cnh bond guide - fx-mm magazine€¦ · · 2016-11-13attempts to globalise its offshore cnh...

CNH Market Guide Vol. 2 17 September 2012

Globalising the Franchise

How did the offshore renminbi (CNH) market come to wield such influence on the

onshore foreign exchange (FX) market? Since May 2012, USD/CNY trading onshore

has consistently pulled away from the People’s Bank of China’s (PBOC) daily fixing

rate towards the direction of the offshore deliverable USD/CNH.

How did the CNH bond market turn from a seller’s market to a buyer’s market

recently? As investors’ expectations switch from FX to bond gains, issuers have

aligned coupons to onshore yields. Higher yields in turn have boosted investors’

appetite for longer tenors. The market now offers bonds up to 20-year maturity.

A confluence of factors – FX and monetary policy reforms, market deregulation,

private sector initiatives, and global politico-economic events – brought about a

spectacular transformation of the CNH market in its first five years.

How will the next five years look? The next phase will be a steeper climb as China

attempts to globalise its offshore CNH franchise before it can reach the final goal of

becoming a world reserve currency. Trading Strategy Woon Khien Chia +65 6518 5169 [email protected] Chiranjiv Sawhney +65 6518 7382 [email protected] Debt Capital Markets Augusto King +852 3961 3102 [email protected] Zoie Teng +852 3961 3146 [email protected]

This guide is a sequel to the CNH Market Guide – A precursor to internationalisation of

the Chinese renminbi, which was first published in March 2011. It addresses the

various facets of a market that still stands the chance of becoming the world’s next

reserve currency; with a focus on the FX, interest rate and bond markets.

This guide provides a review of the developments in the first five years of the CNY

internationalisation. It contains details of regulations, products types, market depth and

market participants. It also contains analysis of how reforms have influenced market

trends that have led to the convergence between the onshore and offshore FX, interest

rate and bond markets.

mailto:[email protected]




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CNH Market Guide Vol. 2

Content The Roadmap .............................................................................................................. 4 The first five years......................................................................................................... 5

Market size ............................................................................................................... 5 Market liquidity.......................................................................................................... 8 Market depth............................................................................................................. 9 PBOC’s CNY swap lines......................................................................................... 11 Onshore market access.......................................................................................... 13 Offshore-onshore market convergence .................................................................. 16

The next five years...................................................................................................... 17 Becoming fully convertible ...................................................................................... 17 Internationalising the CNY ...................................................................................... 18

FX Market ................................................................................................................... 21 Evolution of the market ............................................................................................... 21 Spot............................................................................................................................. 23 Forwards ..................................................................................................................... 24 Cross currency swaps................................................................................................. 25 Options and futures..................................................................................................... 26 Interest Rate Market.................................................................................................. 27 Evolution of the market ............................................................................................... 27 Money market ............................................................................................................. 29 Interest rate swaps...................................................................................................... 29 Sovereign benchmark curve........................................................................................ 30 Repo market................................................................................................................ 30 Bond Market .............................................................................................................. 32 Evolution of the market ............................................................................................... 32 Issuer Base ................................................................................................................. 36

Types of issuers...................................................................................................... 36 Motivations and objectives...................................................................................... 39 Issuance outlook..................................................................................................... 41

Investor base............................................................................................................... 42 Types of investors................................................................................................... 42 Investor outlook ...................................................................................................... 44

Documentation requirements ...................................................................................... 45 Listing practice ............................................................................................................ 45

Reg S is the current norm....................................................................................... 46 Governing law ............................................................................................................. 47 Repatriation rules ........................................................................................................ 48

MOFCOM vs SAFE routes ..................................................................................... 48 Other RMB schemes .............................................................................................. 50

Onshore-offshore convergence................................................................................... 50 Globalising the Franchise ........................................................................................ 53 Building on Asia’s strengths ........................................................................................ 53 Global vs regional hubs............................................................................................... 56

Singapore as second CNY clearing centre ............................................................. 56 Hong Kong-London partnership.............................................................................. 56 Self-service centres in Taipei, Tokyo, Sydney ........................................................ 57 Shanghai as the ultimate global CNY pricing centre............................................... 57

Multilateral platforms ................................................................................................... 58 Appendix A ................................................................................................................ 59 Chronology of Regulatory Changes and Events ......................................................... 59 Appendix B ................................................................................................................ 62 Cross-border Payments on Current Account............................................................... 62 Appendix C ................................................................................................................ 64 List of Abbreviations.................................................................................................... 64

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Appendix D ................................................................................................................ 66 List of Government Agencies ...................................................................................... 66

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The Roadmap

Five years after embarking on internationalising the Chinese Yuan (CNY), it is clear

that the Chinese government now has a full roadmap for realising it plans. Deliverable

CNY is now commonly referred to as CNH.

The first CNH bond was issued in Hong Kong, receiving mixed responses from market

participants. Some saw this as an experiment by the Chinese government to gauge

market acceptance of the CNY. A common area of concern was the huge price

premium of the so-called “dim sum” bonds on onshore bonds. At that time, yields were

benchmarked against the USD/CNY non-deliverable forward (NDF) market.

The NDF curve reflected market expectations for the CNY, which was very strong then.

The curve translated into CNY interest rate levels that were well below both the USD

and onshore CNY interest rates.

Proving sceptics wrong, the Chinese government has opened up the market at a rapid

pace in a sequence resembling a roadmap (see Figure 1):

• 2007-2008: Made CNY deliverable

Launched CNH bonds; signed swap lines with selected central banks

• 2007-2010: Expanded CNH liquidity pool

Launched trade settlement scheme; liberalised bond issuance rules; launched CNH

interbank market

• 2011: Looped back to onshore

Launched CNH equities; CNY inward investment flows allowed

• 2012: Go global

Partnering Hong Kong and London; setting up second CNY clearing centre in

Singapore; setting up dedicated lines for other key markets

Figure 1: Roadmap to internationalisation of the RMB Source: RBS

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The first five years Growing liquidity pool, deepening the markets, expanding the geographical reach

The first five years of the CNH market focused mainly on growing the liquidity pool in

Hong Kong, and deepening the FX and bond markets. It was only in 2011 that the

focus switched to expanding the market outside of Hong Kong – starting within Asia,

notably Singapore and Japan, and more recently further afield to London. The market

has grown multi-fold since its launch in 2007, measured in deposits, trade settlement

volume and bond issuance (see Figures 2 and 3).

Market size

• CNY deposits in Hong Kong have grown ten-fold since late 2009. With resident

deposits at CNY558 trillion (USD88 billion) as of June 2012, deposits account for

8.8% of Hong Kong banks’ total deposit base or 17.5% of their foreign currency

deposit base. However, these account for a mere 0.6% of China’s total deposits.

There are four basic channels through which CNY cash can flow from onshore

into Hong Kong banks:

− Hong Kong residents’ conversion of HKD to CNY, subject to a CNY20,000

daily limit. Banks clear the HKD/CNY exchange under a special clearing

agreement set up in 2005. On 25 Jul 2012, non-Hong Kong residents are

allowed to open CNY account in Hong Kong with unlimited limit. However, banks

are not allowed to clear their HKD/CNY transactions through this special clearing

agreement, the Shanghai conversion window or the cross-border remittance

channels. Effectively, the non-Hong Kong resident accounts would not contribute

to the build-up of CNY liquidity offshore.

− Exports to China settled in CNY. This is subject to an aggregate clearing limit

of +/-CNY8 billion at the Bank of China (Hong Kong) Limited for the net total of

exports and imports. Over the past two years, the flows between exports and

imports have also become more balanced from an earlier 3:1 ratio between

Chinese imports and exports (see Figure 4).

− Chinese corporates’ outward direct investments. This is subject to individual

quotas.

− Chinese tourists’ overseas spending. Since the launch of the Individual Visit

Scheme in 2003 by the Hong Kong SAR government, which enabled residents of

49 cities in China to visit Hong Kong in their individual capacity, tourists from the

mainland have soared 45% on a compounded annual basis from 2007-2011 (see

Figure 5).

• There has also been a rapid build-up of CNY deposits in other offshore centres but

these remained much smaller than in Hong Kong. This is because these other

centres started later than Hong Kong, and had no support of a direct central

clearing line with China. In Singapore, CNY non-bank deposits with Singapore

banks have reached CNY60 billion as at June 2012; and in London, these deposits

reached CNY35 billion as at end 2011.

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• The CNY trade settlement scheme in Hong Kong has grown at an even faster

pace than deposits after the last regulatory hurdles were removed for Chinese

exporters earlier this year (Figure 6 shows the phases of expansion for this

scheme).

In the 12 months leading up to June 2012, trade settlement volume reached

CNY2.32 trillion (USD365 billion). This figure already exceeded 1.2 times of the

China-Hong Kong bilateral trade, suggesting that third parties outside of Hong Kong

have begun settling their trade with China in CNY via Hong Kong banks.

On the other hand, the figure is barely 10% of China’s total external trade,

suggesting there is still plenty of scope for China to drive the use of CNY for settling

its trade with its huge base of foreign trade partners.

• CNY-denominated bond issuance appears to grow relatively slower but it was still

a five-fold increase since 2010. The outstanding stock of corporate bonds,

certificate of deposits and bonds issued by China’s Ministry of Finance (MOF)

currently stands at CNY343 billion (USD55 billion). This is already 55% of Hong

Kong’s total HKD-denominated private sector bond market. The bulk of the CNH

issuance is dominated by financial institution issuance, concentrated mostly in

tenors three-years and below.

Figure 2: CNY-denominated deposits, trade settlement and bonds in Hong Kong (CNY trn) Source: Bloomberg, CEIC

Figure 3: CNY-denominated deposits, trade settlement and bonds in Hong Kong as % of Hong Kong’s total Source: Bloomberg, CEIC

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Figure 4: Export vs import with China under RMB trade settlement scheme (CNY bn) Source: Bloomberg, CEIC

Figure 5: Chinese tourist arrivals in Hong Kong (mn) Source: Hong Kong Tourism Board

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Figure 6: Expansion phases of RMB cross-border trade settlement Source: PBOC

Market liquidity

Liquidity strained by opening of investment avenues back into China

To a large extent, the liquidity situation of the CNH market is demand-driven. The

demand for CNY liquidity is in turn driven by the relative strength of the CNY against

USD and other foreign currencies. The measure of the offshore CNY liquidity pool

should be the same as the measure of monetary aggregates. The broad liquidity pool

should thus comprise of both non-bank deposits and bonds. As such, the drop in

deposits in Hong Kong banks from December 2011 to May 2012 did not reflect a

shrinking CNH liquidity pool in Hong Kong as bond issuance continued to rise (see

Figures 2 and 3 again). Still, the pace of liquidity growth has slowed since fourth

quarter 2011. There are three factors behind this:

• An increase in CNY trade settlement volume for importing Chinese goods since the lifting of restrictions on Chinese exporters to settle in CNY

• An increase in Hong Kong settlement banks’ investments into the onshore bond market as more of them get special quotas from PBOC to do so

• An outflow of non-Hong Kong resident CNY deposits to other offshore centres begin to compete for these deposits

In response to the third point above, the Hong Kong Monetary Authority (HKMA) has

liberalised previously punitive rules on Hong Kong banks’ risk limits for CNH from the

beginning of 2012. More recently, the HKMA also allowed non-residents to set up CNY

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deposit accounts in Hong Kong with no daily conversion limits. See Figure 7 for a list

of rule changes by the HKMA since the start of 2012.

Figure 7: HKMA regulatory changes to improve RMB liquidity

Allow non-residents to convert unlimited daily amount of RMB

• AIs* can offer RMB services to non-Hong Kong resident personal customers, and currency conversion is not subject to

corresponding limits for Hong Kong residents (25 Jul 2012)

Replace RMB limit with RMB liquidity ratio to include more RMB liquid assets

• AIs are required to maintain a RMB liquidity at no less than 25% computed on the same basis as statutory liquidity ratio.

• This update increases flexibility for the inclusion of more RMB liquid assets, and accuracy of matching RMB liquid assets and

short-term liabilities (14 June 2012)

Introduce a facility to provide RMB liquidity to AIs participating in HK RMB business

• The facility uses the currency swap arrangement between the HKMA and the People’s Bank of China.

• This facility increases short-term RMB liquidity, reduces potential market disruptions and increases market confidence (14 June

2012)

• To enable AIs to better assess their RMB needs, the HKMA moved back the time by which AIs may submit their requests for

funds from 10am to 1.30pm (25 Jul 2012)

Replace RMB Net Open Position (NOP) standard with AIs’ self-determined mechanism

• The 20% standard RMB NOP is replaced by a mechanism whereby AIs are allowed to set up their own internal RMB NOP in

consultation with the HKMA. AIs should consider the nature and scale of their RMB business.

• This measure could further increase RMB liquidity and recognise AIs’ effective RMB exchange and liquidity management

practices (22 May 2012)

Require AIs to ascertain the genuineness of underlying cross-border merchandise trade transactions

• This includes know-your-customer (KYC) processes, due diligence procedures. and reviewing supporting documents from

clients ( 2 April 2012) * Authorised Institutions or banks in Hong Kong. Source: HKMA, Bloomberg

Market depth

CNH FX trading volume now on par with NDF market

The launch of the interbank market in October 2010 provided a huge boost to trading

volumes of FX spot and forward market. The introduction of the FX option market

which followed then gradually led to the innovation of structured products. Figure 8

shows the types of FX and rates products, the maturity range and turnover volume for

each product type.

