Beijing has set itself many financial objectives over the coming years, but two targets stand out.
Firstly it wants to turn the renminbi from an inward looking, tightly managed asset to one that underpins a major portion of global trade. The second, and more immediate, is to control runaway inflation.
China is witnessing an unintended consequence of the policies that it has put into action to tackle these two objectives. It is found in the nascent renminbi debt market in Hong Kong.
At the heart of this issue is inflation. Untamed, rising prices threaten to damage China’s economy. While the country’s consumer price inflation is officially at 4.9%, many believe it has hit double digits, particularly due to rising food prices.
As a result, Beijing is making it tough for companies to remit the proceeds of bond issues back into China, which could be used to promote growth in areas where it has inflation worries. And it could do the same with companies aspiring to issue offshore renminbi equity, too.
Beijing is clamping down on property companies as part of its drive to control asset inflation. The same companies are turning to Hong Kong, as the hub for offshore renminbi, to continue fundraising, a concern for the Mainland.
If the government remains intransigent about allowing the remittance of offshore renminbi proceeds, it could effectively dry up the offshore renminbi bond market, which is a major tool for the flow of offshore renminbi.
This is not just a fear; it has already started happening.
RMB remittance pains
Since July last year Hong Kong has done a magnificent job in building offshore renminbi.
China’s cross-border trade settled in its currency sharply increased in 2010 to reach Rmb510 billion (US$77.89 billion), and Hong Kong reportedly handled Rmb370 billion of this over the same period, with the volume increasing consistently each month.
The Special Administrative Region now has roughly Rmb400 billion of deposits, with about 20% invested in bonds.
Yet while Hong Kong has taken full first-mover advantage as the home for offshore renminbi settlement, until China fully opens up its capital account it remains at the whim of its master.
Hong Kong’s financial authorities need to encourage the development of the renminbi bond market. But that will require working with China to ensure the remittance issue doesn’t linger.
The regulators are making it difficult and time consuming to remit the proceeds of bond issues. At present the State Administration of Foreign Exchange has not made clear its system for vetting remittances.
This lack of clarity has left a number of good potential offshore renminbi borrowers sitting on the fence. And that risks dampening demand for the currency.
At first glance, such anxieties may seem unfounded. After all, Royal Bank of Scotland predicts that renminbi bond issuance will triple this year to Rmb120 billion. But the Hong Kong government will need to continue to make clear the importance of this to China.
A healthy debt market will attract more investors, and the demand for more renminbi will allow more products to be made available. Inflation may be a concern for China but it makes sense for Beijing to offer a more transparent process as a sensible compromise.
The increased clarity would benefit the developing bond market, and support the financial services in Hong Kong that depend on such growth.
K.C. Chan, secretary for financial services and the Treasury for Hong Kong, tells Asiamoney that the growth of the city’s renminbi financial services will come in three stages, of which bond issuance is the first, in part because it does not need much in the way of secondary trading.
Second should be the emergence of yield-related products such as real estate investment trusts (Reits) and fund-linked products where there is some trading.
Finally, a full-blown equity market can be created. “For this you need a good liquid [secondary] market,” Chan stresses.
But the fact that the bond market is not working as efficiently as most in Hong Kong is likely to delay this development. The lack of clarity about remitting offshore renminbi proceeds also raises questions for the looming Hong Kong renminbi initial public offering (IPO) market.
Bankers, regulators and investors all believe Hong Kong’s renminbi IPO market could finally open in the next few months. Li Ka Shing’s Cheung Kong Holdings, expected to issue the first offshore renminbi IPO in the form of a Reit, has delayed its deal due to technical issues.
Even if it does proceed, other companies are likely to want assurances that all the requirements for a sustainable secondary market are in place before they conduct an IPO that raises renminbi outside of China.
It’s also far from certain whether renminbi deposits in Hong Kong will be enough to fund both new equity issues, with the necessary secondary market support, in addition to a growing offshore renminbi bond market.
A little repo help
When it comes to this latter point, at least, there appeared to be some good news. On February 18 the Bank of China Hong Kong (BoCHK) announced it would start offering renminbi repurchase (or repo) facilities in Hong Kong to facilitate intraday liquidity management for banks participating in the renminbi clearing system.
A repo is a form of short-term borrowing for dealers typically in government securities. The dealer sells the securities to investors, usually for a fixed short term, and buys them back.
The initial response was positive. A repo system could provide liquidity for investors looking to invest in the renminbi IPO market.
However recent news indicates that the BoCHK is being highly selective with what it will repo, to the point where the market worth of the new derivative has become questionable.
The only instruments that can currently be repoed include bonds issued by China’s Ministry of Finance, Chinese policy banks and the Bank of China itself, according to a circular the bank sent to other financial institutions.
As yet only a small amount of applicable debt has been issued. According to Dealogic, China has only issued roughly US$2 billion worth of sovereign CNH bonds so far.
Concerningly, no bank had tapped the BoCHK’s repo line weeks into its launch.
So far, so disappointing. Yet this is not the only means by which the authorities are trying to drum up market liquidity.
