At the end of June, Zhou Xiaochuan, governor of the People’s Bank of China (PBoC), pledged to expand cross-border use of the renminbi. Few now doubt that the renminbi is on track to becoming a world currency. HSBC estimates that a third of China’s cross-border business will be settled in renminbi by the end of 2015, making it the third most-traded currency globally after the US dollar and euro.
As a major trade partner with China, Europe has a strong interest in this development. Already several cities have declared their interest in becoming a trading hub in the currency. Frankfurt, London, Paris and Zurich have all thrown their hats in the ring. Of all these cities it is Frankfurt that looks to be in pole position.
Germany is China’s largest counterparty in Europe, conducting €144 billion (US$184 billion) of trade with China last year, according to Germany’s Federal Statistics Office. It is steadily building its track record in renminbi too. Trade transactions in the currency comprised 8.2% of deals between Germany and China in May, the largest month-on-month increase among 20 nations using the Chinese currency, according to financial messaging provider Swift.
Key to the race is the establishment of a swap agreement. Towards the end of June, the Bank of England signed a Rmb200 billion (US$32.6 billion) three-year sterling-renminbi currency swap with the PBoC. This could be dwarfed if the European Central Bank (ECB) obtains a swap agreement with the PBoC, potentially for up to Rmb800 billion.
There is certainly scope to grow offshore renminbi deal flow. Year-to-date offshore renminbi or so-called ‘dim sum’ bond issuance stands at US$7.3 billion, up from US$4.9 billion this time last year, according to Dealogic. But non-Asian dim sum deal flow has been limited and there has been only one German issue so far: state development bank KfW’s Rmb500 million tap of its 2% May 2014 bonds in April. It’s been disappointing, as it was hoped the visit of German chancellor Angela Merkel to Beijing in August last year would lead to more deals.
With everything to play for Asiamoney talks to a distinguished panel of German bankers and policy makers about how to make Frankfurt the renminbi hub in Europe.
ROUNDTABLE PARTICIPANTS
Moderator: Andrew Murdoch, contributing editor, Asiamoney
Joachim Nagel, member of the executive board, Deutsche Bundesbank
Ludger Schuknecht, director general, strategy and international economy, Federal Ministry of Finance
Roman Schmidt, divisional board member, investment banking, Commerzbank
Hukan Wohlin, global head of debt origination, Deutsche Bank
Asiamoney [AM]: What are the obstacles to a greater usage of the renminbi (RMB) in Europe?
Joachim Nagel, Deutsche Bundesbank: The internationalisation of currencies undergoes different stages. Usually, a currency starts as a trading currency, then becomes an investment currency and finally turns into a reserve currency. At the moment the renminbi is somewhere between a trading and an investment currency. This is a natural process and I don’t see many obstacles as it develops.
AM: How does the Ministry of Finance see this? Is this part of the development of China?
Ludger Schuknecht, Federal Ministry of Finance: Absolutely. The Chinese economy has developed rapidly over the past few years. The natural next step is to develop the financial sector further and to speed up international liberalisation. We are seeing encouraging signs here. From the Chinese side there is an awareness and a willingness to take the necessary steps for the renminbi to evolve from a trading and investment currency to a reserve one. The timeline might not yet be fully clear but that is to be expected. We Europeans are prepared to do our part so that this mutually beneficial internationalisation can develop.
AM: How are German companies currently using the renminbi?
Roman Schmidt, Commerzbank: Commerzbank recently did some research on this with 158 large corporates in Germany. Of those asked, 73% said that they are convinced that they are going to use the RMB going forward and around 40% mentioned that an offshore centre in Frankfurt would overcome some of the hurdles they are seeing at the moment.
A lot of companies still have to deal with specific regulatory issues such as the limitation on dividends, capped interest rates and the debt quota. Nonetheless, several German companies took advantage of the offshore renminbi bond market last year, like Volkswagen, Bosch, Siemens. It is worth noting that the paper was sold not just in Asia, but in Europe too.
Hakan Wohlin, Deutsche Bank: Deutsche Bank recently conducted a European-wide survey on the use of the renminbi as well. A couple of data points in particular are worth highlighting. One in five of these companies use RMB primarily when invoicing. The other 80% are considering it.
What they said was that the use of the renminbi broadened their supplier or client base; it lets them deal with more Chinese counterparties. They also mentioned the elimination of price negotiation which for anyone who works in a corporate is a big part of winning a contract. The transfer of the currency risk is important too. But if you come back to importers, they said that if they used local currency, they saw an average price reduction of almost 5%.
