Policy practitioner paper

Prepared by Bourse Consult January 2013

C i t y o f Lo n don R e n min b i S eri es

London RMB business volumes: January-June 2012

City of London Economic Development PO Box 270, Guildhall, London, EC2P 2EJ www.cityoflondon.gov.uk/economicresearch

Policy practitioner paper

Prepared by Bourse Consult January 2013

C i t y o f Lo ndo n R e n m i nbi S eries

London RMB business volumes: January-June 2012

City of London Economic Development PO Box 270, Guildhall, London, EC2P 2EJ www.cityoflondon.gov.uk/economicresearch

London RMB business volumes: January-June 2012 is published by the City of London. The author of this report is Bourse Consult. This report is intended as a basis for discussion only. Whilst every effort has been made to ensure the accuracy and completeness of the material in this report, the author, Bourse Consult, and the City of London, give no warranty in that regard and accept no liability for any loss or damage incurred through the use of or reliance upon this report or the information contained herein. January 2013 City of London PO Box 270, Guildhall London EC2P 2EJ http://www.cityoflondon.gov.uk/economicresearch

Bourse Consult contact details: Peter Cox PAC@bourse-consult.com Raymond Sabbah RSB@bourse-consult.com

Contents
Introduction ............................................................................................ 2 1 Further developments in the CNH market during 2012 .................. 3 2 The development of London as a centre for RMB business ........... 5 3 Survey results for January to June 2012 ........................................... 6
3.1 Methodology .......................................................................................................... 6 3.2 Trade related services............................................................................................ 7 3.3 Foreign exchange .................................................................................................. 9 3.3.1 3.3.2 Deliverable foreign exchange products............................................. 9 Non-deliverable foreign exchange products ..................................10

3.4 Total deposits in London ......................................................................................11

4 Conclusions ...................................................................................... 13

Introduction
The recent change of leadership in China has placed a renewed focus on the pace of Chinas development and the speed of its continued growth as a global economic power. The ongoing process of reform to Chinas financial system is likely to continue and may even accelerate following the leadership transition. Further liberalisation of Chinas cross-border capital and currency controls will fuel the already rapid progress of the renminbi (RMB) as a global currency. The Governor of the Peoples Bank of China (PBoC), Zhou Xiaochuan, stated in December 2012 that China remains committed to achieving capital account convertibility for the yuan, although making clear that this will not necessarily mean full convertibility or a freefloating currency. For London, the worlds leading international financial centre, the emergence of a global currency of a size and economic importance which ranks alongside the US dollar and euro is highly significant. The City of London initiative on London as a centre for renminbi business was established in 2011 with the objective of encouraging the development of renminbi products and services in London. The initiatives overarching aim is to contribute to a private and public sector strategy for the development of London as a centre for international RMB business. In April 2012 the City of London published a report by Bourse Consult, London: a centre for renminbi business describing Londons position in the global market for financial products and services denominated in renminbi. It also quantified the existing capabilities of London in renminbi-denominated products and services. The study included the results of a survey of banks to determine the aggregate volume of business done in London during 2011 across a full range of renminbi denominated financial products and services. This set a benchmark against which further developments in the market could be compared. The City of London intends to conduct a similar survey, to report on London RMB market activity during the whole of 2012, which will be published later in 2013. In the meantime this report provides an interim view of the development of the London RMB market by reporting on activity during the first half of 2012 in three RMB product and service categories: trade-related services, foreign exchange and deposits. Throughout the report the terms renminbi, RMB or yuan are used when referring generally to the currency of China. When referring more specifically to either onshore or offshore currency the terms CNY for onshore renminbi and CNH for offshore renminbi are used as shorthand. Monetary amounts of yuan are denoted using the symbol .