USD/CNH spot and forward daily turnover is now USD5-6 billion, broadly on par with the USD/CNY NDF market which started to see some slight slowdown in trading volume since 2011.

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The USD/CNY cross currency swap curve is available up to a 10-year tenor but it is only liquid up to a three-year tenor at the moment. USD/CNH options are also available up to a two-year tenor.

In the bond market, the maturity has stretched to a 20-year tenor by a Chinese policy bank in July 2012. In early 2012, a 15-year tenor was tapped by two Chinese policy banks and China’s MOF with their respective inaugural 15-year issues. The most traded part of the curve remains in three-year tenor and below.

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Figure 8: Range of CNH financial products

Product Tenors Turnover Remarks

Spot T+2 value spot USD1-2bn

Forward O/N - 12m, 18m, 24m

USD2-3bn

CCS 6m – 5y USD300mn

FX Options 1m – 2y USD70-120mn

Illiquid relative to other FX products Better liquidity in shorter tenors

FX Futures 1m – 1y n.a. To begin trading from 17 September

Money Market O/N to 1y CNY2-4bn

Repo n.a. n.a. Tripartite platform operated by Euroclear, JP Morgan and HKMA

CDs/Notes 3m to 3y n.a

Equities n.a. n.a. First and only IPO in April 2011

Structured Products

Up to 3y n.a.

Bonds Sovereign up to 15y; FIs/ corporates up to 20y

CNY50mn

Mutual Funds n.a. n.a.

Source: RBS

PBOC’s CNY swap lines

The biggest use of the swap lines so far is from foreign central banks diversifying reserves into CNY

Since signing the first CNY swap line in December 2008, the PBOC has signed a total

of 19 such lines with foreign central banks. Four of these lines have been renewed

before expiry in 2012 while another three have expired. All the lines cover a three-year

period. The four renewed lines had the quotas increased by at least double from the

original amounts for a three-year extension.

These swap lines serve multiple purposes which evolved with the expansion of the

CNH market.

• Standby credit facility: When the first line was offered to the Bank of Korea (BOK),

the purpose was to provide a standby credit facility for the BOK with no conditions

attached, unlike the facilities offered by the IMF, multilateral agencies or the Fed

during the height of the Lehman crisis.

• CNY trade settlement scheme: The lines that came after the CNY trade

settlement scheme was expanded in 2009,were aimed at promoting the use of CNY

in bilateral trade and investments between China and these countries.

• CNY as reserve currency: A year later in August 2010, the PBOC started allowing

recipient central banks to partially activate these swap lines for them to obtain CNY

to invest in China’s domestic bond market. This move was designed to promote the

holding of CNY in the foreign reserves of other central banks. Since then, several

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central banks have partially converted their CNY swap lines into investment quotas

from the PBOC. Otherwise, these swap lines have never been activated to support

any credit event.

The total sum of the current 16 CNY swap lines comes to CNY1.67 trillion (USD265

billion). Figure 9 shows the list of recipient central banks and the size of their

respective lines and each country’s market share of China’s total trade.

• Relative to external trade: The total bilateral trade of the 16 recipient countries

with China account for 37% of China’s total external trade. The swap quota given to

each central bank is not proportionate to the country’s relative market share of

China’s trade. This proved the point that these lines are designed to more than just

promote the CNY trade settlement scheme.

• Relative to foreign reserves: Nearly three quarter of the lines went to reserves-

rich Asian central banks, which proved the point on promoting the CNY as a reserve

currency. On the flip side, the lines also promoted the PBOC’s own reserve

diversification objective by swapping CNY for the local currencies of these foreign

central banks, which could then be invested in the government bonds of the latter

group. In this regard, the total swap lines currently account for no more than 9% of

China’s USD3.2 trillion foreign reserves, suggesting that there is plenty of scope for

further expansion.

Figure 9: PBOC's CNY swap lines

Date of swap line agreement

Size of swap line (CNY bn)

Bilateral trade as % of China's total trade

Korea* 12 December 2008 180 7.0

Hong Kong* 20 January 2009 200 7.8

Malaysia* 8 February 2009 80 2.5

Belarus 11 March 2009 20 0.1

Indonesia 23 March 2009 100 1.4

Argentina 2 April 2009 70 0.5

Mongolia* 6 May 2011 5.0 0.1

Iceland 9 June 2010 3.5 0.0

Singapore 23 July 2010 150 1.9

New Zealand 18 April 2011 25 7.6

Uzbekistan 19 Apr 2011 0.7 0.1

Kazakhstan 13 June 2011 7.0 0.7

Korea* 26 October 2011 360 7.0

Hong Kong* 22 November 2011 400 7.8

Thailand 22 December 2011 70 2.2

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Pakistan 23 December 2011 10 0.3

UAE 18 January 2012 35 0.9

Malaysia* 8 February 2012 180 2.5

Turkey 21 February 2012 10 0.5

Mongolia* 21 March 2012 10 0.1

Australia 22 March 2012 200 3.2

Brazil 22 June 2012 190 2.3

Ukraine 26 June 2012 15 0.3

Taiwan 31 August 202 to be

determined

4.4

Aggregate 1666 37

*Lines renewed. Source: IMF, CEIC, Bloomberg, Reuters

Onshore market access

Current account fully open/ convertible, capital account still partially convertible

Ultimately, the CNH market should be seen as a conduit into the onshore market.

Otherwise, the market would never take off, proving the sceptics right – that the

experiment at making the CNY partially deliverable/ convertible would end nowhere.

And the sceptics were proven wrong so far.

The rapid deregulation of cross-border trade and investments has now made the CNY

fully convertible on current accounts. The bulk of the capital account is partially

convertible, guarded by quotas and/or application procedures. Figure 10 distinguishes

the currency denomination – USD/ foreign currency, offshore deliverable CNH or

onshore CNY – in which the different current and capital account items are allowed to

be settled. We briefly described them below.

On current accounts (more details can be found in the Appendix):

• Merchandise goods: All goods trades can be settled using the onshore CNY

exchange rate. Chinese exporters also have the choice to exchange their foreign

currency export proceeds in the offshore CNH market before repatriating funds.

However, Chinese importers can only use the onshore exchange rate for making

payments to offshore counterparties.

• Services, interest income and transfers: Transactions settled in CNY can only be

dealt using the offshore CNH exchange rate. This implies that to settle CNY-

denominated payments, onshore Chinese entities must remit foreign currency

offshore to exchange into CNH for the payments.

On capital accounts:

• Foreign direct investments: CNY funding is allowed both ways. Inward direct

investments are funded through the offshore CNH market, while outward direct

investments are funded through the onshore CNY market.

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• Portfolio investments: CNY funding is allowed only one way, by foreign investors

through the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme which

was introduced in August 2011. This is a counterpart of the QFII scheme and mini

QFII scheme which allowed foreign portfolio investments to enter China in foreign

currency denomination. The difference between the regular QFII and mini QFII is

that the latter is open specifically for onshore fund managers to directly tap retail

investors overseas. The reverse scheme – Qualified Domestic Institutional

Investors (QDII) – which allows onshore institutions to invest overseas – does not

have the equivalent CNY counterpart.

• Loans, trade finance and deposits: Onshore corporations were permitted in June

2010 to borrow CNH from the offshore market for longer-term trade finance and

project financing. They are only allowed to extend trade credit in CNY terms for

periods of 90 days or less.

• Special access: This pipeline is open to central banks, sovereign wealth funds and

CNY trade settlement banks in Hong Kong to invest directly in the onshore

interbank bond market. All the quotas are set by the PBOC on a case-by-case basis.

In the central banks’ case, the quotas are activated from the CNY swap lines

offered by the PBOC and hence, only the central banks which have signed such

lines are eligible. As at end 2011, a total CNY255 billion of such quotas has been

allocated through this pipeline, of which CNY185 billion went to the first two groups,

including CNY65 billion to Japan alone.

Figure 10: Level of openness of China’s borders *Long-term (LT) trade credit refers to above 90d term. Short-term refers to 90d term and below. Source: RBS

Goods GoodsOverseas

Direct Investment

Services, Interest Income,

Transfers

Services, Interest Income,

Transfers

Portfolio Investment

Portfolio Investment

Loans, LT Trade Credit*

Loans, LT Trade Credit*

Short-term Trade Credit*

Short-term Trade Credit*

Foreign currency deposits

Foreign currency deposits

Trade settlement

banks, foreign CBs, SWFs

PBOC

Foreign Direct Investment

Current Account Capital AccountOffshore Onshore Offshore Onshore

USD

CNH

(QFII, mini QFII)

(RQFII)

(QDII)

CNY

(foreign debt quota)


(CNY sw ap line & special quotas)


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Recent deregulation on investments favoured domestic bonds

The pace of deregulation accelerated from August 2011 when China and the United

Kingdom jointly announced that the setup of London as a global offshore RMB centre.

In the following 12 months, the deregulation concentrated mainly on inward

investments rather than outward investments. Total QFII quotas were increased from

USD30 billion to USD80 billion in April 2012. Approval time was also cut, leading to a

rapid increase in the number of QFII licences and their total quotas (see Figure 11).

On 27 July 2012, the PBOC announced the easing of application rules for QFII, such

as the opening of multiple securities accounts with different securities companies and

direct investments in the interbank bond market from which they were previously

barred, being restricted investing in the exchanges.

The recent deregulation drive thus clearly favoured the promotion of the domestic

bond market. RQFII licences come attached with the condition of a minimum 80% of

the quota to be allocated to bonds. Total RQFII quotas are set at CNY70 billion. Total

applications approved currently stand at CNY32 billion (USD5 billion). Meanwhile, total

QDII quotas currently stand at USD83 billion, nearly four times the total QDII quotas in

January 2007 after the scheme was introduced in April 2006 (Figure 12).

Figure 11: QFII aggregate quotas (USD bn) and number of licences Source: CEIC

Figure 12: QFII aggregate quotas vs QDII aggregate quotas (USD bn) Source: CEIC

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Key deregulations on investments in the past year

Following are the key regulatory changes affecting onshore market access made since

August 2011 (a full history and details of regulatory changes can be found in the

Appendix):

• August 2011 – The PBOC launched Renminbi QFII and pilot scheme for foreign

banks to tap CNH to recapitalise mainland operations. Onshore non-FIs /

corporates were allowed to issue CNH bonds subject to quotas.

• December 2011 – The Chinese government launched the RMB Qualified Foreign

Institutional Investors (RQFII) scheme on a trial basis for foreign investors to enter

the onshore market. An initial target of CNY20 billion was set for the quotas to be

awarded under the scheme. A minimum 80% floor was set for the funds to be

invested in bonds.

• January 2011 – Ten investment firms in Hong Kong were granted RQFII licences to

invest in China’s securities market with a total CNY10.7 billion of quotas. The firms

planned to develop RMB wealth management products onshore.

• April 2012 – China announced the expansion of USD50 billion investment quota to

both the Qualified Foreign Institutional Investors (QFII) and the Renminbi QFII

(RQFII) pilot programmes. This brought the total quota to USD80 billion from

USD30 billion for the QFII, and to CNY70 billion from CNY20 billion for RQFII. It will

also allow the pilot institutions to use the quota in issuing RMB A-share ETF product,

to invest in the A-share index shares and list them in the Hong Kong Exchange

(HKEx).

• July 2012 – China and Singapore jointly announced that a second offshore CNY

clearing centre will be set up in Singapore, to be operated by the full branch of a

Chinese bank in Singapore. This agreement is part of a China-Singapore Free

Trade Agreement (FTA) signed on 6 July 2012.

• July 2012 – China released new rules for foreign investors, lowering minimum

qualification requirement and simplifying the approval process for applicants under

the Qualified Foreign Institutional Investor (QFII) programme. The changes allowed

QFIIs to invest in China’s interbank bond market. The new rules also allowed

foreign private equity investment entities to apply for QFII licenses

Offshore-onshore market convergence

Offshore CNH FX has become leader for NDF and even onshore CNY FX market

The wave of rapid regulatory changes from late 2011 paved the way for the

convergence between the offshore and onshore markets. In the initial one to two years

of its existence until late 2011, the USD/CNH FX market was directionally driven by

USD/CNY NDF to the extent that some market participants started mulling over the

idea of introducing a NDF version of the CNH market.

Since late 2011, the pull of forces has reversed. The NDF market is now driven by the

CNH market such that it behaves like a semi-deliverable market with the forward curve

tilting upwards to reflect the positive interest rate premium of CNY interest rates over

USD rates. Since April 2012, just prior to the PBOC expanding the intra-day trading

band, the onshore USD/CNY market has also started to follow the offshore USD/CNH

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market, deviating from the direction set by the PBOC every morning through its fixing

(Figure 13).

With the convergence in the FX markets, the bond markets onshore and offshore also

began to converge. The yield discount of the offshore issues to the onshore issues is

now found mainly in the shorter-dated bonds of three-year tenor and below, and has

compressed to no more than 50 basis points (see Figure 14). The pressure for the

yield convergence is also coming from the subtle shift in FX policy direction by the

PBOC – from a strong and stable CNY to a weaker and more volatile CNY. Investors’

expectations on returns from the CNH bond market have thus shifted from FX gains to

yield and/or bond gains.

Figure 13: Offshore USD/CNH spot vs onshore USD/CNY spot Source: Bloomberg

Figure 14: Offshore China MOF 3y bond vs onshore MOF 3y bond (%) Source: Bloomberg

The next five years

Becoming fully convertible

Partial convertibility at best leads to partial internationalisation

Taking a very long perspective, the CNY is just two steps short of becoming fully

convertible and three steps away from becoming an international currency. The steps

are:

1. Allow all capital account items to be settled freely in CNY both ways – inwards

and outward of China.

