The Rmb is ready to dominate

Hong Kong in the meantime kicked off the long-awaited Rmb settlement scheme in July 2010, which is seen to strengthen the SAR's role as an offshore Rmb center and testing ground for the gradual internationalisation of the Rmb. Global banks believe that nearly $2 trillion worth of cross-border trade flows between China and its trading partners will be settled in Rmb in the next five years, making the Rmb one of the top three currencies used in global trade. The Rmb trading settlement and clearing is viewed by many as an important step taken by China in moving forward with the further internationalisation of the Rmb in global trade and finance.

Currency swaps

Since December 2009, China has signed Rmb 650 billion worth of currency swaps with six countries including South Korea, Indonesia and Argentina. The currency swaps would inject Chinese money into foreign banking systems while foreign companies can make payments in Rmb for imported Chinese goods. More countries are expected to sign up as they increase trade with China. China has also provided loans to and made investments in a number of Asian countries. This is seen by many as China trying to increase the Rmb's influence in the region.

Rmb bonds

Rmb denominated bonds can now be issued to investors in Hong Kong. In Sept 2009, China issued Rmb 6 billion worth of treasury bonds in Hong Kong, marking the first Rmb-denominated T-bond issue outside the Chinese Mainland. The PRC Ministry of Finance announced on November 22 that the central government will issue Rmb sovereign bonds worth US$1.2 billion in Hong Kong, the second of its kind issued in the SAR. China Development Bank (CDB), one of China's three policy lenders, launched its Rmb 2 billion of floating-rate Rmb bonds in October 2010 marking it the fourth time CDB has issued Rmb-denominated bonds in Hong Kong since July 2007, when the People's Bank of China (PBOC) permitted mainland-based financial institutions to issue Rmb bonds in Hong Kong. In August 2010, McDonald's Corporation became the first foreign corporation to issue Rmb bonds in Hong Kong. These are key milestones in the continuing internationalisation of the Rmb and the further opening up of the Chinese capital markets.

Rmb bond issues in Hong Kong would also provide international companies with a new fundraising option for their China businesses. The Rmb bond issue is seen as speeding up the pace of the Rmb market development process in Hong Kong and is also expected to help accelerate Hong Kong's role as an offshore Rmb centre. It is understood that US's Caterpillar Inc. is also arranging a Rmb bond issue in Hong Kong following the success of McDonald's. The Rmb bond issue in Hong Kong is seen as another small step toward increasing Rmb circulation worldwide and achieving a larger role for the Rmb in regional and international finance.

Mini QFII

Earlier this year, the Chinese government announced the launch of the so called “Mini-QFII” scheme under which Hong Kong subsidiaries of Chinese fund management companies (FMCs) and securities firms can launch Rmb-denominated funds to which holders of offshore Rmb can subscribe. Detailed rules are not out yet but the mini-QFII scheme is expected to attract a lot of interest from Hong Kong retail investors and companies holding Rmb deposits in Hong Kong bank accounts. Rmb currently sitting in Hong Kong bank accounts can be invested in Chinese A-shares and bonds via subscribing for such Rmb funds so as to enable offshore Rmb holders to diversify their investment and to gain from the expected appreciation of the Rmb. Currently, Hong Kong retail investors can only gain exposure to shares of Chinese companies through investing in Shanghai and Shenzhen B-shares, H-shares and listed exchange traded funds (ETFs) in Hong Kong. It is expected that around five or six Hong Kong subsidiaries of Mainland FMCs and securities firms could participate in this pilot programme and it's likely that the Chinese and Hong Kong regulators want to keep it small so as to manage risks arising from the pilot issue and keep an eye on reaction until the pilot scheme is expanded in the future. Different from the QFII scheme, the mini-QFII programme channels back offshore Rmb into China with the aim of internationalising and popularising use of the Rmb in Hong Kong and throughout the Asia region. Under the QFII scheme, overseas investors are granted certain quota in USD and those dollars are then remitted onshore and converted into Rmb for investment in Chinese stocks and bonds. Although the size of funds involved with the mini-QFII scheme is not expected to be substantial (reportedly capped initially at Rmb 10 billion), this pilot initiative nevertheless is another step toward achieving a greater international role for the Rmb.