Further developments in the CNH market during 2012

There have been a number of important events in 2012 relating to the development of the offshore renminbi CNH1 - market which could have an impact on the growth of the London renminbi market. The PBoC announced in April 2012 that it is planning to develop a new international payment system referred to as the Cross-Border Interbank Payment System (CIPS). CIPS promises foreign banks a direct route to a renminbi clearing system operated by the PBoC for onshore and offshore transactions. While implementation of CIPS is still two years off, there is an expectation that it will be SWIFT-compliant, allowing for standardised international messaging between banks. CIPS is likely to become the primary channel for renminbi settlement and will be the foundation for the sort of settlement infrastructure which is conventional for most major convertible currencies. In the meantime, the global CNH market continues principally to use Hong Kongs RTGS system. From 25 June 2012 the operating hours of the RTGS system in Hong Kong were extended from 18:30 to 23.30 (GMT + 8) to cover the office hours in Europe and part of the United States, enabling customers in western time zones to enjoy the convenience of same-day settlement of their RMB. The extension of operating hours is a positive step in the right direction, and gives a longer window to input instructions on the trade date, although the divergence with onshore hours limits the utility of the extension. Both Taiwan and Singapore have announced plans to develop local RMB clearing systems. Renminbi payments made via the SWIFT network have grown during 2012 such that the renminbi is now ranked number 16 in the SWIFT world currency payment table compared to number 20 at the start of the year. The great majority of SWIFT renminbi payments are interbank but it is also noteworthy that a number of banks, including Citi, JP Morgan Chase and HSBC, have reported publicly significant growth in the use of renminbi for trade payments by their commercial customers. A pilot programme was launched by the Chinese authorities to allow RMB crossborder lending by multi-national corporations with a presence in mainland China. The programme allows them to lend their own RMB funds to offshore parent companies or related companies within the same group. This represented a further notable liberalisation of the Chinese capital account and may encourage more multinationals to use renminbi for cross-border trade settlement. In the exchange traded derivatives arena there have been interesting innovations. CME Group announced that it is expanding its overall suite of Chinese renminbi products to include Deliverable Renminbi (CNH) futures. London-based CME Europe Ltd, which is awaiting regulatory approval as a Recognised Investment Exchange, is

Although there is a single source of RMB the Peoples Bank of China (PBoC) in mainland China the currency has some different characteristics depending on whether it is held onshore or offshore. For the purposes of this report, offshore is used to describe RMB held outside mainland China. The two pools of RMB trade in effectively different markets because the currency is not freely transferable to and fro across the border. The industry has labelled the offshore pool with a pseudo currency code CNH to distinguish it from onshore pool CNY. CNH is widely used as the name for the global offshore renminbi market.

expecting to offer these products from mid-2013. The Hong Kong Exchanges and Clearing Limited (HKEx) introduced renminbi currency futures on 17 September 2012. On the bond issuance stage, HSBC issued a 2 billion three year bond in London in April 2012 60% of which was subscribed by European investors, showing the growing demand in London for offshore RMB investment products. ANZ issued a 1 billion three year bond in August 2012 which was listed in London and had strong support from European institutional and private banking investors. In December 2012 China Construction Bank became the first Chinese bank to issue a renminbi-denominated bond in London. The bank raised 1 billion through its London subsidiary. The bonds, which mature in 2015 and pay an annual coupon of 3.2 per cent, saw strong interest from institutional investors. In May 2012 Standard Chartered announced that it reached a total issue of 1 billion in European Commercial Paper (ECP). ECP bridges the tenor gap between dim sum bonds2 and traditional deposits for investors, enabling investors to access short term RMB securities offering attractive yields. A large part of the funds raised will be used to provide inter-market liquidity between London and Hong Kong to support RMB trade for its clients. Meanwhile, Industrial and Commercial Bank of Chinas London subsidiary issued 100 million certificates of deposit in London in May 2012, the first by a Chinese bank in London. Notably, all participants in the issuance (issuer, investor and dealer) were institutions operating in London. In addition to private sector developments, two meetings of the Hong Kong London RMB Forum have been held, facilitated by HM Treasury and the Hong Kong Monetary Authority. The discussions have focussed on increasing liquidity in the global CNH market, marketing and education to promote the wider use of the renminbi and efficient clearing and settlement arrangements.