2. Lift all quotas and streamline application and approval processes.

3. Increase the use of CNY for international trade and investments.

This is a simplification as the last giant step involves multiple facets. The qualifications

of an international currency are much broader than this one-line description (see next

section). Logically, one would expect China to make the CNY fully convertible before

embarking on the ultimate goal of internationalising the CNY. But China has put the

proverbial horse before the cart by creating an offshore CNY market to promote the

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use of the CNY in international trade and investments before the currency is fully

convertible.

Inclusion in IMF SDR basket will be a strong endorsement

China’s actions seem to suggest some degree of time consideration to achieve the

goal of internationalising the CNY. The government appears to have its sight for the

CNY to be included in the IMF’s Special Drawing Rights (SDR) basket by the end of

2015 when the IMF reviews its basket. The current global climate favours the CNY as

both the USD and EUR are under pressure and global investors are looking for an

alternative reserve currency. In working towards this goal, the Shanghai municipal

government released a blueprint in March 2012, setting goals of making Shanghai the

global pricing centre for both onshore and offshore CNY financial products by 2015,

and a global financial centre by 2020.

In the next few years, we can thus expect to see more of the following:

• Expansion of the trade settlement scheme: Trade in goods and services is the

smoothest or most consistent way to grow the global CNY liquidity pool, considering

especially China’s status as one of the world’s largest trade partner.

• Setting up of more direct clearing lines: This will be targeted at strategic trade

partners. Jointly with China, Singapore has announced that it will set up an offshore

CNY clearing centre, while Taiwan and Japan are believed to be in negotiations

with China for their own dedicated clearing lines.

• Joint ventures with international financial centres: London was announced as

the global offshore CNY centre and this is in partnership with Hong Kong. Getting

the second CNY clearing line will make Singapore a regional satellite centre.

Getting Hong Kong to partner with London may thus be China’s assurance to Hong

Kong that it retains the lead as the main offshore CNH centre above Singapore and

London. In the background, Shanghai is preparing to become the global pricing

centre for all CNY financial products onshore and offshore by 2015, as spelt out in

its blueprint which names Hong Kong as a partner in achieving this goal. Can

Shanghai achieve this goal without the CNY becoming fully convertible?

Internationalising the CNY

BIS’s seven criteria to qualify as an international currency

There are many shades of the definition of an international currency. A short definition

is a currency that is widely held as a reserve currency. The US dollar and the euro fit

this definition as they currently account for 62.2% and 24.9% of world foreign reserves

(see Figure 15). By far the most concise definition of an international currency are the

following seven criteria1:

1. Freely traded: Removal of all restrictions on trading the currency

2. International trade invoicing: Ability for both foreign and domestic firms to

invoice trades in the currency

3. Readily accessible: Ability of domestic and foreign institutions to hold currency

in amounts they deem fit

1 Peter Kenen, Princeton University, “Currency internationalisation: an overview”, BIS Papers No. 61, December 2011

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http://www.bis.org/publ/bppdf/bispap61d.pdf


4. Used for securitisation by private sector: Both domestic and foreign

institutions are able to issue marketable securities in the currency

5. Used for securitisation by multilateral agencies: International financial

institutions such as the World Bank are able to issue debt instruments in the

country’s market and use the currency in their financial operations

6. Reserve currency: Currency may be included in currency baskets of other

countries

7. International confidence in the issuing country

CNY currently ranks as 15th most used payments currency globally

Based on the above criteria, only the USD and the EUR are fit to be called an

international currency while none of the other G7 currencies could. The key criterion

which most currencies are unable to fulfil is that on international trade invoicing.

The CNY currently falls short of more than half the criteria above. The CNY currently

ranks 15th as a payments currency globally with a market share of 0.45%. To be part of

the top five payments currencies, the CNY market share has to reach at least 2%.

EUR and USD’s market shares are 43% and 31% respectively. Hence, the ultimate

goal to become an international reserve currency is still a giant step away.

USD took 30 years to be accepted as international currency through economics and politics

The USD took about 30 years to achieve the status of an international currency – from

the end of the World War II in the mid-1940s to the early 1970s. The collapse of the

Bretton Woods Agreement saw central banks around the world switch from holding

gold reserves to holding USD as their reserve currency. In 1975 when OPEC accepted

USD as the sole pricing and settlement currency for oil, this propelled the USD to

become the currency denomination for all other major commodities, sealing its status

as a world reserve currency.

EUR took less than 10 years through economic union

The EUR was introduced in 1999. With the combined strength of its 12 founding

members, its share of world reserves was set at 18% from the start. As the Euro zone

expanded, its share of world reserves has grown, reaching about 28% by third quarter

2009. The EUR’s ascent as an international currency was also bolstered during this

period by the bursting of the dot.com bubble and the September 11 terrorist attacks on

the US which shook international confidence in the US economy and the dollar.

The last chapter of this guide discusses the chances for China achieving the

international currency status for the CNY. The conclusion is that current efforts to

globalising the offshore CNH market franchise will lead at best to partial

internationalisation without full convertibility.

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Figure 15: Distribution of world foreign reserves (%) Source: IMF

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FX Market

Evolution of the market

CNH FX market is now driven by corporate flows

The CNH FX market officially came into existence in July 2010 when the PBOC and

the HKMA signed a Supplementary Memorandum of Cooperation that allows Hong

Kong banks to directly settle CNY trades among each other. This led to the creation of

the CNH interbank market. In its brief history, the market evolved from one that is

purely driven by regulations to one that is increasingly driven by flows from foreign

multinational corporations (MNCs) and Chinese corporations.

There were major regulatory changes by both the PBOC and HKMA to directly deepen

the FX market.

• Expanding the central clearing line: The CNH FX market had a rather turbulent

first two years, caused primarily by the tight cap imposed on the Bank of China

(Hong Kong) Limited for centrally clearing any long/short CNY positions offshore.

Also, the build-up of liquidity through the trade channel was not fast enough to cope

with a rapidly growing demand from bond investors.

The central clearing limit was breached twice – the first time on 28 October 2010

from the short side and the second time on 23 September 2011 from the long side.

Both times caused huge dislocations between the CNH and onshore markets. In the

first episode, the HKMA stepped in to assure the market that it was standing by to

activate its CNY swap line with PBOC. In the second episode, the PBOC eventually

had to temporarily double the quota. A second central clearing line is on the way to

be set up in Singapore, as announced in July 2012.

• Introducing a daily USD/CNH spot fixing: The introduction of a daily USD/CNH

spot fixing at 11.15am by the Hong Kong Treasury Markets Association (TMA) in

June 2011 was an important turning point. This was a boost to the FX derivative

and option markets as the fixing provides transparency and also a pricing source for

switching to USD settlement in the event of any market disruption that renders the

CNH non-deliverable. This was formalised in October 2011 by a working group of

banks and the International Swaps and Derivatives Association (ISDA) to include a

standard fall-back clause for CNH FX OTC products. However, other products

including CNH bonds have yet to standardise the choice of FX fixing and/ or the

adoption of a market disruption clause.

• Increasing Hong Kong banks’ risk limits: In January 2012, the HKMA increased

banks’ CNY net open positions from the 10% cap imposed since July 2011 to 20%.

In May 2012, the cap was lifted. Banks’ statutory liquidity requirement on CNY

deposits was also liberalised twice, in February and June 2012.

• Widening the onshore intra-day trading band: In April 2012, the PBOC widened

the intra-day trading band on USD/CNY spot from +/-0.5% to +/-1% and lifted the

short-selling ban on USD by onshore banks. This easing of FX rules onshore further

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deepened the offshore market as it broadened the scope for Chinese companies to

arbitrage between the two markets.

Other deregulation steps which indirectly helped boost the FX market trading volume

included those which opened up the inward investment routes into China, and the

lifting of restrictions for Chinese exporters to settle in CNY.

On 27 April 2012, the HKMA extended the real time gross settlement (RTGS) system

by an additional five hours to close at 11.30pm. The aim is to facilitate the settling of

trades as a step to help deepen the market in London. However, the extended RTGS

hours may have limited use as banks are still unable to access their fiduciary accounts

at the PBOC Shenzhen branch whose hours have not been extended. The fiduciary

account channel was set up in early 2011after the first breach on the central clearing

cap in October 2011 so as to reduce banks’ counterparty risks with the sole central

clearing bank, BOC (Hong Kong) Limited. Clearly, banks would favour the PBOC

counterparty risk to the BOC risk.

Figure 16: Types of FX markets in the offshore deliverable, offshore non-deliverable forward and onshore deliverable markets

Offshore CNH Offshore NDF Onshore CNY

Fx Spot

Tenors T+2 value spot n.a. T+2 value spot

Daily volume (USD bn) 1-2 n.a. 20

Ticket size (USD mn) 5-15 n.a. 10-20

Bloomberg/ Reuters CNH TMAF/ CNHFIX= n.a. CNY/ CNY=CFXS

FX forward

Tenors O/N - 12m , 18m, 24m T/N - 12m O/N - 12m, 24m, 36m

Daily volume (USD bn) 2-3 4-5 10

Ticket size (USD mn) 10-20 10-50 10-20

Bloomberg/ Reuters CNH+1M/ CNH1MOR= CCN+1M/ CNY1MNDFOR= CCO+1M / CNY1MOR=

Cross currency swap

Tenors 6m - 5y 1y - 5y 1y - 5y

Daily volume (USD mn) 50-100 20-50 inactive

Ticket size (USD mn) 10-20 10-20 inactive

Bloomberg/ Reuters CGUSSW2 / CNHUSCS=TRHK CCSWN2 / CNUSNDS2Y= CGYSSW2 / CNUSCS

FX option

Tenors O/N-2y O/N-3y O/N-2y

Daily volume (USD mn) 70-300 250-300 Illiquid

Ticket size (USD mn) 10-20 50 n.a.

Bloomberg/ Reuters USDCNHV1Y / CNH1Y0=BRKR USDCNYV1Y / CNY1YO=W USDCNYOV1Y / CNY1YO=CN

FX futures

Tenors 1m-1y (to start on 17 Sep ’12)

1m-1y (CNYUSD) 1m-3y (USDCNY)

n.a.

Daily volume n.a. Illiquid n.a.

Ticket size (USD mn) n.a. 0.1mn per contract n.a.

Bloomberg/ Reuters n.a. n.a. n.a.

Source: Bloomberg, RBS

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Spot

Market vs fixings

Spot market liquidity has picked up significantly since its inception. Daily volumes for

CNH spot are now about USD2 billion, more than a ten-fold increase from inception. In

comparison, the onshore CNY daily trading volume is about USD10 billion. The

average transaction size is around USD10 million (see Figure 16).

Offshore CNH and onshore CNY spot rates have converged although the two fixings continue to diverge

The direction of USD/CNH is ultimately set by the PBOC’s FX policy through its daily

fixing. However, there are still long stretches of deviations from the onshore market for

which the comparison can be made in terms of two spot fixings and the real-time

trading.

Prior to the recent deregulations which allowed more two-way flow of funds for trade

and investments, the deviations between USD/CNH and the onshore market were in

both the fixings and real-time trading (Figure 17). Since May 2012, the deviations in

the fixings on both sides continue to deviate. However, real-time spot trading of the

two markets has converged (Figure 18). This has come about with the onshore real-

time spot rate converging to the offshore deliverable CNH rate rather than its own

onshore fixing set by the PBOC. In other words, the CNH market has taken the lead

over the onshore market.

One can say that the PBOC’s widening of the intra-day trading band in April 2012 from

+/-0.5% to +/-1% marked the turning point for market convergence between offshore

and onshore. At about the time of the PBOC’s move, the country’s top leaders and the

PBOC governor issued statements on allowing the CNY to be more freely trading so

as to see more two-way fluctuations on the basis that the currency is fair-valued and

the country’s exports have come under pressure. This seems like a subtle message for

a switch from a strong FX policy to a neutral or even slightly weak FX policy. The

PBOC’s fixing for USD/CNY has risen by 0.8% since the band widening. The offshore

USD/CNH fixing has risen by 1.1% during the same period.

Deliverable CNY/JPY cross now quoted in Tokyo; expect more crosses to follow

On 1 June 2012, the Tokyo interbank market started directly quoting the deliverable

CNY/JPY cross rate with the PBOC endorsement. As upcoming offshore CNY centres,

we believe that London and Singapore will launch more of the deliverable CNY

crosses, starting with crosses against their own respective local currency units.

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Figure 17: USD/CNH fixing vs PBOC USD/CNY fixing and PBOC intra-day band Source: Bloomberg

Figure 18: USD/CNH spot vs USD/CNY spot and PBOC intra-day band Source: Bloomberg

Forwards

Combining spot and forwards, the CNH FX market is broadly on par with the NDF market

The daily volume for CNH FX swaps and forwards is estimated at USD3 billion. Tenors

are available up to three years, with liquid better in one year and below. CNY NDF

daily transaction volume is estimated at USD6.5 billion. Combining spot and forwards,

the deliverable CNH FX market is now broadly on par with the NDF market. Onshore,

the daily volume of CNY FX swaps and deliverable forwards is estimated at USD10

billion. Combined with spot trading, the total trading volume of the onshore FX market

is about USD20 billion (see Figure 19).

