As we reach the 10th anniversary of the start of renminbi internationalisation, it’s important to recognise how far the currency has come since companies were first permitted to use it as their cross-border trade settlement currency in 2009.
The renminbi (RMB) is now one of the three most important currencies in the world, although its trading volumes remain well below that of the most developed convertible currencies. The reason for its importance is that, even though domestic growth has slowed recently, China still accounts for around 30 per cent of total global economic growth.
Many traders will watch USD/RMB movements more closely than USD/EUR when they are trading equities, fixed-income and particularly emerging markets currencies, explained Charles Feng, Head of Macro Trading for Greater China and North Asia, Standard Chartered.
“Renminbi volatility is roughly on a par with the euro ‒ whether that is on historical volatility or implied volatility – and intra-day volatility can be quite substantial,” he said. “But the People’s Bank of China (PBoC) has pretty much stepped away from intervention, except when the market shows signs of panic.”
As China opens up its bond market, participants are increasingly viewing it as an indicator of the health of the Chinese economy as a whole (and to some extent global risk sentiment). Index membership has boosted foreign interest in China. RMB-denominated government securities were added to the Bloomberg Barclays Global Aggregate Index in April 2019 and Chinese government bonds will be added to JP Morgan’s own emerging market local currency bond index next year.
“Foreign ownership of the domestic bond market has risen significantly ‒ around 8 per cent of the government bond market is already owned by foreigner investors,” said Feng. “But overall, foreign ownership of the Chinese bond market remains low. If the market share of overseas investors were to reach double figures, the importance of the domestic fixed-income market would rise exponentially.”
Bond market bonanza
China has recently accelerated the liberalisation of its capital market to attract more capital inflow and foreign investment, and to increase the pace of financial sector deregulation. Some of these developments have been much awaited by the market and are in China’s best interests, observed Carmen Ling, Managing Director, Standard Chartered.
“China has also established several programmes to help foreign investors access the bond market, including the China Interbank Bond Market (CIBM Direct) and the Bond Connect programme. Investors can choose to open a custodian account onshore to hold the securities (in the case of the former) or invest via an account set up in Hong Kong, depending on their internal operational and governance requirements,” said Ling.
Market participants can access the onshore financial markets to hedge their RMB exposures. Those who opt not to apply for these China access channels can also take advantage of structured products such as total return swaps to invest in RMB denominated securities synthetically.
“China has been gradually opening up CIBM Direct since 2016 and we have seen increasing numbers of private sector and real-money asset managers enter the market,” said Ling.
“For example, more than 1,500 entities have signed up through Bond Connect. Many of these are domiciled in the United States, but we are also seeing Japanese and, increasingly, European-based investors signing up. Inflows from these private sector investors have outweighed public sector investment significantly since the start of 2019.”
Local knowledge crucial
Because the market in China ‒ especially the onshore market ‒ remains relatively technical, elements of monetary policy, economic data, liquidity management and daily open market operations management by PBoC can be difficult to understand.
This is particularly relevant in light of growing interest in the wholly foreign-owned enterprise (WFOE). While the Chinese government has made it easier for foreign investors to incorporate WFOEs by removing regulations relating to the level of upfront investment required, investors are advised to declare a sufficient level of registered capital to support the cost of establishing the enterprise.
“Transparency is increasing but on-the-ground expertise remains important,” said Ling. “Standard Chartered is the only foreign bank that has a local fund custody licence. In many instances we act as a bridge between investors or clients and the regulator, to reflect operational challenges that investors are facing and to propose solutions to address these challenges.
As China continues to open up its capital markets as a means for financial reform, along with its growing global economic impact, investor interest in RMB-denominated assets will continue to rise at a very fast pace given the low current percentage of foreign ownership in the onshore stock and bond markets.
“In a market of this size, doubling foreign investment would equate to massive inflows and a huge volume of hedging,” concluded Ling. “Our role is to help investors find the most appropriate vehicle and ease their journey into China’s onshore markets.”