Dim sum bonds refer to bonds denominated in RMB and issued outside mainland China.

The development of London as a centre for RMB business

London is an international financial centre, enabling the efficient allocation of capital for global clients and customers. This includes enabling international companies to source funding, hedge risks such as changes in currency or interest rates and fluctuations in the prices of the commodities and to manage capital efficiently. Londons financial services market is highly international, with particular strengths in markets such as foreign exchange. For example, twice as many US dollars are traded in the UK than in the US and twice as many euros as in the Eurozone drawing on a highly mobile pool of US dollars and euros. Through the international forex market, Londons global institutions are able to access funds from around the world and provide liquidity in whichever currency is needed, irrespective of where the funding is held. The development of renminbi business in London is consistent with Londons role as an international financial marketplace. London offers its RMB services to any investor holding RMB in the global CNH pool and Londons global institutions regard the maintenance of full fungibility across the global pool of offshore RMB to be vital to the development of the offshore market. RMB passes to the offshore pool both via Hong Kongs infrastructure and by trade settlement directly between mainland Chinese companies and foreign companies. Once RMB is offshore, it moves freely between different offshore locations when business opportunities arise. For example, Asian as well as European investors participated in the three London dim sum bonds issued in 2012. Hence the growth of Londons RMB business is not dependent upon the amount of RMB specifically held within London institutions. As the offshore RMB market continues to develop, further investment opportunities are created by the liberalisation of RMB cross-border controls and market confidence increases, transaction volumes in the key centres for RMB business including Hong Kong, London and Singapore can be expected to continue to grow. The growth of transaction volumes represents the most significant metric to measure this development across centres. The report London: a centre for renminbi business demonstrated that London offers a full set of RMB products and services, and the growth in these business volumes is a benchmark of the London markets development. This is consistent with the measurements used for business in currencies such as the US dollar and euro: transaction volumes rather than the physical location of deposits are the measure of market development. For example, forex volumes are a well-established and quantifiable metric for gauging currency activity in different financial centres through the surveys of market practitioner committees hosted by central banks such as the Bank of England3. The following section provides data on business volumes in London for the period January June 2012, which demonstrate substantial growth in the London market.
3

For example the Foreign Exchange Joint Standing Committee, the New York Foreign Exchange Committee, the Tokyo Foreign Exchange Market Committee, the Canadian Foreign Exchange Committee and the Australian Foreign Exchange Committee.

Survey results for January to June 2012

3.1 Methodology
The methodology for this study was the same as that used for the April 2012 report, which covered trading during 2011, except that data was collected on a sub-set of the financial instruments covered by the 2011 full year survey, namely trade-related services, foreign exchange and deposits. In order to avoid any double counting of deals with Hong Kong, the definition of London business used for this report is any deal generated and/or executed in London. Care has also been taken to avoid any misunderstanding in the definition of the individual financial instruments and the way these should be accounted for. A sample of 12 banks was approached which are estimated to cover the majority (estimated at 85 per cent) of the market. One bank which reported no London RMB business in the 2011 survey was not canvassed in this survey. All responses were scrutinised for reasonableness including comparisons with the submissions for 2011, and a number of queries were raised and resolved either by revision of data or confirmation by the submitting banks. In addition to banks covered in the last survey, three custodians were approached but it is clear that their only involvement in the currency markets is occasional transactions to facilitate customer business. As is normal the quality of responses improves with repetition of such surveys and respondents are more able to gather the data and ensure data quality. The January-June 2012 survey obtained comprehensive returns from some banks which previously had given less detailed data. More generally, the comparison of returns from the two periods has enabled the researchers to question apparent anomalies and improve data quality. The data provided by the banks was then aggregated and extrapolated to produce total market figures. The extrapolation takes account of the proportion of the market covered by the banks providing returns. Comparisons between this survey and the full year 2011 survey were made between end-of-period levels for deposits and average daily volumes for forex trading. Business relating to trade services in this survey was compared with 50% of the 2011 level of business since there is no indication, at this stage, that there are seasonal effects in the market. Throughout the report, percentages are calculated on unrounded figures.