Nagel, Deutsche Bundesbank: The most important thing to remember is that this process will take time. If you take a look back at the history of the deutschmark, you can see some similarities to the current situation of the renminbi.
The important difference is that the formerly fixed and currently managed floating exchange rate of the renminbi is a self-chosen fundamental factor in China’s economic development. It is clear that the internationalisation of the Chinese currency is therefore taking place more gradually than was the case with the deutschmark. The deutschmark was subject to radical upheaval, such as the collapse of the Bretton Woods system and the European Monetary System crisis in the early 1990s. In contrast to that, the internationalisation of the renminbi is a calm process.
Given the overall gradual transformation process of the Chinese economy, I do not think that it will speed up.
AM: As the renminbi becomes an international currency, is it possible to separate the market-driven process from the political process?
Nagel, Deutsche Bundesbank: I see the demand side and the supply side going hand-in-hand. The demand side is driven and influenced by the terms of trade with China and is one of the triggers that will drive the process. The supply side is more or less influenced by the political will of the Chinese government. As far as I can see, the leaders in China are fostering the internationalisation of the renminbi and striving to liberalise their currency.
Schuknecht, Federal Ministry of Finance: As my colleagues from the banking side rightly pointed out, both the trade volume and the interdependence between China and the rest of the world have increased enormously. This increased integration and cooperation have generated huge real economy gains. And as the interaction evolves from the typical developing /developed economy pattern – that of low quality and low technology products – to a more emerging market/industrial economy pattern, the need for more sophisticated finance and a level playing field in this area increases.
At the same time I want to stress that policy is extremely important. What is it that governments do? They provide a framework for markets to develop. The tremendous progress in terms of international trade that China has made shows this. The financial sector is the next challenge.
There is a great deal of discussion at the moment about a swap agreement between the renminbi and the euro, but we should step back and ask ourselves why this is being discussed right now. The reason is not just that we are at a stage where China has advanced economically, but also that Europe has created a stable international macro and financial environment. Of course this was beginning to emerge in the early 2000s, but was then interrupted by the global financial crisis. It is important to have confidence in macro stability because only then can the currency environment be stable.
Europe has done a great deal in the last two or three years to move forward and to regain the trust and confidence of countries all around the world. At the same time we have to make sure that the macro environment in China and other emerging economies is stable enough to have such an arrangement in place. And at the micro level, the regulatory environment needs to strengthen and improve. This is happening both in China and in the euro area.
Wohlin, Deutsche Bank: The volumes are mindboggling and moving incredibly quickly. I sometimes have to pinch myself to check they are real. China’s trade on a dollar basis is the same as that of the US: US$3.9 trillion. That is about 11% of the world’s trade. But when you look at the foreign exchange volume in RMB it represents only 0.5% of global volume, versus the US dollar which stands at 42%.
Three or four years ago China didn’t use its own currency in its trade at all. It stands at about 15% today. The new leadership is accelerating reforms to a market-based economy in many different areas which will involve privatisations, foreign investment, but also currency strategy. Some suggest China’s goal is to hit 40% within three years. And if you take 40% of today’s almost US$4 trillion [China’s trade on a dollar basis], that is an awful lot of renminbi sloshing around. Even if the economy grows at only 6% rather than 8%, that is still a lot of renminbi rapidly growing in circulation.
Because the RMB is growing as an asset class, global asset allocation will continue towards that currency and that will involve much more liquidity and instruments across fixed income as well as equities. Given that the equity story is just beginning in the offshore market, the question for the next five years is going to be what investors can look at in RMB to invest in. Our challenge is going to be to provide first of all liquidity and provision of trade finance and hedging, and financing for corporates, but it is also going to be on the investment side. At the very least we need to offer investors ways to follow indices.
We need the cross-currency swap. Chinese corporates and the government want to do business in the eurozone. A swap sends a signal that the eurozone and Germany are open for business, but it also sends a strong political signal. And that is in itself a large part of the value of a cross-currency swap.
AM: What is stopping Frankfurt being a centre for the renminbi?
Schmidt, Commerzbank: Chinese corporates have already started to look for opportunities within Germany and we have seen a few good examples of that over the last few years like Kion Group [Jinan-based Shandong Heavy Industry took a 25% stake in the German forklift manufacturer for €467 million in August 2012].
