As the Chinese currency continues its gradual internationalisation, Nicholas Pratt examines the impact of cross-border renminbi-based settlement on clearing and settlement services across Asia.
March saw the launch of a pilot platform developed by two central banks, Hong Kong Monetary Authority and Bank Negara Malaysia, and an international central securities depository, Euroclear Bank.
The plaform is designed to strengthen the local issuance of – and overseas investment in – domestic renminbi-denominated bonds, among other domestic debt. While large international players have access to international central securities depositories, domestic players in Asia are traditionally restricted to their domestic central securities depositaries (CSDs).
The platform’s key benefit is that members of Bank Negara and Hong Kong Monetary Authority will have access to foreign counterparties and settlement of cross-border trades through a single point of access, easing transaction flows between domestic and foreign counterparties. Further modules are planned focusing on corporate actions, the issuance process and collateral management.
Previous attempts to create cross-border harmonisation in Asia’s capital markets have often failed because they have been too single-minded in their objectives and were not able to resolve the different political interests and cultural traits of each market.
The pilot platform represents a changing approach to developing a cross-border settlement mechanism across Asia, says Gaetan Gosset, director, product management, at the Euroclear Bank branch office in Hong Kong.
“It is apolitical. The modular nature of the platform means that each CSD and/or central bank in Asia can move at their own pace and concentrate on their own priorities. They can use it as a toolbox.”
The past two years have also seen accelerating developments in cross-border renminbi settlement as the Chinese authorities look to liberalise its currency for international investors.
The concept for the pilot platform was first discussed in 2008, before the move to standardise cross-border renminbi settlement, as a way of making cross-border settlement easier and cheaper.
Reserve currency
While the move to standardise cross-border renminbi settlement is undoubtedly a big influence, Gosset maintains that improving settlement was the primary inspiration.
Nevertheless, the discussion around offshore renminbi can be seen as the first step in the internationalisation of the Chinese currency, says Gosset, and this is going to play a big part in the shaping of the Asian investment market, including the development of clearing and settlement.
“At some point in the future, the yuan will become a reserve currency used much like the dollar is at present – that is inevitable. So right now, different participants are positioning themselves for this inevitability and looking at what renminbi-based financial products they can offer.”
Dim sum bonds, for example, are issued in Hong Kong and in Euroclear Bank. Meanwhile, there are discussions about the issuance of renminbi-denominated sukuk in Malaysia and about Japan offering the J-sukuk, its own Islamic finance product potentially renminbi-denominated.
The development of cross-border renminbi-based settlement will be a critical component in the wider project to create a pan-Asian securities market, says Alton Man Lee Chan, executive director, Clearstream Asia Pacific. “There is still some way to go but the renminbi is on the way to becoming a global currency,” says Chan. “On the post-trade side, we will just have to develop the infrastructure to go with these changes.”
Expansion has to be weighed against the gradual pace at which the Chinese supervisors are prepared to liberalise its currency and open its capital markets to overseas investors.
Consequently a balance also needs to be struck in developing the post-trade landscape, says Chan. “If the infrastructure is not there, the market will not be able to grow and reach critical mass. But a fully developed post-trade infrastructure for a market with little liquidity runs the risk of becoming a white elephant.”
The most likely way forward is co-operation between commercial and central banks.
Chan also says any efforts to create a pan-Asian clearing and settlement landscape should be focused on linking different domestic CSDs, rather than creating a central utility akin to T2S in Europe or trying to enforce a standard operating model for all CSDs to follow.
“It will be more than difficult to harmonise markets in Asia. Market linkages such as the existing CSD joint venture model Link Up Markets seem to be a viable way forward: the setup cost is low and the CSD partners can decide how far they want to get involved,” Chan adds.
The infrastructure for an efficient clearing and settlement landscape for renminbi-based securities is there, the question is how flexible Chinese regulation will be, says Cheeping Yap, head of fund services for Asia at Citi.
“The Chinese authorities are happy to see more money leave China than come into China because it makes it easier in terms of foreign exchange,” Yap says.
Flexibility
For example, qualified domestic institutional investor (QDII) funds which allow China-based investors to invest overseas, have a lot of flexibility in terms of daily access to liquidity. But in terms of investment flows going the other way, via qualified foreign instutional investor (QFII) licences, the liquidity of those investment funds is only granted once a month with special approval.
This is why the establishment of the renminbi qualified foreign instutional invstor (RQFII) programme is so important, says Yap. “This shows a concession from the Chinese authorities because it allows for more flexibility.
The programme allows investors to establish renminbi funds in Hong Kong that can directly access the Chinese stock market. Chinese authorities are treating renminbi held in Hong Kong as the same as renminbi held in China, though exchange rates are different.
Therefore, any securities transaction would be considered a cross-border renminbi settlement rather than a foreign exchange transaction which in turn enables for daily access to funds.
However, says Yap, the establishment of the RQFIIs has gained little media attention and the international investment industry has been slow to show interest. “I do not think everyone understands the implications of the RQFII. It may only be eligible for Hong Kong-based funds, but it opens the way for international companies to enter the Chinese market and have daily access to their own liquidity.”
The implications for international clearing houses are even greater, says Yap. “I spoke to the London Stock Exchange recently and it has established a link with Hong Kong Clearing House, and there is nothing to stop other clearing houses doing the same and using Hong Kong as a gateway to China.”
Currently, many pension funds and institutional funds are prohibited from investing in China because of the restricted access to their assets and potential for lock-up. But by going through a national clearing house and then through Hong Kong, these funds can get daily access to the Chinese market.
The basic infrastructure for efficient cross-border renminbi-based settlement exists and the next step is to turn the RQFII into something meaningful, says Yap. Currently, RQFII funds account for just 0.6% of the Chinese stock market.
In comparison, a similar fund structure was set up in Vietnam and now accounts for more than 50% of the market capitalisation of the stock market.
Increased quota
China Securities and Regulation Committee’s deputy director Yao Gang recently announced plans to increase the quota for both the QFII and RQFII schemes in order to attract more long-term offshore capital to the domestic market.
And as far as Yap is concerned, the quotas must increase yet further. “The demand is always greater than the Chinese authorities are willing to allow,” Yap says. And while the infrastructure may be there, Yap says without a meaningful number of funds or investors, that infrastructure becomes pointless.
“If it is dominated by 99.4% of local flow, then it is not a free market,” Yap says. “I would like to see China recognise that the market is more mature than it was 10 years ago and to say that the number should be 5% in five years time and 10% in 10 years time.”
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