Market participants are increasingly migrating from NDF to deliverable CNH forwards

There is increasing pressure for the onshore market to trade in line with the offshore

deliverable market and away from the onshore fixing. Given this, we expect market

participants to increasingly migrate to the deliverable CNH market from the NDF

market which takes an onshore fixing. In fact, the behaviour of the USD/CNY NDF

market has long stopped behaving like a normal NDF market, behaving more like a

deliverable market. Well before the PBOC’s subtle shift to a weaker FX policy, the

NDF curve has moved upwards steeply. It was dragged up by the steepening pressure

from the deliverable USD/CNH forward curve (see Figure 20). As a typical NDF market

reflects market expectation for the strength or weakness of the currency to USD,

USD/CNY NDF had been inverted to reflect market expectation of a strong CNY

before the deliverable CNH market became deep and active.

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Figure 19: USD/CNH 12 mn outright vs USD/CNY NDF 12m outright and onshore USD/CNY 12 mn outright Source: Bloomberg

Figure 20: Implied 12 mn CNY appreciation by USD/CNH forward vs USD/CNY NDF and onshore USD/CNY forward Source: Bloomberg

Cross currency swaps

Cross currency swaps are offered by major interbank players with tenors from six

months to five years, although liquidity is poor above three years. The daily turnover is

reasonably big at around USD300 million, with an average ticket size of USD10-20

million. Liquidity has been gradually improving as market participants increasingly

switch from ND-CCS to the deliverable CCS for hedging trade and investments. For

trade, transactions are mainly confined to tenors one-year and below.

On the investment channel, the flows currently tend to come from investors paying

CNY CCS rather than issuers receiving CNY CCS. However, as the CNY CCS basis

becomes less negative (see Figure 21) and the market gets deeper, USD-based

issuers might be increasingly attracted to come to the CNH bond market to raise funds

and swap them into USD.

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Figure 21: 1y CNH CCS vs CNY ND-CCS and onshore CNY CCS Source: Bloomberg

Figure 22: 3m USD/CNH vol. vs USD/CNY NDF vol (%) Source: Bloomberg

Options and futures

CNH options now trade up to 2-years

Still in a relatively nascent stage of development, the CNH options market is growing

at a brisk pace. The first OTC RMB option was traded in November 2010. The liquidity

has since picked up, averaging around USD70 -120 million, reaching USD300 million

on busier days. Tenors of up to 12 months are fairly liquid (see Figure 22). Two year

options are not as liquid but not uncommon.

Futures to be available from September 2012

On 22 August 2012, the Hong Kong Exchanges and Clearing Limited announced that

it will introduce the first deliverable CNY currency futures on 17 September 2012. The

USD/CNH contract would be the first deliverable CNY currency future. The final

settlement price will be based on the spot USD/CNH fixing published by the Treasury

Markets Association at 11.15 am. The first batch of contract months that will become

available are October 2012, November 2012, December 2012, January 2013, March

2013, June 2013 and September 2013.

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Interest Rate Market


Starting a money market, IRS still non-existent

Until the end of 2011, the CNH interest rate market comprised only a thinly traded

deposit market and a vibrant bond market (see Figure 23). Since January 2012, Hong

Kong banks have started to activate a money market by providing a daily fixing on a

CNY Hibor curve.

There are three reasons which remain today as to why Hong Kong banks struggled to

activate an interest rate swap curve in the CNH market:

• Lack of a policy interest rate target: The PBOC’s interest rate policy targets are

Chinese banks’ commercial deposit and lending rates. Hence, the onshore money

market of repo and Shibor are driven entirely by liquidity factors, including the

PBOC’s open market operations (bills, repos and reverse repos), required reserve

ratio (RRR) moves and FX fund moves. Given the vastly different liquidity condition

in the CNH market from the onshore market, the onshore Shibor is thus highly

inappropriate for setting the CNH interest rate swap market.

• Lack of access to onshore Shibor: As the CNH IRS is a deliverable market –

similar to the FX market, market makers for the IRS curve would require access to

the short-end fixing to be able to manage their interest rate risks. However, there is

no access to the onshore Shibor market.

• Onshore market is highly speculative: There are several different IRS markets

onshore, the most heavily traded being that fixed on the seven-day repo rate with a

daily turnover of CNY3-4 billion. The Shibor-fixed market is the second most traded

market with daily volume barely half of the former. Other IRS curves have fixings on

the PBOC’s one-year lending and one-year deposit rates, These are used by

corporate borrowers on a case-by-case basis. Until recently, the onshore seven-

day-fixed and Shibor-fixed IRS market is highly speculative as both borrowers and

investors do not use the market for hedging interest rate risks. More recently,

corporate bond issuers have begun using the IRS curve to do hedging.

PBOC monetary policy overhaul underway

For all the above points, it is clear that the offshore market cannot use the onshore

money market to start an offshore interest rate swap market. This was the reason why

Hong Kong banks have come together to start an interbank CNY Hibor curve in

January this year. Meanwhile, the PBOC has started managing interest rate policy

changes.

• OMO becomes two-way with regular reverse repos: Firstly, the PBOC has

replaced the use of RRR tool with reverse repurchase operations, regularising the

reverse repos in the twice-weekly open market operations (OMO) since the

beginning of June 2012. Previously, the OMO comprised only repos and the central

bank bill auctions while reverse repos were conducted on a discretionary and

bilateral basis with banks in need of liquidity.

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• Subtly deregulating commercial lending and deposit rates: Secondly, the

PBOC has started to use the interest rate tool more frequently, cutting the policy

targets on banks’ commercial lending and deposit rates twice on 7 June and 5 July

2012 (see Figure 24). These cuts were accompanied by a softening of the hard

corridor by allowing banks to give discounts to their lending rates below the policy

targets and premiums to their deposits rates above the policy targets. In the last

move, the discount on lending rates is allowed up to 30% while the premium on

deposit rates is allowed up to 10%.

Possible switch in interest rate targets coming up

The second move clearly reduced banks’ protected interest rate profit margin. While

intending to make banks more competitive, it is possible that the PBOC is also looking

at changing its interest rate policy targets.

Specifically, we believe the central bank might introduce a repo and reverse repo

corridor target as its interest rate policy and move away from targeting banks’

commercial lending and deposit rates. The country’s top leaders and the central bank

governor have openly talked about interest rate reforms at about the same time they

have spoken about FX reforms. Hence, a regime shift could be underway which will

switch the PBOC’s monetary policy from an active quantity-based approach using the

RRR tool to a price-based approach using market interest rate tools. If so, this would

create a more policy-driven and deeper Shibor market onshore from one that is

currently liquidity-driven and often speculative.

Figure 23: Types of interest rates markets in the offshore deliverable, offshore non-deliverable forward and onshore deliverable markets

Offshore CNH NDF Onshore CNY

Interbank borrowing

Tenors O/N, T/N, term deposits(to 1y) n.a. O/N, T/N, term deposits to 1y

Daily volume CNY2-4bn n.a. CNY500-800bn

Ticket size CNY50-500mn n.a. CNY300mn

Bloomberg/ Reuters CGDR1 / CNHIBOR n.a. CCDR1 / SHIBOR

Interest rate swaps

Tenors inactive 1y-10y 1y-10y

Daily volume inactive CNY1-2bn. CNY3-4bn

Ticket size inactive CNY50-300mn CNY100-300mn

Bloomberg/ Reuters CGSW1 / CNHIRS=BRKR CCSWNI1 / CNNDIRS= CCSWO1 / CNYIRS7R=CN or CNYIRS3S-CN

MOF bonds

Tenors (benchmarks) 2y, 3y, 5y, 10y, 15y n.a. 1y, 3y, 5y, 7y, 10y, 20y (longest 50y, not benchmark)

Daily volume CNY50-200mn n.a. CNY300bn

Ticket size CNY5-10mn n.a. n.a.

Bloomberg/ Reuters n.a. n.a. GCNY2YR / CN2YT=RR

Source: Bloomberg, RBS

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Figure 24: PBOC 1y deposit-lending rate policy corridor, 7d repo rate and 3m Shibor rate Source: Bloomberg

Figure 25: 3m CNH Hibor vs CNH FX implied rate, CNH deposit rate and onshore Shibor (%) Source: Bloomberg

Money market

The daily transaction volume of CNH deposits and loans is estimated to be CNY2-3

billion. For overnight (O/N) and tomorrow-next (T/N) deposits, the size per transaction

is around CNY100 million-1 billion while the size for term deposits is usually smaller

around CNY50-200 million (See Figure 23).

On 3 January 2012, Hong Kong TMA announced it would establish a CNH Hibor curve

by getting three banks to commit to publishing their interbank offered rates at 11am

daily. Based on their customer flows, the rates from the three banks were initially wide

apart from each other. More members were added subsequently. The number of

contributing banks stands at 13 as of August 2012.

Although the rates posted by banks have become less disperse, the curve remains

illiquid and is hardly traded. From overnight to three months, the rates are fixed at

about the same levels as the rates implied from the USD/CNH FX forward curve (see

Figure 25). For the longer tenors, the rates vary according to the fixing and banks’

funding requirements.

Interest rate swaps

As said above, the CNH interest rate swap market practically does not exist at all. The

rates posted by Hong Kong banks basically are taken from the onshore market and

there seems to be a tacit agreement among interbank market players not to trade the

curve.

The best alternative is to create a new IRS curve using the CNY Hibor as fixing once

the latter becomes more tradable. An IRS curve would help to deepen the CNH bond

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market, especially for secondary trading of the bonds, by allowing issuers and

investors to hedge their interest rates.

Sovereign benchmark curve

Only the Chinese government can set the sovereign CNH bond benchmark curve as

the CNY is the sovereign currency of China. China’s MOF launched its first bond

issuance in September 2009 in tenors of two-years, three-years and five-years, with

tranches for retail and institutional investors. Since then, it has issued three more

batches of bonds, with roughly six to nine-months frequency in December 2010,

August 2011 and most recently in June 2012. In the last issuance, the MOF extended

the duration of the sovereign benchmark curve from 10-years to 15-years.

Similar to the CNH corporate bond market, the MOF’s bonds in the offshore CNH

market used to command significant coupon discounts over the onshore bonds. In fact,

the yield discounts were wider than those issued by regular Chinese bank issuers.

These premiums have since evaporated as investors’ expectations have switched from

FX gains to bond gains (see Figures 26 and 27).

Figure 27: 3y MOF offshore CNH bond vs onshore bond (%) Source: Bloomberg

Figure 26: Offshore MOF benchmark curve vs onshore benchmark curve as at 1 Sep 2012 (%) Source: Bloomberg

Repo market

One of the initiatives which emerged from the Hong Kong-London RMB Forum was a

tripartite repo arrangement jointly set up by the HKMA central money market unit,

Euroclear and J.P. Morgan in late June 2012. The system is designed to facilitate CNH

repurchase transactions involving a wider choice of international securities through the

Euroclear and J.P. Morgan platform. It can be a start to a full repo market for CNH

bonds which would help to boost the extension of bank lending using the limited pool

of CNH liquidity. The system also helps to reduce the settlement risks among banks.

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Bond Market


There are broadly three phases of development in the CNH bond market over the past

five years: 2007-2009 – a sellers’ market; 2010-2011 – the Big Bang paving way for

global issuers and investors; and 2012 – a buyers’ market. We briefly document below

the important milestones in each phase.

The expansion outside of Hong Kong took off from 2010 after the central banks,

investors and corporations increasingly showed support for CNY trade settlement and

investment. It became a case of supply creating its own demand – the issuance of

CNH bonds by global MNCs attracted global investors outside of Hong Kong and Asia.

We briefly document the important milestones in these three phases.

• 2007-2009: Sellers’ market

Jun 2007 – first CNH bond issued by CDB

Dec 2008 – first CNY swap line signed with Korea

Jul 2009 – CNY trade settlement pilot scheme launched

In January 2007, the PBOC and the National Development and Reform Commission

(NDRC) jointly announced that the country’s banks would start to issue CNY-

denominated bonds outside of the mainland, specifically in Hong Kong. In June 2007,

China Development Bank (a state-owned policy bank) became the first issuer, followed

by other state-owned commercial banks. In the beginning, these issuances were

primarily targeted to absorb the excess offshore RMB in circulation in Hong Kong and

route them back into China.

The playing field was confined largely to the Hong Kong marketplace. Motivated by FX

gains rather than yields, Hong Kong-based investors facing a weak USD currency peg

and low USD interest rates were willing to accept yields as much as 250-300 basis

points below the yields of bonds issued by the same banks onshore. This made the

market very much in favour of sellers or issuers. The trade-off was that the maturity of

the bonds was mostly capped at a three-year tenor because of the investors’

motivation for FX rather than yield gains.

In September 2009, China’s MOF issued its first offshore bonds in three tranches for

both retail and institutional investors. This further spurred issuance from bank issuers,

which had by then broadened to China-incorporated foreign banks’ subsidiaries,

namely HSBC Bank (China) Company Limited and Bank of East Asia (China) Limited

as the first two non-Chinese bank issuers. The MOF bonds also extended the CNH

bond curve from three to five years, setting a sovereign benchmark.

This period also marked a critical phase of the RMB internationalisation process, which

involved two important developments. First was the signing of bilateral CNY swap lines

between the PBOC and the central banks from China’s strategic trade partners. These

lines were designed to promote confidence in the use of CNY for trade settlement.

Another critical development was the launch of the CNY trade settlement scheme on a

pilot basis in July 2009 for selected Chinese coastal cities with Hong Kong and ASEAN

member countries. Although the limitation of the scheme did not help much to boost

CNY liquidity or deposits in Hong Kong (not fast enough to cope with the increasing

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demand for the CNH bonds), it signalled Chinese Government’s efforts to facilitate the

RMB internationalisation process by developing the offshore RMB bond market.