On March 2 Hong Kong Exchanges and Clearing (HKEx) issued details on how it would help investors struggling to get renminbi exposure to buy shares denominated in the currency in Hong Kong.
Hong Kong’s stock exchange operator said that it would establish a Trading Support Facility (TSF) for this purpose by the second half.
Under the HKEx’s scheme, TSF-participating banks provide a pool of renminbi, which investors can access in return for Hong Kong dollars. They have to use this renminbi to invest into renminbi-denominated stocks in Hong Kong. The HKEx has so far declined to comment on what size the pool would need to be.
Crucially, if an investor pulls out of an investment they receive the equivalent value in Hong Kong dollars at the given TSF exchange rate.
The hope is that investors can access the currency via other avenues, meaning that the TSF should barely be used. But the HKEx is still working overtime to convince banks to provide liquidity into the TSF, and to persuade would-be corporate issuers that there will be enough investor liquidity to make renminbi equity funding viable.
It’s far from certain that there will be enough investor support for renminbi shares, because they lack some of the key appeal of bonds denominated in the same currency.
Renminbi-denominated bonds have a set shelf life and value, which means that they will benefit from the rising value of China’s currency, but the values and dividends of renminbi shares would vary a great deal and have no maturity date.
In other words they lack the renminbi bond market’s selling point of currency appreciation, a key factor in attracting investor demand.
Buy now, pay more later
Even assuming investors are willing to take part in renminbi IPOs for their own sake, the market faces another issue: foreign-exchange conversion risk.
Investors buying renminbi now will have to pay more due to its relative scarcity. However assuming more renminbi comes into Hong Kong, it should become cheaper to purchase the currency from the TSF. Therefore if an investor was to purchase a renminbi stock under the TSF programme and sell it later, they would very likely receive a worse rate in Hong Kong dollars.
The market limitations will raise questions in the mind of any company looking to conduct an IPO in renminbi in Hong Kong – particularly when the Hong Kong dollar equity market is already highly efficient.
The biggest issue for the banks is buying into the value of the TSF itself. They may be reluctant to hand over their renminbi when they can use it more effectively themselves.
This is where the banks would need to take a strategic view rather than just a purely commercial one. One possible perk of their participation is that they would get to set the FX conversion rate – although prospective investors would be put off by a rate that is too costly. The HKEx will need assurances that this will not occur.
As Asiamoney went to press, Bryan Chan, head of the HKEx renminbi products task force, said it was close to securing the signature of one major bank into the TSF. Clearly the HKEx needs many more, and soon, if the deadline is to be hit.
The indication from the street is that banks will get involved but they are themselves finding that their institutional investors are anxious about liquidity.
Opening the tap
The limited impact of the repos and the TSF facility so far just goes to underline how much the market still needs more renminbi liquidity. Yet the powers that be seem to be are aware of these issues and are trying to find ways to increase renminbi more naturally.
Already there is evidence of Hong Kong banks popping off to Singapore to raise deposits, which are not subject to daily conversion limits or interest-rate caps. HSBC is offering a relatively juicy 1.35% on a 12-month time deposit.
“The reason for the need for more renminbi liquidity in Hong Kong is quite simply that there could be substantial oversubscription of these CNH-denominated IPOs,” says Woon Khien Chia, head of emerging markets strategy at Royal Bank of Scotland.
This is good news but there is still no guarantee that there will be enough liquidity to support the new market. Cheung Kong’s Reit is expected to soak up Rmb28 billion when it does proceed. Any pipeline of deals after this looks likely to seize up until more renminbi comes in.
Ultimately, these are teething issues. As the amount of renminbi circulating internationally rises, liquidity fears will eventually recede, as will the need for the TSF – exactly what the HKEx wants to see.
The HKEx’s Chan says: “Looking further out we are confident, unless the China policy changes, we can see a path which will take us to a more significant market denominated in renminbi.”
Many in the industry match this buoyant sentiment. Most acknowledge that although product take-up is thin right now the sheer volume of renminbi coming through in Hong Kong, and the promise of more products, will create an inevitable surge of investment.
There is an air of inevitability about the growth of renminbi offshore, but the speed at which it comes around is still dependent on China. The country’s regulators are clearly listening to market feedback from Hong Kong, and appear receptive to sustainably growing the offshore market.
Yet one worry remains: the murkiness surrounding remittances. Beijing’s pressing inflationary concerns could prevent it from allowing companies to easily repatriate renminbi proceeds raised offshore.
For example, the government is clamping down on property companies in its drive to control asset inflation. These same companies are turning to Hong Kong, as the offshore renminbi hub, to continue their fundraising activities and then try to remit onshore.
The risk is that if China is slow to allow such activity it could stunt the growth of the renminbi bond market and the birth of the IPO market (and the necessary secondary market that goes with it).
The two markets could even cannibalise each other for demand until renminbi flows reach critical mass.
In its 12th five-year plan, China dedicated a chapter to Hong Kong for the first time, a clear indication that it would like to see the city continue to succeed as an international finance centre.
Beijing could best do that by making clear which companies are allowed to remit money onshore, and which are not.
Such clarity might run contrary to the instincts of China’s inscrutable regulators, but it would help Beijing align its sometimes contradictory financial priorities.