3.2 Trade related services

The volume of trade related services provided by the London banks in January to June 2012 shows strong growth across the board when compared to half the full year 2011 volumes reported in the previous survey4. This category includes all the import/export related activities in RMB from London. Letters of credit (L/C) includes L/C in RMB issued in London and does not include L/C to China in others currencies. Financing includes loans to importers/exporters for trade related activities in RMB from London. Trade services grew to 2.2 billion, a 390% increase compared to the six month average for 2011. The volume in letters of credit grew to 3.7 billion, a 20-times increase compared to the six month average for 2011. Import/Export financing volume grew to 10 billion, a 19% increase compared to the six month average for 2011.

Comments on trade results These figures show a vigorous growth in the use of RMB for commercial trade being facilitated in London. Surveyed banks have commented that a growing number of their customers, both importers to and exporters from China, are making trade payments in RMB. Some have recognised that they may gain a competitive advantage by being able to settle or quote in RMB. Banks have also been making efforts to adapt their trade related services so as to make it easier for their commercial customers to settle in RMB. For offshore importers of Chinese goods it has therefore become easier for them to buy RMB to effect payment or to borrow RMB and hedge it in the forward market. Notably, the price curves for non-deliverable forwards (NDFs) and offshore RMB are no longer pricing in future appreciation of the yuan. In fact for some time they have been pricing in an expected depreciation. The prospect of a depreciating yuan means that it is increasingly less important for Chinese importers to deal in US dollars or euros than previously and is a further motivation for an increase in RMB denominated trade settlement.

Revised figures submitted by the banks after the publication of the report for 2011 show that the figures for trade services were understated. The revised full year 2011 figures for the three lines are therefore: trade services 894 million, letters of credit 370 million and import/export financing 16.87 billion. A six-month average of these revised figures is used as the basis for comparison with the January-June 2012 figures.

Chart 3.1 Volume of trade related services

12,000

10,000

8,000

mn

6,000

TradeServices LettersofCredit Import/ExportFinancing

4,000

2,000

2011(6months)
Source: Bourse Consult survey

2012JanJun

3.3 Foreign exchange

Overall forex activity in RMB products increased significantly compared to 2011. In the first six months of 2012 there was a very significant shift in trading from nondeliverable products to deliverable in all classes except interest rate swaps where the move was firmly in the opposite direction. The value of deliverable products traded increased by 150% compared to a fall of 27% in non-deliverables. This shift into deliverable forex products reflects greater liquidity in the pool of offshore RMB, which in turn may be due to a reduction in speculative pressure on RMB from offshore investors.

3.3.1 Deliverable foreign exchange products

The forex category includes all transactions done on a currency basis including spot (for immediate delivery) and forward (for delivery in the future). The swaps and options are all traded over the counter on a bilateral basis between two counterparties. The forex swaps, options, interest swaps and options and cross currency swaps are OTC derivative instruments used by banks for hedging and risk management purposes. There was strong growth in the main deliverable product lines: Spot RMB forex grew to an average daily volume of US$ 1.7 billion, a 150% increase compared to 2011. Deliverable forwards grew to an average daily volume of US$ 1.1 billion, a 33% increase compared to 2011. Deliverable FX swaps grew to an average daily volume of US$ 3.1 billion, a 240% increase compared to 2011. Deliverable cross currency swaps grew from a low base to an average daily volume of US$ 40 million, a 250% increase compared to 2011.

Comments on deliverable forex results Reflecting on these figures, the surveyed banks commented that the onshore market is becoming more liquid and that this has given investors confidence to reenter the offshore market especially as the divergences between onshore and offshore rates seen in 2011 did not reoccur in the period of the survey. Some banks also attribute the growth to the increase in intra-day volatility, which has stimulated trading, and an increase in technical trading, such as the squaring of futures positions resulting from the general growth and increasing diversity of the market.