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• 2010-2011: Big Bang – issuers and investors go global

February 2010 – all forms of CNH fund raising allowed in Hong Kong

July 2010 – CNH interbank market launched

October 2010 – first supranational issue by ADB, also first 10-year issue and first bond traded on the Hong Kong Stock Exchange

December 2010 – first non-Asian EM issuer, VTB Bank

This period was marked by rapid liberalisation steps by China, paving way for Hong

Kong to aggressively promote the market to global issuers, drawing in global investors.

The first step came in February 2010 with the HKMA announcing that all forms of CNH

fundraising by any Hong Kong or non-Chinese entities are allowed without prior

approval in the Special Administrative Region (SAR) if the proceeds are not to be

repatriated into China. In the latter event, repatriation would require the Chinese

regulators’ approval. This was followed by the signing of a Memorandum of

Cooperation between PBOC and HKMA in July 2010 that allows the Hong Kong banks

to set up an interbank market for CNH FX and interest rates.

Hopewell was the first non-Chinese corporate issuer in July 2010. This was followed

by McDonald’s issue in August 2010 which became the first MNC issue. The

McDonald’s issue set the precedent for MNCs with substantial business in China to

look at the CNH market as an alternative funding source for their Chinese operations.

By this time, the market had grown four-fold since its launch in 2007 to CNY41 billion

at the end of 2010. The demand for CNY liquidity to invest in the bond market became

so great that it breached the central clearing quota managed by Bank of China (Hong

Kong) Limited in October 2010. This activated the HKMA to announce that it would tap

the CNY swap line facility from PBOC to ease the market pressure (see FX section).

The October 2010 episode prompted the Hong Kong TMA to start its own USD/CNH

daily spot fixing at 11am in June 2011. This indicated China’s commitment to allow

market forces to play a greater role in determining CNH exchange rate, without being

pressured by the PBOC’s onshore daily fixing for the CNY. In addition to improving the

stability of the CNH FX market, it reduces the FX spot basis risk for CNH-denominated

products and in turn, provided more comfort for bond investors.

June 2011 – HK TMA started daily 11am fixing for USD/CNH

September 2011 – Chinese Vice Premier visited London to

promote London as a RMB centre

In September 2011, China’s Vice Premier Wang Qishan visited London to promote

London as a global offshore RMB centre. Preceding that visit, in August 2011, Chinese

corporates which had been kept out of the CNH bond market were allowed to tap the

market. The PBOC launched the RMB QFII scheme and a pilot scheme to allow

foreign banks to use CNH funds for recapitalising their Chinese operations.

In 2011, the market reached CNY225 billion, which was nearly a 23-fold increase since

its 2007 launch.

Despite the market opening up, the supply and demand imbalance remained in this

phase. The low yields on CNH bonds reflected strong investor demand and showed

that investors’ investment decisions were motivated by FX gains rather than return

from yields. With the shift in RMB appreciation expectations, we have seen that

investment in RMB bonds has come under greater scrutiny and requires more rigorous

credit analysis.

• 2012: buyers’ market

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Euro crisis and subtle shift in PBOC’s FX policy

The concerns on China’s growth and the subtle shift in the PBOC’s FX policy stance

from the beginning of this year combined to turn this market from a sellers’ market to a

buyers’ market. The yield premium has now almost completely closed up. Considering

that onshore and offshore CNY bond markets have their inherent risks, the question

now is whether there should be any yield differentials between the two markets.

For the onshore market, the basic issue is market access and the risk of capital

controls. For the offshore market, the issue is currency convertibility. Until the CNY

becomes fully convertible, there is still a chance, however remote, that China decides

to backtrack to a full non-convertibility status. In a way, the risks onshore and offshore

are in fact not dissimilar, stemming from the FX angle.

Moreover, the CNH DF market has priced in the shift in RMB appreciation

expectations, and has moved the basis swaps in favour of foreign issuers who would

issue CNH bonds and swap the proceeds into other major currencies like USD. These

market developments have provided favourable arbitrage opportunities for issuers who

do not have imminent needs in RMB.

January 2012 – HK TMA launched CNY Hibor fixing

January 2012 – HKMA eased banks’ CNY open risk limits

February 2012 – HKMA eased banks’ SLR for CNY deposits

February 2012 – Shanghai sets 2015 target to be global CNY pricing centre for both onshore and offshore markets

April 2012 – PBOC widened onshore USD/CNY intra-day trading band

April 2012 – City of London launched London-Hong Kong forum

June and July 2012 – PBOC cut interest rates twice and softened policy rate corridor

Despite market pressure, issuance volume continues to go up and investors’ interests

remain sturdy as issuers were willing to adjust to higher yields. To a large extent, this

was aided by further market reforms and liberalisation of rules. In January 2012, the

HK TMA launched CNY Hibor fixing. In January and February 2012, the HKMA

consecutively eased Hong Kong banks’ risk limits and statutory liquidity requirements

(SLR) on their CNY exposure. Onshore, reforms took the form of a widening of the

USD/CNY intra-day trading band in April 2012, and two rounds of rate cuts in June and

July 2012 which came with a softening of the corridor on banks’ interest rate margin.

The rate cuts in particular helped to further tighten the yield premiums of the onshore

bonds to the offshore CNH market.

Two other developments also surfaced in parallel. In February 2012, the Shanghai

municipal government released a blueprint, setting a 2015 target for the city to become

the global pricing centre for all CNY-denominated financial products onshore and

offshore. In April 2012, the City of London followed up on the Chinese Vice Premier’s

visit in September 2011 to London by launching a London-Hong Kong forum on the

global offshore RMB market. These are very subtle manoeuvres going on here which

we will discuss in a later chapter.

While Shanghai has its long-term ambition to become the country’s key financial

centre, including taking over the current role of Hong Kong as the main offshore RMB

pricing centre, Hong Kong has been given the chance to tap on the global financial

centre strengths of London to advance its RMB business in the interim. How the future

of the two cities pan out would be something to watch out for.

Meanwhile, in the pipeline, a second central clearing line will be set up in Singapore, to

be operated by a Singapore branch of a Chinese bank. Tokyo and Taipei are also

separately discussing their own respective direct clearing lines into China. All these

clearing lines would bypass Hong Kong, which as we said in the last chapter, has now

become a more mature market in our opinion.

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Shift in investors’ expectations from FX gains to yield or bond gains

At this point, we see the market has evolved from a seller’s market, where investors

continuously seek returns on FX appreciation, to a buyer’s market, where investors

would treat CNH bonds as a credit product and begin to evaluate the credit-worthiness

of the bond and not only the FX gains. The imbalance between demand and supply

has improved but not quite yet to demand-supply equilibrium, as shown by the

narrowing of the offshore/onshore premiums/discounts. The biggest uncertainty now is

the PBOC’s FX policy direction as investors adjust their expectations from chasing FX

gains to chasing yield or bond gains.

Issuer Base

The CNH market has experienced an exponential growth since 2010. As of August

2012, total new issues (including CDs) in 2012 amounted to CNY199 billion. Issue

volume for financial institutions (FIs) grew at a CAGR of 155% in 2010- August 2012

while the issue volume for corporates increased at a CAGR of 54% in the same period.

In its early stages of development, CNH issuance was dominated by Chinese

Government (Ministry of Finance), Quasi-government (policy banks) and China/Hong

Kong FIs. Since the landmark reforms in July 2010, which paved the way for offshore

entities to issue CNH bonds in Hong Kong, the issuer base has expanded greatly in

terms of issuer type, credit quality, geography, sector and tenor.

Types of issuers

Chinese FI are the leading issuers in the CNH market; foreign FIs and corporates gained market share since the opening of CNH bond market to offshore entities in July 2010

CNH bond issuers consist of state-owned enterprises, MNCs, Hong Kong branches of

Chinese banks and foreign banks, and onshore banks direct issuance. The CNH

market is still dominated by Chinese FIs (both policy banks and commercial banks),

which accounts for 70% of total market share as of August 2012. China/Hong Kong

corporates represents the second largest category of issuers (apart from MOF

issuance), accounting for 8% of total market share as of August 2012.

Figure 28: Issuance by issuer type (CNY bn) Source: Bloomberg; includes both bonds and CDs issuance

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From 2010 to August 2012, non-Chinese issuers accounted for over 14% of total CNH

issue volume, of which, corporates made up 50% of the issuer base and FIs took up

47% of the market share.

Figure 29: Increasing participation by non-Chinese issuer (CNY bn) Source: Bloomberg; includes both bonds and CDs issuance but excludes China MOF issuance

Figure 30: Issuance by Chinese issuers (CNY bn) Source: Bloomberg; includes both bonds and CDs issuance

Figure 31: Issuance by non-Chinese issuers (CNY bn) Source: Bloomberg; includes both bonds and CDs issuance

The geographical composition of the issuer base has also changed over time. Since

the first MNC issuance by McDonald’s in August 2010, we have seen a growth in

issuance by non-Chinese companies, notably Europe, North America and other parts

of Asia. In particular, CNH bond issuance by European issuers increased from a share

of only 1% in 2010 to 7% and 6% in 2011 and 2012 August YTD respectively.

We have also seen an issuer testing the new market with alternative issuing structure,

namely Khazanah Nasional, as the first issuer to sell an Islamic bond in the offshore

RMB market. The success of this transaction demonstrates the readiness of the

market to accept innovation.

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In addition, Korean frequent issuers have also access the market leveraging on the

window in the swap market.

Figure 33: Issuance by country (2011) Source: Bloomberg; includes both bonds and CDs issuance but excludes China MOF issuance



In terms of tenor, the majority of the issuances are concentrated in the shorter end of

the curve – three years or less where issuers enjoyed the deepest investor pool.

Traditionally, investors’ involvement was driven by an anticipation of RMB appreciation

and investors tended to have a directional view in the shorter maturities. As the market

evolves further where there are new entrants to the market, issuers were successful in

closing transactions with longer maturities. The most notable was when China

Development Bank raised CNY1.5 billion for the first 15-year CNH offering in January

2012 where insurance companies supported the transaction. China Development Bank

did another CNY1 billion 20-year trade in July 2012.

Figure 35: Issuance by tenor Source: Bloomberg; includes both FI and Corp bonds and CDs issuance but excludes China MOF issuance

Figure 36: Issuance by tenor Source: Bloomberg; includes only Corp bonds

Size-wise, 33% of CNH issuance has an issue size of CNY500 million-1 billion,

reflecting investors’ preference for liquidity. As of to date, the record of the largest

single issue volume is kept by the China Development Bank (CNY5 billion issue) in the

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FI space, and the New World China Land’s CNY4.3 billion issue in the corporates

space.

Figure 37: Issuance by issue size Source: Bloomberg; includes both FI and Corp bonds and CDs issuance but excludes China MOF issuance

Figure 38: Issuance by issue size Source: Bloomberg; includes only Corp bonds

Motivations and objectives

Chinese corporates and banks

CNH market is an important option for Chinese companies given the tight bank credit environment in China

We see the following incentives for Chinese corporates/banks entering the CNH bond

market:

1. Bank credit environment in China remains tight

As discussed in the earlier sections on FX and Interest Rates, the recent PBOC cuts in

both the benchmark lending and deposit rates, in our view, were moves to liberalise

interest rates rather than to ease policy. Credit environment remains tight and

unsecured term funding is not readily available.

New loans extended by Chinese banks in July 2012 fell to the lowest level since

September 2011. Chinese banks lent nearly CNY540 billion worth of new loans,

considerably lower than that of the previous six months. Although this can be partly

explained by the weaker overall macro economic situation in China, policy control over

lending was still underplayed. For example, there are still considerable policy

measures against lending to real estate developers in China.

On the contrary, Chinese banks’ overseas subsidiaries in Hong Kong or branches

continue to remain active in supporting their clients’ overseas activities. These Chinese

lenders constitute an important source of CNH investment pool servicing their clients’

overseas ambition.

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Figure 39: China’s new loan growth in July reached lowest in 2012 (CNY bn) Source: PBOC, Bloomberg

2. Previous and ongoing development of the offshore bond market as supported by the Chinese and Hong Kong governments

In light of the Chinese government’s initiative to internationalise RMB, a realistic

strategy would be to open the RMB bond market to international investors as soon as

the offshore bond market becomes mature.

In 2012, Chinese and Hong Kong regulators have taken numerous policy initiatives to

promote the depth and breadth of the CNH market. As a result, the CNH market has

developed substantially with a wide range of products:

• HKMA boosted RMB liquidity and expanded the assets range which can be

computed in RMB liquidity, enabling RMB deposits in Hong Kong to

increase and boost the diversification of issuers of CNH bonds

• Chinese government expanded QFII and RMB QFII quotas and simplified

the approval process, promoting more RMB backflow channels

• Chinese government liberalised trade settlements which significantly

expanded the RMB deposit base in Hong Kong to buy CNH bonds

• Allowing offshore RMB loans (by banking institutions operated in Qianhai)

• Further development of offshore RMB products and Exchange-traded Funds

(ETFs) listed in both China and Hong Kong

• Encourage two-way movements of RMB to support RMB internationalisation

We have seen more RMB inflows into and outflows from China through Hong Kong,

and diversified offshore RMB financial products with these policies. We anticipate the

pool of RMB to expand further and enhance demand for offshore RMB products.

3. Expanding Chinese borrowers’ overseas activities and their use of RMB

Chinese companies have expanded overseas and we continue to see growth here.