Shanghai International Bourse

Global financial institutions and multinational companies (MNCs) have for some time expressed interests in seeking a listing in Mainland China. In addition to building up their profile and brand in the Chinese market, China's high savings rate and approximately $8 trillion in bank deposits might be another reason for foreign companies to pursue an initial public offering (IPO) in the PRC. Last year, the China Securities Regulatory Commission (CSRC) announced its plan to set up the Shanghai International Bourse (SIB), on which foreign companies could list their shares denominated in Rmb. Detailed rules are not out yet but a large number of global financials and MNCs have been busy preparing for a Shanghai IPO hoping they would become one of the first batch of companies to list in Shanghai. Key clarifications expected to be addressed in the draft rules include accounting standards, listing requirements and thresholds, share sale limits and rules governing how the IPO proceeds can be used and whether funds could be remitted offshore. A Chinese listing might also enable foreign companies to pursue future M&As in China using both cash and their Chinese listed shares.

Rmb IPOs in Hong Kong

The Hong Kong Exchange (HKEx) has announced that Rmb IPOs in Hong Kong could happen in 2011. Under the plan, foreign companies would be able to list and fundraise in Rmb in Hong Kong. This would be a landmark development if it does in fact go ahead. Given China is pushing for Shanghai to become an international financial centre in line with China's economic strength and the international status of the Rmb by 2020, it is not clear how the proposed SIB and the Hong Kong Rmb IPOs would be implemented together. It would make more sense for international corporations to raise Rmb and list in Shanghai for their future China operations as opposed to doing a Rmb listing in Hong Kong and have the IPO Rmb proceeds channeled back to the PRC to use as working capital. Having a Chinese listing is also key to building consumer awareness and branding in China's huge market. How the proposed Hong Kong Rmb IPO initiative will unfold remains to be seen, but it will no doubt be another key milestone in achieving a greater international role for the Rmb.

Outlook for 2011 and beyond

Given the fragile economic recovery worldwide, the ongoing Euro problems and the anticipated weakening of the US dollar in the long run, international investors and MNCs are shifting their resources and funds to Asia which is expected to drive global economic growth in the next decade. China is seen by many as the most attractive market in Asia given the size and growth rate of its economy, potential size of its stock market - expected to overtake the US in the next 15 to 20 years or sooner, the expected appreciation of the Rmb, high savings rate and vast size of its consumer market.

Against the backdrop of increasing trade flows between China and Asia and the expected weakening of the USD in the long run, regional Rmb-based trade between China and its trading partners should speed up in the coming years. If this proves to be successful, then more emerging and developed countries would sign up to settle trade in Rmb. China will enter into more currency swap arrangements with other countries so as to push for a larger role for the Rmb in global trade and finance.

The SIB could be up and running sometime in 2011 and we could see a number of leading global financials and MNCs fundraising in Rmb and listing their shares in Shanghai to tap Chinese savings and to further build up their brand and consumer awareness in the domestic Chinese market. Rmb IPOs could happen in Hong Kong but the pace of which would probably be dictated by other Rmb internationalisation initiatives including the SIB launch and Rmb bond issues in Hong Kong. Implementation of the Mini-QFII scheme should speed up which would see Hong Kong retail investors and companies holding offshore Rmb putting their Rmb savings in Hong Kong-launched Rmb funds which would play the role of channeling back offshore Rmb holdings to the PRC. These Rmb funds would gradually build up a cross-border Rmb circulation. More foreign companies would follow in the footsteps of McDonald's and Caterpillar to issue Rmb bonds in Hong Kong. However, if international companies are allowed to list in Shanghai or issue Rmb bonds on the Mainland, it is not clear whether Hong Kong Rmb bond issues or as the anticipated Rmb IPOs in Hong Kong would still be as appealing to international investors as they are at present.

Rmb in 2020

The aforementioned policies and programmes put forward by China over the last two years signal China's aspiration and determination to let the Rmb play a greater and more influential role in global trade and finance as the country's economy continues to grow. China overtook Japan to become the world's second largest economy in 2010. A number of leading global accounting firms and investment banks have predicted that China will overtake the US to become the world's number one economy by 2020 (some say this will happen in 2026). If and when this happens, it would be safe to assume that the Rmb will serve as one of the major reserve currencies in the world alongside the greenback, Euro, Yen and the Pound Sterling.

China has set the goal of establishing Shanghai to become an international financial centre by the year 2020. Assuming that China unseats the US to become the world's largest economy by 2020, Shanghai's role in the Chinese economy might be similar to that of New York's role in the US economy today. By then, the Rmb could become the “Euro” of Asia if not rivaling or standing alongside the dollar as the world's dominant currency. It would be interesting to see how Hong Kong will further develop and maintain its position as an offshore Rmb centre if the Rmb does become fully or partially convertible before 2020. A safe bet is that Shanghai would be the onshore and offshore Rmb pricing centre. 2020 is still some way off but there is little doubt that the Rmb will continue to march forward to achieving a greater role in global trade and finance as China strives to become the world's largest economy in the not too distant future.

Hubert Tse, Partner, Boss & Young PRC Attorneys, Shanghai