Chart 3.2 - Trading in deliverable RMB denominated foreign exchange products

3.5 3.0 2.5

ADV$bn

2.0 1.5 1.0 0.5 0.0

2011
SpotFX FXOptions
Source: Bourse Consult survey

2012JanJun
Forwards InterestRateSwaps FXSwaps CrossCurrencySwaps

3.3.2 Non-deliverable foreign exchange products

Non-deliverables are specific cash settled instruments for non-convertible currencies. RMB non-deliverable contracts are predominantly based on the onshore (CNY) exchange rate and traded offshore specifically because trading in deliverable CNY is not possible offshore. The fact that significant volumes of non-deliverable RMB forex products are traded in London reflects the non-convertible status of RMB. As currency controls are eased and offshore liquidity in RMB increases, a shift from non-deliverable to deliverable products can be expected. It is therefore not surprising that trading in the two main non-deliverable forex product lines declined compared to 2011: Non-deliverable forwards fell to an average daily volume of US$ 3.8 billion, a 31% decrease compared to 2011. Non-deliverable FX options fell to an average daily volume of US$ 2.1 billion, a 20% decrease compared to 2011. By contrast there was very strong growth in non-deliverable interest rate swaps and non-deliverable cross currency swaps, albeit from a relatively low base. o Non-deliverable interest rate swaps grew to an average daily volume of US$ 0.1 billion, an increase of 380%.

10

Non-deliverable cross currency swaps grew to an average daily volume of US$ 0.16 billion, an increase of 220%.

Comments on non-deliverable forex results Reflecting on the figures for non-deliverable products, the surveyed banks commented that, in addition to the expected trend away from non-deliverables as offshore liquidity increases, there has been a feeling among some investors that the official fix against which non-deliverables are settled is not as reflective of the actual onshore spot market as it could be. This, combined with the convergence of onshore and offshore rates, has meant that they have chosen the use the offshore deliverable market rather than non-deliverable products. Banks expect this trend to continue. The relatively low volumes of non-deliverable interest rate and cross currency swaps and the fact that swap regulation is undergoing a sea change which will affect trading patterns in the future mean that it is too early to draw conclusions about the trends in these products. Chart 3.3 - Trading in non-deliverable RMB denominated foreign exchange products
6

ADV$bn

2011
Forwards FXSwaps FXOptions
Source: Bourse Consult survey

2012JanJun
InterestRateSwaps CrossCurrencySwaps

3.4 Total deposits in London

The size of the pool of renminbi held in deposit accounts offshore of mainland China has, in the past, been used as the main indicator of the effectiveness of Chinas relaxation of currency controls and the progress of the internationalisation of the renminbi. That was appropriate when the offshore RMB market was relatively immature and there were limited investment options for offshore holders of RMB. However, it is not the measure which would be employed to monitor the size or health of a more diverse and mature financial market. As investment opportunities are created by the further liberalisation of RMB cross-border controls and the

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development of offshore RMB investment products, CNH deposits can be expected to decrease. London deposits have proved to be much more variable than was expected and this is reflected in the latest survey. This variability reflects in part the relative newness of the market in London, in part the behaviour of deposits when they are held as an asset class and in part the difficulty of collecting a new dataset which led to some misreporting in the first survey. Deposits at the end of June 2012 compared to those reported in the last survey for December 2011 were as follows: Deposits in accounts for personal customers rose by 6% to 4.1 billion. Interbank deposits fell sharply from 74 billion to 7.2 billion. This decrease was largely due to intra-banking group movements of deposits from London to other locations. It has been necessary to rebase the figure for deposits in accounts for corporate customers as a result of misreporting in the previous study. When this is taken into account, the figure for corporate deposits remains stable at 3 billion.