These overseas activities would need to be funded by borrowing offshore. Given the

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restrictions mentioned earlier, we expect to see more offshore funding through the

issuance of bonds in the offshore market.

Some of these companies may find the offshore RMB bond market a forum for their

fundraising.

Multinational corporations / overseas subsidiaries of Chinese companies

For MNCs or overseas subsidiaries of Chinese companies, the CNH market is an important funding channel for their onshore companies in addition to bank lending

For large global companies, MNCs, that have investments and operating subsidiaries

in China, the primary channel for funding working capital is bank lending unless their

onshore establishment is large enough to access the domestic bond market.

Bank borrowing, however, has certain restrictions which makes borrowing cost high

and maturity short term. The recent PBOC rates cut reduced the burden somewhat,

however, bank credit conditions continue to remain tight. Therefore, the offshore RMB

bond market offers term RMB funding at competitive rates.

When the authors visited potential issuers in Europe and North America, there were no

shortage of interest in this market. The challenge for these companies to issue, which

hinders the growth of MNC issuance volume, is the limitation of channels for the CNH

to flow back into their China operations as CNY. We will discuss the repatriation rules

in later sections.

Apart from repatriation matters, there are also two other opportunities for MNCs to

consider a potential issuance:

• Visibility: For many issuers, the offshore RMB market is the only platform for them

to gain access to the growing influence of the RMB currency as the domestic capital

market is currently closed to foreign issuers.

• Arbitrage: The development of the cross currency swap market (although for the

shorter end of the curve) provides opportunities for issuers to raise CNH and swap

into major currencies if there is no intention to move the bond proceeds to onshore.

Issuance outlook

FI issuers will continue to dominate while we expect to see more diversified names from corporates; longer maturities and larger issue sizes

Based on the above-mentioned incentives, we expect the composition of CNH issuer

base to continue to evolve over time.

• Continued strong supply from onshore financial institutions and corporates

We expect China will continue to use the offshore platform as a means to promote the

development of the offshore RMB market. This strategic initiative enhances

opportunities for Chinese policy banks, commercial banks and SOEs to issue CNH

bonds outside China. Hence we expect Chinese policy banks will continue to use the

CNH market as a stable wholesale funding source in addition to the onshore market,

and overseas subsidiaries and branches of Chinese commercial banks will use this

market to meet the demand of CNY loans outside China. We also expect more

onshore companies to issue CNH bonds, following the cases of Baosteel and China

Datang, that have been granted approvals by the NDRC to issue CNH bonds in Hong

Kong.

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• Increasing issuance by non-Chinese issuers

MNCs with a significant presence in China will increasingly be using this market,

especially when repatriation process has proved to be more accommodative than

before. Moreover, the latest development where PBOC has widened the fluctuation

band of CNY (from 0.5% to 1.0%) has helped to support the development of the swap

market. As the liquidity of the swap market improves, we expect to see more

international issuers who do not have natural needs in CNH tapping the CNH market,

as they could potentially achieve more competitive pricing compared to direct USD

funding.

• Longer maturities for CNH bonds

As the CNH market develops, investors are more receptive to longer tenor issuance.

This is evident by the recent China Development Bank’s 20-year offering, which has

received strong support from Taiwanese life insurance companies who look for long-

dated CNH assets to match their portfolio of liabilities.

Investor base

Types of investors The composition of investor base has been more diversified over time

The investor community in the CNH bond market has evolved rapidly since its

inception a few years ago. There is diversification in the composition of the investor

base both by investor type and by investor geography. In the beginning, the pool of

CNH liquidity resided predominantly with commercial banks as retail CNH deposits.

As the CNH market evolves over time, the composition of the investor base has

become more diversified – fund managers, insurance companies, private banks and

central banks have started to participate in larger proportion than they did a year ago.

In the beginning when there was a strong RMB appreciation play, hedge funds

participated in the appreciation story. As the market changed, where there is now an

equal balance between the appreciation and depreciation story, we have seen a

reduced involvement of hedge funds in this market.

Geographically, we have also seen wider investor participation. In the beginning, Hong

Kong-based investors were the main drivers of this product. We have seen strong

interest from Singapore-based investors who took up significant portion of the order

book of any single transaction. In the region, we have seen secondary market activities

involving investors from Southeast Asia. And the latest interests came from the

Taiwanese insurance companies who have contributed significant investor demand for

long-dated CNH bonds.

Outside of Asia, we have seen interest from European investors. Lanxess’s three-year

bonds were allocated 44% to European investors while 25% of Veolia’s three-year

bonds were was sold to European investors. Obviously, the issuers in the examples

above are well-known European blue-chip borrowers and European investors are very

familiar with their credit stories which made the investment decision more

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straightforward. Nevertheless, we have seen European interest in some pure-Asian

play too.

As the RMB appreciation story fades away, the CNH bond market has evolved from a

“currency” play to a “credit” play. Depending on the credit story, the yield demanded by

investors would reflect the underlying risk and the tenor of the bonds on offer, leading

investor composition to vary. The following charts show the investor composition of

some recent transactions in four categories of issuers namely, MNCs, SOEs,

commercial banks and policy banks.

Figure 40: Investor base breakdown by geography - MNC issuers Source: RBS, IFR Asia, The Asset

Figure 41: Investor base breakdown by investor type - MNC issuers Source: RBS, IFR Asia, The Asset

Figure 42: Investor base breakdown by geography - SOE issuers Source: RBS, IFR Asia, FinanceAsia

Figure 43: Investor base breakdown by investor type - SOE issuers Source: RBS, IFR Asia, FinanceAsia

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Figure 44: Investor base breakdown by geography – Commercial Banks Source: RBS, IFR Asia, The Asset

Figure 45: Investor base breakdown by investor type – Commercial Banks Source: RBS, IFR Asia, The Asset

Figure 46: Investor base breakdown by geography – Policy Banks Source: RBS, IFR Asia

Figure 47: Investor base breakdown by investor type – Policy Banks Source: RBS, IFR Asia

Investor outlook

By type and by geography

We expect the investor base to become more diverse over time for the following

reasons:

• Growing importance of RMB attracts more investors

The pace of RMB internationalisation has come at a faster pace than expected. The

Chinese government has broadened the investment channels for offshore RMB,

including the launch of offshore RMB products such as RMB IPOs and RMB bond

ETFs. The opening up of more channels for RMB will increase investor interest in CNH

bond issue.

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We expect to see an expansion of these schemes, considering the Chinese

government’s objectives to internationalise RMB in the future. Moreover, as RMB

become more internationalised, global fund managers are expected to set up more

RMB funds to tap the growth opportunities in China.

• Opening up of additional offshore RMB centres

With policy support from the Chinese Government and the importance of trade, Europe

is becoming a significant growth area for the RMB business. The push to make

London as the European centre for RMB would further enhance the development of

the European liquidity for RMB.

In the Asia time zone, Singapore’s position is further enhanced by its ability to settle

offshore RMB trade outside of Hong Kong. As interest continues to grow from other

Southeast Asian countries, Singapore’s role for pooling demand from its neighbours

will continue.

• Increasing participation from central banks

In recent CNH deals, we have seen an increase in central banks participations. Export-

Import Bank of China’s CNH bonds received anchor interests from central bank

accounts, while 17% of Sinotruk’s bond was sold to central banks accounts. Moreover,

for the first time ever, China’s MOF has set aside a central bank tranche for central

banks of countries that have no quota to invest directly in China’s onshore bond

market.

With RMB becoming more internationalised, we expect central banks to hold more

RMB funds for trade settlement and potentially as part of their reserve currencies.

Going forward, we expect to see more participation from central banks.

Documentation requirements

In the CNH market, eurobond style documentation is well accepted by the investors.

For frequent issuers that have MTN programmes in place, it is also common for them

to issue through these programmes.

In the early stage of market development, investors were keen to look at a variety of

credits and paid less attention on structures and covenants. Most recently, covenants

requirements have become more common and customary for unrated and high yield

issuers.

Listing practice

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Reg S is the current norm Reg S is the current norm. Increasing penetration into US market creates need for 144a deals

Most of the CNH bonds are not listed, although some of them chose to be listed in

Hong Kong, Singapore and Luxembourg for example (see Figure 48 below). For

existing listed entities, the listing norms should be simpler – they should be allowed an

abridged version of disclosure. For issuers that have their MTN programmes listed,

they simply list their bonds accordingly.

Hong Kong and Singapore exchanges are the most popular listing venues as the

listing process in these exchanges is easy and straight forward.

Figure 48: Issuance by listing venue Source: Bloomberg; includes both FI and Corp bonds and CDs issuance but excludes China MOF issuance

Figure 49: Issuance by listing venue Source: Bloomberg; includes Corp bond and CDs issuance but excludes China MOF issuance CDs issuance but excludes China MOF issuance

Generally speaking, investors are not fixed on listing venue although listing is preferred

by some investors. In terms of secondary market liquidity, being listed or not does not

affect the liquidity of the bonds, as CNH bonds are traded primarily Over-The-Counter

(OTC) in the secondary market. In many situations, the purpose of listing a CNH bond

is to enhance the marketability of the bond, as some institutional investors are

restricted to investing only in listed securities.

Given the general acceptance of eurobond documentation by the market, Reg S

format is the current norm. Reg S limits US investors’ participation in the primary

market. Based on our discussions with some US investors, there is a growing interest

from them to invest in CNH bonds. However, we have not seen any issuance done

through the 144A format. To date, there was only one CNH deal that came with a SEC

registration format – America Movil’s CNY1 billion three-year bond. The deal attracted

close enough US onshore investors to take up 26% of the deal. With growing interest

from US investors, we expect to see more deals structured to cater for their demand in

the future.

More rated issuers coming to the market

In the early days of the market development, investors primarily focused on the

potential FX gains when investing in a CNH product. Investors paid less attention to

the underlying credit quality of a bond and in fact were prepared to do all their own

credit work. As the RMB appreciation story shifted, investors have begun to pay

attention to the credit quality and hence have developed a preference for rated issuers.

From statistics, over 50% of the corporate issuers were unrated.

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In addition, investors have also developed a preference for the need of covenants for

weaker credits or unrated issuers. Maintenance/bank-style covenants were used in

most recent transaction for this category of issuers and high yield covenants are less

common.

Figure 50 Issuance by rating Source: Bloomberg; includes both FI and Corp bonds and CDs issuance but excludes China MOF issuance

Figure 51: Issuance by rating Source: Bloomberg; includes Corp bond and CDs issuance but excludes China MOF issuance

Governing law

The common documentation practice for CNH transactions follows the eurobond

process. For most CNH bond issues, Hong Kong or English laws are generally

acceptable by investors. Based on our statistical analysis, 43% of corporate issuers

used Hong Kong law, followed by 38% who used English law.

Figure 52: Issuance by governing lawSource: Bloomberg; includes both FI and Corp bonds and CDs issuance but excludes China MOF issuance

Figure 53: Issuance by governing law Source: Bloomberg; includes Corp bond and CDs issuance but excludes China MOF issuance

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Repatriation rules

MOFCOM vs SAFE routes Regardless of the issuers’ identityMOFCOM and SAFE are the gatekeepers for CNH repatriation, by way of equity injection and shareholder’s loan

Use of proceeds and approval process

The Chinese regulators do not regulate the issuance of CNH bonds by foreign

companies. In other words, no pre-approval is needed for the issuance of CNH bonds

by offshore institutions. Typically, the use of proceeds as stated in the offering

document is kept general.

Since October 2011, PBOC ceased to become the primary regulator to approve

repatriation of CNH proceeds. Regardless of the issuers’ nationality of incorporation,

the State Administration of Foreign Exchange (SAFE) and Ministry of Finance

(MOFCOM) have become the gatekeepers to accept CNH repatriation applications.

CNH repatriation generally takes two routes – equity injection and shareholder’s loan.

Under the current regulatory regime, the shareholder’s loan arrangement is regulated

by SAFE and there is a prerequisite for the onshore entity in China to have sufficient,

unused foreign debt quota. The onshore subsidiary receiving the shareholder’s loan

would need to register with local SAFE where the use of proceeds would be discussed.

Based on the existing rules, SAFE would treat repatriation of CNH loan proceeds just

like any foreign debt in other currencies such as EUR or USD.

Under existing SAFE regime, long-term loans (one year or shorter), no matter in which

currency (ie, in RMB or other foreign currencies like USD or EUR), would consume

permanently into the debt headroom. For short-term loans (less than one year) in

foreign currencies, the foreign debt quota can be revived once the debt is fully repaid.

However, RMB cross border loans, regardless of what loan tenor, the debt quota is

utilised once it is drawn down and cannot be revived.

This move is viewed as a means to discourage short-term speculation on RMB. It is

worth noting that the rules governing the repatriation of proceeds in RMB are not

dissimilar to those governing the repatriation of proceeds in other currencies such as

EUR or USD.

MOFCOM is the primary gatekeeper on approving equity-related foreign direct

investment (FDI). Under RMB FDI regime, MOFCOM will treat RMB as a preferred

currency for FDI. The approval for RMB FDI shall be granted by the MOFCOM at the

local level, but for the investments involving special industries like micro-finance and

leasing or industries under tight control by the Government like iron and steel or

investments exceeding a certain amount (ie, CNY300 million) must still be approved by

MOFCOM at the head office level.

A brief overview of current regulations on CNH bond repatriation is illustrated in the

tables below.

