HK poised to benefit as yuan gains currency

Hong Kong expects dramatic gains in its yuan business as the currency is being used more widely around the world in trade settlements and other financial transactions, report Emma Dai from Hong Kong and Shi Jing from Shanghai.

Surging renminbi deposits in Hong Kong reflect the wider use of the currency in global trade and financial transactions, and the expansion of other offshore yuan centers will bring synergies to the city's banks, experts said.

HSBC Holdings Plc, Hong Kong's largest bank, said that by 2015, it expects total yuan deposits in the city to reach 2.6 trillion yuan ($426 billion), or 30 percent of the total, up from 960 billion yuan at the end of October.

Yuan deposits in the city will likely show double-digit growth each month, outstripping the increase of deposits in other currencies - including the Hong Kong dollar, Anita Fung Yuen-mei, the chief executive of HSBC's Hong Kong office, told a local newspaper.

"The boom in yuan deposits in October reflected market expectations for further appreciation. Higher interest rates for the currency also attracted many individual investors," said Raymond Yeung, senior economist of the Australia and New Zealand Banking Group Ltd.

"On the corporate front, cross-border trading picked up in October. More capital flows in and out of the Chinese mainland also supported the rise of yuan deposits in the city."

Also in October, the yuan overtook the euro to become the second-most widely used currency in trade finance, the Society for Worldwide Interbank Financial Telecommunication said on Tuesday.

The yuan stood just behind the US dollar, which remained the leading currency in trade finance with a share of 81.1 percent.

The top five markets using the yuan for trade finance in October were the Chinese mainland, Hong Kong, Singapore, Germany and Australia, SWIFT said in a statement.

Although Hong Kong has been consolidating its leadership as a yuan trading center, there's a new competitor: the China (Shanghai) Pilot Free Trade Zone, which harbors the same ambition.

Earlier this week, the People's Bank of China released guidelines for the FTZ covering capital account convertibility, cross-border use of the yuan and interest rate liberalization.

The central bank's guidelines specify that resident individuals employed in the FTZ may invest in securities abroad using their income in the zone. Non-resident individuals employed in the FTZ may invest in securities in the mainland.

The central bank also said that offshore parent companies of enterprises in the FTZ will be permitted to issue yuan-denominated bonds in the mainland's capital market. Further, entities in the FTZ may hedge risks associated with currency and maturity mismatches, either within the FTZ or offshore, and they may use derivatives for that purpose.

Economists from Citi Research, a unit of Citigroup Inc, said the reforms associated with the FTZ are in general "more liberal relative to pilot programs in the rest of China", especially with regard to cross-border transactions.

The economists pointed to liberalization measures that cover foreign direct investment, portfolio investment, cross-border lending and derivatives.

However, Shuang Ding, senior China economist of Citi Research, said that the financial reforms in Shanghai are still "conservative". He agreed that the moves will facilitate cross-border use of the yuan, but he added that there's "limited" interest rate liberalization.

"Whether the FTZ or Shanghai as a whole will shoulder the role of a financial center in China largely depends on whether there is a smooth two-way flow of funds in and out of the FTZ," said Shen Minggao, economist at Citi Research.

Willing investors

Rising yuan deposits in Hong Kong signal a larger scale of trade settlements denominated in the currency. The increase also indicates that investors are more willing to hold the yuan, which means more opportunities for Shanghai, said Shen.

"If Shanghai can provide more renminbi-denominated products and provide more convenient foreign exchange settlement business, Shanghai can hope to become a renminbi center," he said.

"But mere growth in deposits has little to do with the market," said Yeung. "Deposits are debts on banks' balance sheets. Banks have to find a way to lend that money out. Now, most of the loans are in US dollars. If there is a crisis, the currency mismatch can lead to a shortage of capital."

"Hong Kong's yuan market is dominated by trade finance. However, we need more yuan-denominated investment vehicles to make the city an offshore yuan hub," he said.

The current choices are mainly dim sum bonds (yuan-denominated bonds issued outside the mainland) and exchange traded funds related to the A-share market.

Yeung noted that the quota for the RQFII program, which allows foreign holders of the yuan to invest their funds domestically, isn't being fully utilized in Hong Kong.

Overseas investors lack confidence in the A-share market because of corporate governance loopholes and the risk of local government debt, Yeung said.

Commodity 'gap'

He said yuan-denominated commodity prices represent a gap in the market.

"China is the major consumer of metals, sugar and cotton in the global market. But up to now, prices for all of these products have been calculated in US dollars.

"If we can have deals in these products cleared in renminbi, the offshore yuan market will take a leap forward," he said.

Since Hong Kong Exchanges and Clearing Ltd, which operates equity and derivative markets in the city, has acquired the London Metal Exchange, "we should see if they will roll out some products", Yeung said.

Conditions in the offshore yuan market also depend on the opening of China's capital account. "It's still inconvenient for issuers to bring the funds they raised in Hong Kong back to the mainland," said Ivan Chung, senior credit officer of Moody's Investors Service.

"That curbs their appetite to issue more dim sum bonds in overseas markets."

According to Chung, most holders of dim sum bonds in Hong Kong are individual investors who buy short-term debt, usually with terms of two to three years, and hold it until it matures.

They're buying yuan bonds because these instruments offer higher interest rates than savings accounts.

"The secondary market is very quiet," Chung said. "In a developed market, such as US dollar bonds, you should see high liquidity in the secondary market. If the secondary market is more active, there will be more long-term bonds. And we should see more institutional investors adding yuan-denominated bonds to their portfolios."

Second thoughts

"It will be positive for the market if the 20,000 yuan daily conversion cap per person is lifted," Chung said.

"But the central government might have second thoughts, as doing this might lead to fluctuations caused by 'hot money'. Most likely, we will see the cap raised gradually to 100,000 yuan a day."

The Shanghai FTZ offers challenges to Hong Kong, but more important, it will mean more participants in the offshore yuan market.

The rise of other offshore yuan centers, such as London, is expanding the global market for the currency, and Hong Kong stands to benefit.

"The Shanghai FTZ is bringing more players to the offshore renminbi market," said Yeung. "As it allows free capital flows, that will benefit the offshore yuan business as a whole, and that will help Hong Kong."