Renminbi flows to be rebalanced by QFII reforms

By allowing international investors to purchase equities with offshore renminbi and permitting its greater use as collateral, Chinese regulators are further increasing the circulation of a currency that is already inching toward global reserve status.
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By allowing international investors to purchase equities with offshore renminbi and permitting its greater use as collateral, Chinese regulators are further increasing the circulation of a currency that is already inching toward global reserve status.

A number of different initiatives have sparked greater use of the currency recently, including the China Securities Regulatory Commission (CSRC) revealing it was reforming monetary policy to enable offshore renminbi to be used both for trading Chinese equities by firms in the qualified foreign institutional investors (QFII) scheme and as collateral on the CME Group’s Chicago-based derivatives exchange.

A new pilot programme revealed last week will let QFIIs invest up to 20 billion offshore reniminbi in domestic securities, marking a further effort to boost the currency’s use. The new rules mark the start of a new renminbi-qualified foreign institutional investor (R-QFII) programme, where subsidiaries of domestic securities companies and fund managers in Hong Kong can invest up to 20% of the capped funds in equities and the rest in fixed income.

“Big hopes are being pinned on the Chinese currency,” said Stephen Green, regional head of research, greater China, at Standard Chartered. “Some analysts, both in China and overseas, believe that it stands a good chance of becoming a reserve currency. This will take time, but many are impatient, believing that the world desperately needs a new reserve currency as long-term fiscal decline in the US and Europe undermines ‘old world’ currencies.”

The pressure of currency flows has so far been outbound rather than inbound, due to the relatively few options for renminbi to be repatriated via investment.

“Liberalising rules for foreigners to buy Chinese securities might help offset that,” said Nick Ronalds, executive director of trade body FIA Asia.

Ongoing liberalisation, with the aim of Chinese cities becoming major financial centres by the end of the decade, is a stated objective of Chinese authorities, Ronalds noted. “Freeing the use of offshore renminbi is broadly consistent with medium and longer-term goals,” he said.

“Over the last 18 months we have seen the emergence of a new global currency but the pace of this emergence has picked up recently,” said Richard Jaggard, head of sales, Asia Pacific for HSBC Payments and Cash Management business.

“The new changes have helped to balance the flows of offshore renminbi in and out of the mainland,” said Jaggard. “Using the QFII arrangements, investors can use the currency to invest in mainland stocks, while its liquidity in Hong Kong also has greater use for settlement.”

To date, the usefulness of QFII status – the primary apparatus for trading in Chinese financial instruments by non-domestic investors – has been constricted by limits imposed by the CSRC since the category’s inception in 2002. QFIIs continue to face multiple restrictions on their trading and investment activity, including quotas limiting the amount of Chinese securities each QIFII is allowed to purchase. Arbitrage is not permitted, while short selling in China is a complex and expensive activity. In May, the CSRC issued guidelines that permit firms with QFII status to trade stock index futures. The guidelines state that QFIIs may only trade stock futures in China for hedging purposes and must abide by strict limits on daily volumes. By the end of Q3 2010, investments of around US$ 20 billion made by just under 100 QFIIs had been approved by China’s foreign currency regulator and around 10 additional QFII licences have been granted since. While guidelines for acquiring a QFII licence exist, they are subject to interpretation.

From January, CME Group – the world’s largest futures exchange – will include the currency in the range of instruments to meet performance bond requirements on all exchange futures products cleared through CME Clearing, with HSBC Global Banking and Markets in Hong Kong serving as the firm’s first clearing custodian in Asia. HSBC Hong Kong will be able to hold offshore renminbi deposits from CME Group clients and to use those deposits as collateral.

“As our business in Asia grows, we are looking at ways to provide services that fulfil the needs of our increasingly diverse customer base,” said Kim Taylor, president of CME Clearing.

Offshore use of the renminbi started when China permitted trade settlement by importers and exporters in a geographically limited pilot in 2009 but the currency’s circulation has since expanded rapidly for both trade and investment flows. RMB deposits in Hong Kong stood at 553.6 billion yuan as of June 30, 2011, up 57% from year-end 2010, according to the Hong Kong Monetary Authority.

“Corporates have accumulated a lot of offshore renminbi,” said Jaggard. “At HSBC, all our cash management services are now renminbi-enabled and the currency can be included in our multi-currency pooling structures.”

The Hong Kong Exchange (HKEx) is currently in the second phase of its development roadmap which aims to make Hong Kong the offshore renminbi centre for China and places heavy emphasis on the opportunities arising from the ongoing internationalisation of the RMB, including offering issuing and trading capabilities in the Chinese currency. The first phase was focused on attracting Chinese issuers to list in Hong Kong as well as international investors that want exposure to Chinese firms through these listings. China-related companies now account for about 60% of HKEx’s market capitalisation and around 70% of daily trading volume.