Comments on deposit results Considering these figures, deposits for personal customers in London appear to reflect speculative asset allocations rather than trading balances. Therefore funds are likely to be moved out of deposit accounts and into other assets when a better opportunity presents itself. This occurred in the period January-June 2012 as market sentiment shifted against further appreciation of the RMB and consequently a significant portion of deposits reported as private banking deposits in 2011 were moved into other assets, particularly into dim sum bonds. It is very likely that the shift was facilitated by the increase of RMB Qualified Foreign Institutional Investor (RQFII) scheme5 quotas in 2012 and the development of dim sum bond issuance in London at the same time. The data collected does not reveal average deposit levels, it can only provide a snapshot at the end of the period. The CNH market in London is relatively new, and there is therefore a lumpiness to the deposit base, with relatively few participants holding relatively large proportions of the deposits. A small number of institutions accounted for the interbank deposits in the first study and the drop in this figure reflects large intra-group transfers to other locations. As the market matures and confidence increases particularly with the London market seeing substantial increases in both forex liquidity and the use of RMB in trade settlement an increasing amount of RMB will be held in transaction balances and interbank deposits can be expected to become more stable.

The RQFII scheme permits approved Hong Kong subsidiaries of fund management and securities companies in the Peoples Republic of China to invest in the Chinese securities markets by using RMB raised offshore.

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Conclusions

The rapid development of the offshore renminbi market has continued during 2012 on a path and at a rate which is consistent with the progress made since 2010. The process of reform to Chinas financial system is likely to continue and may accelerate following the change of leadership in China. Recent statements by the Governor of the PBoC reinforce this view. During 2012 a number of additional liberalisation measures have been launched by the Chinese authorities. In addition there has been a significant growth in the range of renminbi denominated products and services available to offshore holders of renminbi. The results of this survey demonstrate that in the first six months of 2012 London grew its business in renminbi products and services at a very rapid rate. The key conclusions from the survey are: Trade related services There was very vigorous growth in renminbi trade related services done in London, reflecting the growing use of RMB as a trade settlement currency outside China but also an acceleration of this activity in London. There was a 390% increase in trade services, a 20-fold increase in letters of credit and a 19% increase in import/export financing. This growth also reflects the development by London banks of new and improved RMB services designed to make RMB denominated trade easier for their commercial customers. Foreign exchange There was strong overall growth in RMB forex trading in London. There was also a very significant shift in trading from non-deliverable forex products to deliverables. The aggregate average daily volumes of deliverable RMB forex products rose by 150% and the headline spot RMB forex product grew by 150% to an average daily volume of US$1.7 billion. The particularly strong growth of spot RMB forex is evidence of the growing liquidity of the offshore RMB market, the increasing confidence of investors to trade in it and the growing diversity and sophistication of the offshore market. Deposits Deposits in accounts for personal customers rose slightly, while the interbank sum fell due to significant intra-banking group movements. Corporate deposits remain stable (allowing for the adjustment made to the base sum following the previous survey) at 3 billion. The availability of additional investment products such as RMB bonds which have been issued in London since 2011 has also had an impact on the level of funds held in deposit.

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Overall The results of the survey show that Londons RMB business is responding vigorously to the growth in the use of RMB for international trade and the appetite for a broader range of RMB denominated products and services from holders of offshore RMB. London is clearly drawing on its capabilities and experience to develop products which are particular to the needs of the offshore RMB market. The strong growth in RMB forex trading is building on the predominant position London has in the global foreign exchange market and demonstrating its ability to grow transactional business with holders of offshore RMB across the world. Following the growth in RMB business volumes in London in the first six months of 2012, further expansion of products and services to meet the needs of corporate and institutional clients can be expected. A full review of London products and services will be published in 2013 to provide a fuller picture of the development of the market.

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C it y o f Lo ndo n R e nmin b i S eri es

City of London Economic Development PO Box 270, Guildhall, London, EC2P 2EJ www.cityoflondon.gov.uk/economicresearch