China would like to see the renminbi gain a higher global profile, but it doesn’t yet want to make the currency convertible, which could drive up its value and threaten the country’s export industries. So the Chinese authorities have been fostering the growth of an offshore renminbi market in Hong Kong, similar to the Eurodollar market that sprouted in London half a century ago to avoid U.S. taxes and regulation.
“Beijing has found a savvy way to use market forces to benefit Chinese companies without adopting those market forces itself,” says Marc Chandler, global head of currency strategy at New York–based Brown Brothers Harriman & Co.
China authorized offshore renminbi accounts in 2004, but the market only took off last July, when the People’s Bank of China and the Hong Kong Monetary Authority signed an agreement allowing nonbank financial institutions to open renminbi accounts in Hong Kong. The currency in these accounts is called CNH, while the onshore renminbi is called CNY.
Trading in the CNH market has mushroomed to between $500 million and $700 million a day from $200 million to $300 million last July, according to Enoch Fung, a Hong Kong–based Asia economist for Goldman Sachs Group. The CNH is beginning to rival the more-established offshore market in renminbi nondeliverable forwards, or NDFs, which trade in such financial centers as New York and Singapore to the tune of about $3 billion a day.
The Chinese currency in Hong Kong accounts comes from Chinese companies that settle their trade in renminbi offshore rather than by sending dollars overseas. The CNH market has mainly attracted companies with business interests in China that need cash renminbi at the end of the day. NDFs, by contrast, are futures contracts priced in renminbi but settled in U.S. dollars; the market appeals mostly to institutions such as hedge funds that are betting on the appreciation of the renminbi. All of that could soon change, though.
The CNH rate tracks the domestic spot renminbi rate, which is closely controlled by the Chinese central bank. On the other hand, the NDF’s value already reflects an expected rise in the renminbi. “If the one-year NDF is pricing in at 2 percent and the currency moves by 3 percent, then you only make 1 percent,” says Richard Yetsenga, global head of emerging-markets FX strategy at HSBC Holdings in Hong Kong. “But if you are in the CNH market and the currency moves 3 percent, then you make 3 percent.”
The CNH market is benefiting from a host of financial instruments recently introduced by the Chinese authorities, including deliverable renminbi forward contracts, interest rate swaps, cross-currency swaps and — most dramatic of all — renminbi-denominated bonds sold in Hong Kong. Issuance of such bonds, known colloquially as “dim sum bonds,” greatly increased last year, with 33 deals valued at a total of $6.3 billion, according to BBH. The market has attracted such well-known corporate issuers as McDonald’s Corp. and Caterpillar. Strong investor demand has forced yields on dim sum bonds a substantial 1 to 2 percentage points below government bonds issued on the mainland, according to Standard Chartered Bank.
China knew that to promote trade settlement in renminbi, it needed to give companies a venue so they could hedge their positions, not just trade on the spot market. As a result, the U.S. dollar–CNH forward market is growing in liquidity. CNH forwards are now the most attractive vehicle for hedging out as far as one year, thanks to the currency’s relatively flat yield curve, while the NDF remains a better bet for short-term hedging of up to three months, says Kelvin Lau, an economist at Standard Chartered in Hong Kong.
Most analysts believe the CNH will gradually displace the NDF because of its greater variety of financial products and could ultimately be the forerunner of a fully convertible renminbi. But few are willing to predict when that may happen. “It is far too premature to speak of a challenge to the greenback by the redback,” BBH’s Chandler says.
