The renminbi’s non-deliverable forwards market is going to be marginalized sooner or later. Trading data from London’s fast-growing offshore renminbi center shows that the currency’s internationalization has expanded with rising liquidity in the offshore deliverable RMB (or CNH) market, overtaking that of the non-deliverable forwards (NDF) for the first time in 2013.
When the CNH market was first introduced in London in the second half of 2011, the average daily trading turnover of US$2.4 billion in deliverable RMB-denominated foreign exchange products could be said to have been a pale green in comparison with the rosy US$8.1 billion daily turnover of the non-deliverable RMB-denominated products. However, within two-and-a-half years, the deliverable CNH market has turned red hot, with a daily trading turnover of US$18.7 billion, nearly treble the US$6.6 billion daily trading value of the NDF products. Anecdotal evidence from banks in Singapore and Hong Kong also shows rising CNH trading volume overtaking NDF volume.
These trends of rising deliverable CNH and dwindling NDF trading are expected to continue; the NDF market will likely be marginalized eventually. The reason is simple. The NDF market emerges as a means of hedging foreign exchange risk for non-convertible currencies, especially of those markets which have capital controls but have grown significantly to have greater global economic importance. The RMB fits the bill perfectly.
However, the situation has started to change as Beijing pushes for RMB internationalization, capital account convertibility and corresponding financial liberalization, even though these are long-term processes that will take years to complete. As RMB capital account convertibility deepens, deliverable CNH will become more liquid. This will, in turn, improve the quality of CNH pricing, attracting more market players to the deliverable CNH market. There will, thus, be no need for the NDF market in the longer term.
Meanwhile, offshore RMB has expanded further into Europe, with two clearing banks assigned to the region in late June – Bank of China can now offer an RMB clearing service in Frankfurt, while China Construction Bank can do so in London. Similar arrangements are being considered for Luxembourg and France. Canada is also studying the setting up of an RMB clearing centre for the private sector.
Assigning clearing services to different offshore RMB centers enables foreign banks to access China’s onshore funds, subject to quotas, without relying on Hong Kong’s infrastructure. This will improve the efficiency of using RMB for trade and financial settlements, and goes a long way towards creating an incentive for RMB demand for both international trade and non-trade purposes.
Adding to the internationalization momentum is the arrangement made in mid-June for direct trading between the RMB and the pound sterling (GBP). This makes the GBP the sixth currency that can directly trade with the RMB. The other five are the US dollar, Japanese yen, Canadian dollar, Australian dollar and New Zealand dollar. South Korea is also preparing for direct trading between the Korean won and RMB.
It is noteworthy that direct trading with the RMB is a step towards eroding the global dominance of the US dollar in the long term since there are not many currencies that can and will do direct cross-trading without using the USD as a conduit. But do not get too excited yet. The challenge posed to the US currency by the RMB will not be a serious one until the very slow and prolonged process of full RMB internationalization is complete.
Currently, RMB trading with non-USD currencies remains very limited, with daily RMB-USD trades averaging about US$113 billion and RMB-euro trades averaging only US$1 billion, according to the Bank for International Settlements. In global payments where the RMB ranks as the seventh most widely used currency in the SWIFT system, it only has a 1.5 percent share, compared with the 41 percent share of the USD, 32 percent of the euro and 8 percent of the GBP. Even in Asia, where China ranks as one of the top three trading partners for every country, the USD is still the region’s predominant trade settlement currency, with an 80% share.
Hence, although the CNH market may displace its NDF cousin soon, the ability of the RMB to displace the USD as a global premier currency is still some years away. Meanwhile, we can expect an increase in offshore RMB financial transactions, creating more investment and hedging opportunities for global investors.
The writer is senior economist of BNP Paribas Investment Partners (Asia) Ltd.
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