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Figure 54: CNH repatriation into onshore

By equity injection By foreign debt / shareholder’s loan By trade settlement

Route • Through establishment of a

foreign invested enterprise (FIE)

or acquisition of equity in an

existing onshore company

• Through loans granted to an

onshore FIE by its shareholder(s),

group affiliate(s) or an offshore

financial institution

• Settlement of import and

export of good and services

Approving entities

• MOFCOM • SAFE • No pre-approval needed

Approval process

• MOFCOM is primary gate keeper

for approving RMB funds by equity

and by debt; the approval for RMB

FDI shall be granted by the

MOFCOM at the local level, but

the investments involving special

industries (e.g. microfinance and

leasing) or exceeding a specified

amount (ie, CNY300 mn) must still

be approved by MOFCOM at the

head office level

• Registration of funds with PBOC –

FIEs receiving RMB investment

should register with PBOC local

branch and open RMB capital

accounts with a settlement bank

for remitting the upfront fees and

capital contribution under RMB

FDI

• Cross-border foreign debt

arrangement is processed by local

SAFE where the onshore entity is

incorporated

• Pre-requisite for the onshore entity

to have sufficient foreign debt quota

for incremental borrowings from its

overseas parent

• Foreign debt quota is pre-

determined and calculated as the

gap between total investment and

registered capital. Actual amount of

funds to be raised is the unused

foreign debt quota, free from any

outstanding foreign debt

• Cross border RMB loans, regardless

of their terms, consume permanently

into the headroom, ie, the headroom

will not be restated even after the

debt has been repaid

• PBOC along with other

competent authorities

announce that all parts of

China are opened for RMB

settlement for cross border

trades

Use of repatriated proceeds

• Funds repatriated into China under RMB FDI must not be invested in

securities and financial derivatives (unless approved as a strategic investor of

listed company), wealth management products, real estate (other than for

own use) or extend entrustment loans

• Not applicable

Approval timeframe

• 3-6months*

• 4-8 weeks*

• Not applicable

*Approval process depends on the sufficiency of foreign debt quotas of the onshore entity, as well as the industry or nature of the investment the proceeds would be

used for.

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Other RMB schemes Increased channels for funds to be moved to China and elsewhere will allow for easier CNH repatriation

RMB FDI and RQFII

As announced by Chinese Vice Premier Li Keqiang during his visit to Hong Kong in

August 2011, the Chinese Government has created more channels for CNH funds to

flow back into China. The RMB FDI channel is one such channel which allowed foreign

enterprises to use CNH for foreign direct investment. This has opened a new door for

RMB lending as customers may now also borrow RMB funds for investment in China.

The implementation of RQFII also provided more channels for institutions to invest its

CNH deposits in China. Going forward, we would expect the continued development of

CNH usage channels will allow for easier repatriation of funds back into China.

Onshore-offshore convergence

Since August 2011, CNH bond yields have been on an upward trend, shrinking their

differences with onshore bond yields. MOF’s sovereign bonds in the offshore market

trade at a slight discount in yields to the onshore issues. The discount currently is

much less than what it was a year ago (see Figure 55). The surge in yields of CNH

bonds reflects the investors’ reassessment of RMB appreciation prospect, greater

emphasis from investors on issuers’ credit quality and the growing supply of new CNH

bonds. We have also seen an increase in average yields of Chinese banks’ CNH CDs

(see Figure 56).

Figure 55: Historical trends on offshore CGB bonds vs onshore CGB bonds (%) Source: Bloomberg

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Figure 56: Trends on CD issuance yields for China Construction Bank HK (%) Source: RBS

According to our analysis, yields for three-year CNH bonds across the rating spectrum

have widened by an average of 1.5- 2.0% since January 2011 (see Figure 57), partly

due to the softening of the RMB appreciation. In the onshore market, concerns over

China’s economic slowdown have driven down the onshore bond yields. These factors

have caused the price premium of the CNH bonds and onshore bonds to converge.

Figure 57: CNH bond yields (3-year) per rating category (%) Source: Bloomberg

The offshore CNH bond market has now emerged as another platform for RMB

funding for Chinese FIs and corporates. The onshore market, albeit allowing greater

market access than before, still has certain regulatory restrictions that continue to

make the offshore market attractive in the short term. The figure below illustrates the

onshore and offshore yield curves of CDB. There exists a larger price premium of the

CNH bonds to onshore bonds at the shorter end of the curve than the longer end of

the curve. However, we expect the spread between the offshore and onshore bond

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yields to further narrow, considering the possibility that the CNY will become fully

convertible in the longer term.

Figure 58: Offshore CDB bonds vs onshore CDB bonds (%) Source: Bloomberg, RBS

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Globalising the Franchise

China employs a two-prong approach in globalising the franchise of the offshore

deliverable CNH market: using Asia as a launch pad at the private sector level; and

engaging G7 countries, BRICS partners (Brazil, Russia, India and South Africa) and

multilateral agencies bilaterally and on multilateral platforms. We discuss both

approaches below.

A two-prong approach

Building on Asia’s strengths

Asia’s strengths come through trade and savings which together amassed for the

region a huge stockpile of foreign reserves. The Fed’s quantitative easing has further

enriched the region’s reserves positions in more recent years. Hence, not only for the

reason of geographical proximity, Asia is the natural starting point for China to promote

the use of the CNY as a trade settlement currency and for reserves diversification.

Amid its strong trade growth, the region has seen a gradual increase in intra-regional

trade in the past one to two decades after China switched to an export-growth model in

the early 1990s.

• Of the USD10.5 trillion stock of world foreign reserves, USD6.5 trillion (62% of

world total) are held by central banks in Asia within which China holds nearly at

USD3.24 trillion (31% of world total). China’s reserves have grown more than 10

times in the past 10 years. Over the same period, reserves for the rest of the region

excluding Japan have grown by more than 6.5 times (see Figure 59).

• China’s share of world trade has risen from 3.5% at the start of this millennium to 10.5%. During the same period, US’s share of world trade has

dwindled down from 15% to 10.7% (see Figure 60). China has been the primary

force behind Asia’s increasing intra-regional trade dependency.

• More than a quarter of China’s external trade is with Asia ex-Japan, well above

its trade with EU (14%), Japan (12%) and the US (8%). Vice versa, the region’s

dependence on China is also significant at 21% (see Figures 61 and 62).

• Asia’s trade with China has doubled in the past 10 years at the expense of US

and Japan as Asian manufacturers relocate their production bases to China which

provides a vast labour pool and domestic consumer market.

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Figure 59: Breakdown of world foreign reserves (%) Source: Bloomberg

Figure 60: Market share of world trade- China vs US, EU and Japan (%) Source: IMF

Figure 62: Breakdown of Asia 9’s (ex Japan, China) total trade (%) Source: CEIC

Figure 61: Breakdown of China’s total trade (%) Source: CEIC

As Asian countries’ reserves have grown well above comfortable levels, the need to

seek greater reserves diversification has grown. After going through a string of banking

and sovereign crises in the developed markets, Asian countries turn inwards in the

same way that their trade has become more intra-regional. Consequently, although the

CNY does not qualify as a reserve currency because it lacks full convertibility as

defined by the International Monetary Fund (IMF), many central banks have started to

diversify reserves into the CNY. Vice versa, China has also diversified into many other

Asian regional currencies.

• Holding CNY in excess reserves: Malaysia was the first central bank to openly

announce that it was adding CNY to its FX reserves in 2010. Since then, several

central banks such as Korea, Thailand, Chile, Saudi Arabia, and Nigeria have all

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diversified or expressed interest in diversifying their reserves into CNY. In

December 2011, China signed a pact with Japan to promote the use of their

currencies for bilateral trade and investment flows which came with a CNY65 billion

investment quota for the latter to invest in China’s domestic bond market.

• Likewise, China has also diversified its reserves into the regional currencies:

For instance, China’s purchases of Korea’s domestic bonds grew six-foldsin the

past 2.5 years, increasing its market share of the KTB market from virtually nothing

to 3.1%.

Asia’s deepening bond markets. Enabling this push towards intra-regional reverses

diversification is the rapid deepening of the region’s bond markets which have grown

by more than six-fold in the past decade. This is at a much faster rate than that in other

emerging markets regions (see Figure 63). Amid this growth, there was a greater push

by Asian issuers towards their own currency denominations, away from hard currency

denominations, notably USD. 92% of Asia’s bond markets is now denominated in local

currency versus 81% in Latin America and only 50% in Eastern Europe, Middle East

and Africa. Within the region, it is interesting to note that the country with the highest

proportion of local currency bond issuance is China by as much as 25 times over its

hard currency bond issuance (see Figure 64). A key reason for the shift from hard

currency to local currency bond issuance in Asia is the governments’ conscious efforts

to diversify from external borrowing in the aftermath of the 1997/98 Asian FX

devaluation crisis.

Figure 63: Asia vs other EM regional bond markets, split by local and foreign currency (USD trn, % split) Source: BIS, RBS

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Figure 64: Asian countries’ bond markets, split by local and foreign currency denominations (% of GDP) Source: BIS, CEIC

Global vs regional hubs

Understanding the region’s strengths is not good enough. China is clearly not waiting

for things to take its natural course. Having given Hong Kong a good five year head

start, China is turning now to other strategic regional partners as well as further afield

to London to launch its next phase of CNY internationalisation. We believe every

international partner has been selected strategically to perform different roles in the

CNY internationalisation game plan, as we will explain below.

Singapore as second CNY clearing centre

In July 2012, China and Singapore jointly announced that the world’s second CNY

central clearing line will be operated out of Singapore. This was the cornerstone of a

Free Trade Agreement (FTA) that the two countries had signed. The bank running the

centre will be a Singapore branch of a Chinese bank, which will be granted a full

banking licence by the Monetary Authority of Singapore. Prior to the announcement, in

May 2012, the MAS has said that full banking licences from then on would only be

granted in future to banks from countries which have FTA with Singapore.

Given Singapore’s strong role as a regional trade partner – Singapore’s contribution of

intra-Asia trade is by far the highest at 27%, China is fully aware that the CNY clearing

line will be utilised by not only Singapore but by Singapore’s trade partners. This is a

great way for China to promote the use of CNY with “third country” trade partners, that

is countries which might not directly trade with China. If so, Singapore will pose strong

competition on Hong Kong for the offshore CNY business. The only other condition is

that Singapore’s CNY clearing quota has to be large enough.

Hong Kong-London partnership

Fully aware of the competition that Singapore may pose on Hong Kong, China has

engaged London to partner Hong Kong in promoting the CNY business globally and

outside of Asia. To quote the UK Chancellor of the Exchequer, George Osborne, on 14

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June 2012, “London is not in competition with Hong Kong, it is a complement –

providing a Western hub for RMB business”.

By the end of 2011, the volume of RMB deposits in London had already reached

CNY109 billion, of which CNY35 billion are non-bank customer deposits. London

currently accounts for 26% of the global offshore CNY FX spot market.

Self-service centres in Taipei, Tokyo, Sydney

Then there are what we believe will be more self-service centres in Taipei, Tokyo, and

Sydney where negotiations are underway. The justifications are on various grounds:

• All three countries have relative importance to China as trade partners

• It is relatively more difficult to get these strategic trade partners to consider CNY as

trade settlement currency (Japan and Taiwan)

• Time zone differences (Sydney captures the closing hours of the Americas which

can probably be considered the last frontier for the CNY internationalisation).

On 31 August 2012, Taiwan and China announced the signing of a CNY swap

agreement which will come with a direct CNY clearing line to be operated by a

Chinese bank in Taipei. Unlike other CNY swap lines which act mainly as standby

facilities or provide investment quotas for the recipient central banks, Taiwan’s CNY

swap line will be a “live” one to support CNY clearing with China. In other words, the

CNY swap quota will be used directly as the clearing quota. Because of their closed

domestic market, Taiwanese banks currently cannot take delivery of CNH from Hong

Kong. Hence, it was necessary for China to provide a direct clearing line for Taiwan.

Shanghai as the ultimate global CNY pricing centre

In a blueprint unveiled in February 2012, Shanghai has set 2015 as its goal to become

the global pricing centre for all CNY financial products offshore and onshore. By 2020,

the city aims to become an international financial centre. Hong Kong is named as

Shanghai’s twin city in building its financial hub. Shanghai’s advantage is its direct

access to the PBOC while Hong Kong has the international financial network. If the

CNY is not fully convertible by 2015, Shanghai can set up an offshore financial centre

that serves both onshore and offshore market participants.

After Shanghai becomes the global CNY pricing centre, Hong Kong’s role in the twin-

city concept may evolve into one serving China for the non-CNY market activities. By

that time, Shanghai may find London a more strategic partner to continue globalising

its CNY franchise business.

• The blueprint also reveals the intention to embark on policy reforms. It sets

two specific targets on FX and interest rate fixing for the global CNY markets:

− On FX, to get the offshore market to adopt the mid-pricing fixed by the PBOC

every morning

− On interest rates, to make Shibor the benchmark for CNY-denominated fixed

income papers globally

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This explains the recent operational changes in the PBOC’s exchange rate and

monetary policy management (see sections on FX Market and Interest Rate Market).

Multilateral platforms

If inclusion into the SDR basket entails greater financial contributions to the IMF, China has willingly done so

We believe 2015 was selected as this interim goal because the IMF is due to review its

Special Drawing Rights (SDR) basket composition at the end of that year. If the CNY

gets included in the SDR, it would be hugely boost its odds to becoming a world

reserve currency.

There are costs for entering the global arena which China has willingly played its part.

In June 2012, China pledged USD43 billion to help the IMF double its lending capacity

which has been grossly depleted by the European sovereign crisis.

