The views expressed in this column are solely those of the
author and do not reflect the views of SVB Financial Group, or Silicon Valley
Bank, or any of its affiliates.
China's effort to
create an offshore international market for its currency in Hong Kong has
generated huge excitement. Since China liberalized trade settlement and
investment rules last July, large amount of CNH (CNY that are freely traded in
Hong Kong) has accumulated in Hong Kong's banking system. CNY deposits in Hong
Kong jumped to 300 billion at the end of 2010, from 63 billion at the end of
2009. By contrast, the overall foreign currency account in Hong Kong increased
by just 15 percent in the past year.
It can be reasoned that CNH trading
is a very minute step towards the internationalization of the Chinese currency
because the liberal CNY regime has been largely confined to Hong Kong. And China
ultimately controls the amount of yuan available to be freely traded offshore.
However, market participants are optimistic about the outlook for the offshore
market based on heavy demand for the currency for trade and investment purposes.
By allowing an offshore CNY market to flourish, it reveals the savvy financial
skill of the Chinese government to manage the growing offshore interests in CNY
and to take advantage of the speculative interests on CNY appreciation to direct
it into a more productive application.
Investors Seek Wealth in
For years, there has been a
consensus among investors that the CNY is going to appreciate in the short and
long term. Given this much-anticipated appreciation of the currency against the
USD, many retail investors have already been making daily purchases of the
Chinese currency up to the permitted limit of CNY 20,000 per person. Since
Beijing ditched the CNY's de-facto peg to the greenback in June last year,
China's currency has appreciated over 3 percent. Investors will continue to find
ways to speculate on CNY appreciation as long as CNY is a restricted currency.
With the CNH market, investors can now build exposure in CNY by
acquiring CNH-denominated assets. Offshore companies without any immediate
trade-related reason can now hold CNY in an offshore CNH account to build CNY
exposure. On the other side are mainland businesses, often Chinese companies
owned or backed by the government that want to borrow CNY to fund onshore
operations. Backed by the demand for CNH assets from offshore investors,
mainland companies can borrow, issue bonds and soon raise equity in CNH.
Indeed, investor interest is fuelling the rapid development of a
CNH-denominated corporate bond market, nicknamed "dim sum" bonds by traders. In
August 2010, McDonald's became the first foreign company to issue such a bond in
Hong Kong, followed by Caterpillar, a Macau casino operator and a Russian bank.
To date, 33 deals raised a cumulative sum of about CNY42.5 billion. Analysts
estimate the outstanding could reach CNY 80 to 100 billion by the end of 2011.
Despite the rapid growth of CNH bonds, demand for them already far
exceeds the supply of new issues. As a result, the cost of CNY capital is less
than half of what it is onshore. On average, dim sum bond issuers save 197 basis
points in interest payments by issuing in Hong Kong rather than in Shanghai. Dim
sum bonds pay an average yield of about 1.83 percent, according to the Hong
Kong's Treasury Markets Association, while Bloomberg reports that the average
yield paid on three-to five-year bonds sold by government-linked companies in
China is 3.8 percent.
The pace picked up a bit in early 2011, but the
bigger story may be "synthetic CNY bonds," by which investors buy the bonds with
USD and are paid back in CNY. In January, there have been more synthetic CNY
issues than all last year and they have raised five times more money than in the
dim sum market. This market is dominated by Chinese property developers who
choose to raise USD than CNY because they have most likely been approved by the
Ministry of Commerce to bring USD back to China. It is ironic that the driver of
synthetic CNY bonds is the ease for the issuers to wire USD into China, in order
to sidestep the stringent requirements for CNY. At the same time, issuers
command lower coupons synthetic CNY bonds than USD bonds, although they forego
any gains on CNY appreciation.
New Hedging and Cash Management
The CNH market is not without obstacles. Bringing offshore
CNH onshore into Mainland China remains a challenge. CNH can be only wired into
Mainland China if the transaction is trade-related. The Mainland Chinese
beneficiary must reside in one of the 20 authorized provinces and must be a
Mainland Designated Enterprise (MDE). MDEs can settle export and import as well
as services in deliverable CNY with offshore trade counterparties. Silicon
Valley Bank is ready to quote trade-related and general purpose
(non-trade-related) USD/CNH. Trade-related CNH can be wired to onshore
beneficiaries subject to documentation checks by the beneficiaries' banks.
CNH for general purpose has traded at a premium to onshore CNY,
reflecting the fact that CNH can be used for trade-related settlement purposes
and invested in CNH-denominated assets with positive carry. The key driver of
CNH premium is the lack of fungibility between onshore and offshore markets.
Companies with potential future CNY exposure related to trade or
investment can purchase CNH and deposit to an offshore account as a hedge. Given
CNH contracts are settled through the Real-Time Gross Settlement in Hong Kong
and cleared by the Bank of China Hong Kong, companies can take delivery of the
CNH purchased through spot or forward contracts. An offshore company that
exports to China can now invoice in CNH. The company needs to open an offshore
CNH account to collect CNY payments. The CNH accumulated can be used for future
CNY payments, converted into USD or other foreign currencies, or hold it in
appropriate CNH-denominated assets in the short term.
can also hedge the CNH on forward basis if necessary. In terms of liquidity,
transaction sizes up to USD 100 million are now common out to one month, and up
to $20 million out to three months. Beyond that, liquidity becomes quite thin.
Onshore MDEs also have an economic incentive to either collect CNY receivable in
a CNH account or bring CNY into Hong Kong before buying USD when the USD/CNH
premium is rich.
As the number of MDEs expands and the use of CNY in
trade settlements rises, the pool of offshore CNH liquidity will grow. This will
give rise to greater demand for risk management and investment products. As a
result, the size of the CNH forward and offshore bond market is expected to grow
The views expressed in this column are solely those of
the author and do not reflect the views of SVB Financial Group, or Silicon
Valley Bank, or any of its affiliates. This material, including without
limitation the statistical information herein, is provided for informational
purposes only. The material is based in part upon information from third-party
sources that we believe to be reliable, but which has not been independently
verified by us and, as such, we do not represent that the information is
accurate or complete. The information should not be viewed as tax, investment,
legal or other advice nor is it to be relied on in making an investment or other
decisions. You should obtain relevant and specific professional advice before
making any investment decision. Nothing relating to the material should be
construed as a solicitation or offer, or recommendation, to acquire or dispose
of any investment or to engage in any other transaction.
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