentials to be the offshore renminbi hub, he says, as it has inherent advantages such as developed foreign exchange, derivatives and capital markets, a sound legal and regulatory environment, and the unique time zone advantage. But the most important factor is that the UK government itself is keen to make London an offshore renminbi center and has expressed its strong willingness and intention to make it a reality.

London's efforts to boost yuan business started in September 2011 when the then Chinese vice-premier Wang Qishan, in his meetings with George Osborne, the British Chancellor of the Exchequer, welcomed private sector initiatives for the development of an offshore yuan market in London.

Since then, London's financial players have actively worked on developing new yuan products, so that more yuan transactions for both trade and investment purposes are undertaken in London.

London's private sector initiative to develop yuan products has been led by the City of London Corp, the local authority in charge of London's square-mile business district.

"(We are) working hard to increase awareness of and confidence in the use of yuan products and services in London," says Mark Boleat, policy chairman of City of London.

In April 2012, the City of London launched an initiative for making London the hub for offshore yuan business. The plan aims to provide leadership to the wider financial markets on the technical, infrastructure and regulatory issues relevant for the development of the yuan product market in London.

It also advises the Treasury on maximizing London's capacity to trade, clear and settle the yuan and articulate practical steps and long term aims for the development of the yuan market in London. Additionally, the group advises the Treasury and other UK authorities on any financial stability concerns the members may perceive.

"Recent data has indicated strong growth in demand for spot yuan, which is evidence of the growing liquidity in the offshore yuan market, the increasing confidence of investors to trade in it, and the growing diversity and sophistication of the offshore market," Boleat says.

Spot yuan foreign exchange trading in London is estimated to account for 26 percent of the global offshore yuan spot market, according to City of London's statistics.

Last year, the London yuan offshore market made further development in terms of products and business scale, especially in foreign exchange trading businesses.

According to data released by the City of London, by the end of 2012, London achieved robust growth in trade-related renminbi businesses. The volume of import and export financing increased by 100 percent, compared with the end of 2011, to 33.6 billion yuan.

London also saw a few yuan bond issues in 2012, including ones by HSBC and China Construction Bank.

China Construction Bank, the country's second-largest lender, launched a 1 billion-yuan London-listed bond, or a so-called dim-sum bond, in November 2012, the first Chinese borrower to issue bonds in the London yuan bond market.

"China Construction Bank's decision to float the bond in London is proof of London's growing stature as the Western hub for renminbi business," Osborne says.

Another example of a product that helped boost London's yuan liquidity is the repo transaction between UBS AG in London and HSBC Holdings Plc's Hong Kong branch, carried out in December 2012, with the Hong Kong Monetary Authority managing the collateral.

The deal allows HSBC to lend its renminbi in Hong Kong to UBS in London, where the liquidity for renminbi is smaller, so effectively helping London to deal with the risk of fragmented liquidity in London, says Candy Ho, HSBC's head of renminbi business development in Hong Kong.

"Hong Kong has the most liquidity for renminbi, but there have also been a lot of renminbi transactions coming through different parts of the world," she says.

"By reducing the risk of fragmented liquidity, and allowing funds to flow between different renminbi centers, overall offshore liquidity for renminbi will increase."

As London is not currently an offshore center for yuan, offshore renminbi accumulated in London can only flow into the Chinese mainland via Hong Kong's clearing bank, Bank of China's Hong Kong branch. This allows European banks with renminbi accounts to participate in the yuan Real Time Gross Settlement system in Hong Kong.

But Boleat says he does not see an urgent need for London to have a clearing bank because the Hong Kong arrangements serve London's needs.

Boleat adds that maintaining a single pool of offshore yuan is important for the development of a liquid, global offshore market. "We hope that developments in other centers will not see segregated pools of renminbi being developed."

Fang of BOC says: "In the beginning, it's better to take advantage of Hong Kong's system. But we should never underestimate London's potential in conducting renminbi business. We all believe that there's great potential for London to be an offshore center."

Zhu Yinan, a senior associate at the international law firm Clifford Chance, adds that the People's Bank of China, Bank of England and other market participants are constantly monitoring the progress and evaluating the need for having a separate settlement and clearing system for London.

"As we are all aware, PBOC has been developing a new payment system, the China International Payment System, which is being designed specifically to cover renminbi settlement from different time zones and this could be introduced as early as the beginning of 2014," Zhu says.

Zhu says how the CIPS will interact with existing payment channels and clearing banks is yet to be seen, although the reference to "eligible participants" to CIPS by PBOC implies it will not replace the existing payment systems straightaway.

Zhu says that if London has its own clearing bank, it will make local transactions more efficient and also help to develop the capital market activities in the city.

"It would make more sense to have the swap line if there is a local clearing system in London," Zhu says. "Earlier this year, the chief representative of PBOC in Europe indicated that it would be supportive of London having its own clearing bank if that's what London needs."

"International and Chinese banks have been eyeing opportunities and movements across the continent in this regard, and working behind the scenes to win the support of Beijing in circumstances where a yuan clearing bank in London may be appointed."

When it comes to the main obstacles facing London, Wim Raymaekers, head of banking market at the Society for Worldwide Interbank Financial Telecommunication, says: "Rather than obstacles, we see an opportunity for financial institutions in the UK to further support their corporate customers by settling their commercial trade in renminbi."

Fang says the advanced financial infrastructure, the mature legal and regulatory system and the highly developed financial markets make London the ideal destination for internationalization of the renminbi.

"London will also help improve the depth of the yuan offshore market and stimulate a more active yuan investment market because it has a huge number of institutional investors and a significant liquidity pool," Fang says.

Zhu says that by establishing the renminbi swap line with China, London remains in pole position to become the offshore renminbi business center in Europe, even though other centers such as Paris and Luxembourg have become increasingly vocal on grabbing a slice of the yuan pie.

At the same time, it is also not clear how the swap deal will be put to use, Zhu says. "Effective and meaningful use of the swap will be key for sustained development of the offshore yuan business," Zhu says.