Becoming an international aid donor would also serve China some good as it can

gradually get recipient countries to accept aid in CNY denominations. In this regard,

being a SDR component currency will help encourage recipient countries to accept

CNY aid.

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Appendix A

Chronology of Regulatory Changes and Events

Date 2007

January Chinese FIs allowed to issue CNH bonds in Hong Kong by PBOC

8 June Details of issuing CHN bonds by Chinese FIs were announced by PBOC and NDRC

25 June China Development Bank (a Chinese policy bank) issued first CNH bond

12 September Bank of China, the first issuer of Chinese commercial bank

2008

8 December Corporates with substantial business in China were allowed to issue CNH bonds in Hong Kong by State Council

2009

25, 29 June HSBC and Bank of East Asia (PRC-incorporated foreign banks) issued CNH bonds

6 July PRC commenced a pilot scheme for CNY cross border trade settlement in 5 Chinese cities with Hong Kong,

Macau and ASEAN nations

28 September China’s Ministry of Finance issued CNH bonds (first sovereign issuer)

2010

11 February Issuer restrictions fully lifted to abide by Hong Kong regulations. China’s approval is only needed if proceeds would

be remitted into the country

22 June Trade settlement scheme was expanded to allow settlement with all nations and eligible firms were selected from

20 instead of 5 provinces in China

19 July Limits on Hong Kong-based corporates converting CNY lifted; types of CNY investment products fully liberalised,

including CDs, CNY loans; CNY central clearing system set up

6 July CITIC Bank International (first issuer of CNH certificate of deposits)

7 July Hopewell Highway (first non-Chinese, non-FI issuer)

19 August McDonald's (first multinational corporation issuer )

1 October PBOC expanded CNY clearing centres, allowing foreign banks to clear CNY with any Chinese-incorporated banks

18 October Asian Development Bank (supranational, longest-dated CNH bond and also first CNH issue traded on the Hong

Kong Stock Exchange)

30 November First tendering of China MOF’s sovereign bonds through the Central Money Markets Unit

9 December Galaxy Entertainment (first high yield CNH bond issuer)

10 December VTB Bank (a government-owned Russian bank, first non-Asia emerging market issuer)

2011

30 January PBOC launched pilot programme to allow qualified domestic firms to use CNY for outward/overseas direct

investments (without foreign currency conversion)

27 June HK Treasury Markets Association launched USD/CNH daily spot fixing to provide a reference rate for pricing of

CNH products

17 August Chinese-incorporated non-FIs allowed to issue CNH bonds; Issuance of sovereign bonds on a regular basis in

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Hong Kong; Extending the RMB trade settlement scheme to nationwide in China

12 October MOFCOM and PBOC issued new circulars governing the remittance of offshore RMB into mainland China for FDI

purposes

13 October Khazanah Nasional (first CNH sukuk issuer)

24 November Baosteel (first direct issue by a Chinese corporate)

16 December RQFII launched on a trial basis, allowing Hong Kong investment firms to invest offshore RMB funds in onshore

securities market with a CNY20 billion quota, subject to a condition that minimum 80% of the quota to be allocated

to bonds

2012

3 January HK TMA launched daily fixing on CNH Hibor

11 January NDRC granted approval for 10 domestic banks to issue CNH bonds with a combined CNY25bn quota

17 January HKMA increased limit for CNH net open position from not exceeding 10% to not exceeding 20% of a bank’s total

RMB assets and liabilities

13 January China Development Bank (first issuer to offer the longest tenor CNH bond – 15-year; also the first issuer to adopt

dual issuance channels (CMU and bookbuilding)

1 February America Movil (first Latin America issuer, first SEC Reg CNH issue sold to onshore US investors)

9 February HKMA relaxed rules on inclusion of RMB liquid assets in the calculation of statutory liquidity ratio. The revised

regulation is expected by the market to increase exposure on RMB assets

14, 21 March Ford (first MNC high yield issuer) and HNA Group issued CNH bonds (first CNH bond with onshore parent

guarantee since change in regulation)

4 April China announced the expansion of investment quota to both the QFII and RQFII (USD80bn from USD30bn for

QFII and CNY70bn from CNY20bn for RQFII)

13 April ILFS Transportation (first CNH issue from India structured with India EXIM guarantee)

14 April PBOC widened USD/CNY onshore intra-day trading band from +/-0.5% to +/-1.0%

25 April NDRC has approved 4 state-owned enterprises to issue CNY18.5bn of CNH bonds in HK:

The companies are China Minmetals, Guangdong Nuclear Power, Huaneng Power, Datang Power (second batch

of non-financial companies allowed to issue CNH bonds, following Baosteel China)

2 May NDRC issued a Circular which sets forth a formal approval process for onshore non-financial corporates to issue

RMB bonds in HK

1 June Tokyo interbank market started directly quoting the CNY/JPY cross rate

14 June HKMA announced new arrangements for providing RMB liquidity: Authorised Institutions in Hong Kong were

allowed to use RMB liquidity ratio to replace the existing RMB risk limit; and a one-week term RMB funding facility

were available to them from the HKMA (with eligible collaterals) to ease short-term RMB liquidity needs. These

expanded the asset range which can be computed in RMB liquidity

21 June Veolia issued CNH bond (longest maturity and largest size achieved by a BBB+ non-Asian issuer in the CNH

market; first corporate CNH bond to be listed in the Euronext Paris)

29 June RMB ETF allowed to be listed in both mainland China and Hong Kong

6 July Second offshore CNY clearing centre to be located in Singapore

14 July PBOC issued circular clarifying the details of RMB FDI, which supplements the rules released by MOFCOM and

/68


PBOC in October 2011

25 July HKMA allowed non-Hong Kong residents to open CNY deposit accounts in Hong Kong with no daily conversion

limits

26 July China Development Bank issued the longest dated tenor CNH offering – 20-year

27 July

CSRC issued rules to lower the track record and assets under management requirements for QFII applicants and

allows QFIIs to open multiple securities accounts with different securities companies as long as the total number of

accounts corresponds to the special RMB account approved by SAFE (while previously a QFII could only open

one securities account with one securities company). QFII license holders were also allowed to invest directly in

the onshore interbank bond market and private placement bonds issued by small and medium-sized enterprises

and hold up to a 30-percent stake in a listed company, up from the previous 20% stake cap.

22 August HKEx announced that it will introduce the first deliverable CNY currency futures on 17 September

Source: Bloomberg, NDRC, PBOC, HKMA

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Appendix B

Cross-border Payments on Current Account

The tables below set out the main regulatory considerations relevant to a corporate

entity trading with mainland Chinese companies or through its own China-resident

operating entity. The information is by no means exhaustive and should be viewed

merely as an introductory overview, which can be followed up with more detailed

discussions as appropriate.

Offshore to Mainland China

Payment Type Payment Currency

Regulatory Considerations

Foreign currency

Payment to exporters permitted

Payment must go through a transit account

Exporter to provide documentary evidence of trade transaction

Payment for goods

RMB

Payment to exporters permitted

Exporter to provide documentary evidence of trade transaction

If exporter elects to receive funds into an offshore RMB account, separate reporting to

PBOC (People’s Bank of China) is required

Offshore participant banks also need to take approaches to monitor the trade

background

Foreign Currency Payment to service providers permitted

Service provider to provide documentary evidence of service transaction Payment for services

RMB Payment to service providers permitted

Service provider to provide documentary evidence of service transaction

Foreign currency

Loans to a FIE (Foreign Invested Enterprise) must be registered with SAFE

Maximum borrowing amount permitted is calculated as Total Investment less

Registered Capital where:

Total Investment = total capital of borrower including working capital

Registered Capital = capital subscribed and registered with MOFCOM

Maximum permitted gearing (RC/TI) is: 70% if RC ≤ USD 3m; 50% if 3m > RC ≤ 10m,

40% if 10m > RC ≤ 30m; 33% if RC > 30m

Inter-company loans (Resident borrowing from a non-resident shareholder)

RMB

Permitted, but requires prior registration with SAFE

PBOC approval is no longer required

Maximum permitted gearing same as for foreign currency loans

Foreign currency

The amount of a FIE’s registered capital and any subsequent increases must be

approved by MOFCOM (can take months)

SAFE processes equity injections based on MOFCOM’s approvals Capital infusion

RMB MOFCOM approval required

PBOC governs account management (application made via domestic settlement bank)

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and SAFE filing procedures must also be followed

Mainland to Offshore

Payment Type Payment Currency Regulatory Considerations

Foreign currency Payments from importers permitted

Importer to provide documentary evidence of trade transaction Payment for goods

RMB Payments from importer permitted

Importer to provide documentary evidence of trade transaction

Foreign currency Payments from service recipients permitted

Service recipient to provide documentary evidence of service transaction Payment for services

RMB Payments from service recipients permitted

Service recipient to provide documentary evidence of service transaction

Payment Type Payment Currency Regulatory Considerations

Foreign currency

Permitted, subject to sufficient retained earnings/reserves and fully paid up capital

Supporting documentation required

Withholding tax applicable with potential for reduction under tax treaties Dividends/profit repatriation

RMB

Permitted, subject to sufficient retained earnings/reserves and fully paid up capital

Supporting documentation required. The amount payable should also be governed by

the quota in SAFE FDI system and the actual payments to be filed through FDI system

Withholding tax applicable with potential for reduction under tax treaties

Foreign currency

Transfer pricing arrangements will be monitored by Tax Bureau

Tax certificate generally required for most payments under service agreements (not only

inter-company related fees)

SAFE approval is delegated to designated FX banks. Supporting documentation

required Inter-company management fees, service fees, royalties

RMB

Transfer pricing arrangements will be monitored by Tax Bureau

Tax certificate generally required for most payments under service agreements (not only

inter-company related fees)

SAFE approval is delegated to designated FX banks. Supporting documentation

required

Foreign currency Restricted and subject to SAFE approval Inter-company loans (Resident lending to a non-resident)

RMB Restricted and subject to SAFE approval

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Appendix C

List of Abbreviations

Abbreviation Full name

AIs Authorised institutions

ASEAN Association of Southeast Asian Nations

BOC (HK) Ltd. Bank of China (Hong Kong) Limited

CAGR Compound Annual Growth rate

CCS Cross Currency Swap

CD Certificate of Deposit

CGB CNH Government Bonds

CNH CNY Deliverable

CNY Chinese Yuan

Corp Corporates

DF Deliverable Forward

EM Emerging Market

ETF Exchange-traded Fund

FDI Foreign Direct Investment

FI Financial Institution

FIE Foreign Invested Enterprise

FTA Free Trade Agreement

FX Foreign Exchange

Libor London Interbank Offered Rate

Hibor Hong Kong Interbank Offered Rate

IPO Initial Public Offering

IRS Interest Rate Swap

KYC Know-your-customer

MNC Multinational Corporation

ND Non- deliverable

NDF Non-deliverable Forward

NDS Non-deliverable Swap

NOP Net Open Position

O/N Overnight

OMO Open Market Operations

RMB Renminbi

RRR Required Reserve Ratio

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RTGS Real Time Gross Settlement

SDR Special Drawing Rights

Shibor Shanghai Interbank Offered Rate

SOE State-owned Enterprises

SLR Statutory Liquidity Ratio

T/N Tomorrow-next

YTD Year-To-Date

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Appendix D

List of Government Agencies

Abbreviation Full name

BOK Bank of Korea

www.bok.or.kr/eng/index.jsp

BIS Bank for International Settlements

www.bis.org/

CMU Central Monemarkets Unit

www.cmu.org.hk/

CSRC China Securities Regulatory Commission

www.csrc.gov.cn/pub/csrc_en/

Fed Federal Reserve

www.federalreserve.gov/

HKEX Hong Kong Exchanges and Clearing Limited

www.hkex.com.hk/

HKMA Hong Kong Monetary Authority

www.hkma.gov.hk/

HKSAR Hong Kong Special Administrative Region

www.gov.hk/en/

HKTMA Hong Kong Treasury Markets Association

www.tma.org.hk/

IMF International Monetary Fund

www.imf.org/

ISDA International Swaps and Derivatives Association

www.isda.org/

MAS Monetary Authority of Singapore

www.mas.gov.sg/

MOF Ministry of Finance

www.mof.gov.tw/engweb/

MOFCOM Ministry of Commerce

english.mofcom.gov.cn

NDRC National Development and Reform Commission

en.ndrc.gov.cn/

OPEC Organization of the Petroleum Exporting Countries

www.opec.org/

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http://www.bis/

http://www.cmu.org.hk/

http://www.csrc.gov.cn/pub/csrc_en/

http://www.federalreserve.gov/

http://www.hkex.com.hk/

http://www.hkma.gov.hk/

http://www.gov.hk/en/

http://www.tma.org.hk/

http://www.imf.org/

http://www.isda/

http://www.mas.gov.sg/

http://www.mof.gov.tw/engweb/

http://www.english.mofcom.gov.cn/

http://www.en.ndrc.gov.cn/


PBOC People’s Bank of China

www.pbc.gov.cn/publish/english/963/index.html

PRC People’s Republic of China

english.gov.cn/

QFII Qualified Foreign Institutional Investors

www.csrc.gov.cn/pub/csrc_en/affairs/

SAFE State Administration of Foreign Exchange

www.safe.gov.cn

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http://www.pbc.gov.cn/publish/english/963/index.html

http://english.gov.cn/

http://www.csrc.gov.cn/pub/csrc_en/affairs/

http://www.safe.gov.cn/


/68

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