Further development needs to be created out of real trade flow. For example, if you look at payments in RMB in May 2013, the percentage of payments due to commercial or corporate business from Germany to China was four times larger than those between France and China.
On the back of that trade flow we would expect to see the normal growth of what you might see in markets. Banks settle down because there is more commercial banking and with more banks there is greater use of the RMB. At the moment you can’t do cash pooling on a worldwide basis in renminbi and it is not possible to have a debit account. All accounts need to be covered all of the time. Although a few things need to change, the most important thing is to have serious trade flow. Let’s face it. The trade flow between Germany and China is the most serious in Europe. Germans are big fans of growing things organically and as you see from the numbers, they [the trade statistics] are going in the right direction.
AM: Are there concrete steps that Frankfurt and Germany can take?
Nagel, Deutsche Bundesbank: Frankfurt can be more than a niche player. In the future I can imagine that German companies would like to have the opportunity to do all trade-related renminbi transactions via Frankfurt. This should include clearing and settlement. Generally speaking, a strong demand for renminbi in Germany will be the precondition for further developments and will give Beijing the signal that strengthening renminbi trade in Frankfurt would be a great opportunity for both China and Germany.
Wohlin, Deutsche Bank: I am not going to get in the argument of which is a better financial centre: Frankfurt or London. They are both great cities and both play a significant role in providing trade and liquidity. It is not a question of one versus another. The renminbi is going to be a world currency and it is just a matter of time before it becomes one of the top G4 or G3 currencies in terms of liquidity.
Nagel, Deutsche Bundesbank: It is not a question of London versus Frankfurt versus other cities. Frankfurt could be a complementary place.
Wohlin, Deutsche Bank: If you look at spot transactions and FX (foreign exchange) forwards and options today, between 30% up to the high 40% of the volumes are traded out of London. But when we say traded out of London, what we mean is that that is where the risk is managed. The German corporate that transacts with a number of banks here in Frankfurt will, in our case, face our German bank. It is quite clear to them that this is a German transaction. And yet the risk in the bank might be taken in London. The question we need to ask is whether more can be done.
To come back to China, it is important to debate this now. The new leadership seems to encourage state-owned enterprises and many of the large privately owned enterprises to expand their foreign direct investment (FDI) overseas. Relatively speaking, more of their FDI is going to developed markets and we may see a lot more tour buses with business executives in Europe than we have done in the past.
But I don’t think that there is one single item that you can point to that needs to change in terms of clients’ need to transact currency, trade finance or other hedging and financing needs. There is nothing that is stopping our corporate clients’ transactions.
Schmidt, Commerzbank: Large corporates choose their banks, with whom and where they trade depending on liquidity and where they see the best service. But the German economy is very much based on small and medium-sized enterprises, the famous Mittelstand. These Mittelstand companies don’t always call a large bank in New York for an FX quote. They would like to go to their local branch if possible, which then places a call. And ideally that should not have to be an international call.
Schuknecht, Federal Ministry of Finance: I want to jump in on the policy side here. This is not just an issue for Germany. There is a complementary role for Frankfurt as the potential hub not only for renminbi transactions, but, in a broader sense, as part of the eurozone too. We are building a Banking Union which will create a level playing field on the regulatory and supervisory sides and a truly integrated financial system with cross-border banks and much more intra-eurozone financial integration. We have had some disintermediation and disintegration in recent years, but over the next couple of years, we will see huge progress as the financial markets of the eurozone see renewed integration.
This will give Frankfurt the chance to become a hub within the eurozone. As all of us have emphasised it is a process that takes time and we are in competition with other financial centres, but we also complement each other. We should show some self confidence here. The quiet, persistent and long-term strategy we have been pursuing will be the successful one in the long run.
AM: Is there a role for specialisation?
Wohlin, Deutsche Bank: Let’s look at the dim sum market, offshore RMB financing in bond format. It is a rapidly growing market that people use for natural needs or arbitrage funding. It began, and still is largely, in Hong Kong where the investors are depositors, and then continued with Taiwan. The significant role that Taiwan plays is that it has life insurance companies which tend to buy long term liabilities to match their assets. That market has developed quite healthily into longer term opportunities for corporates to borrow money.
If we come to Europe where even though a lot of investors are looking at dim sum, it has not really taken off yet. It is on the margin. In my view this will change. There are about €1.3 trillion-€1.4 trillion in insurance assets just in Germany. If you think about strategic asset allocation between euros, dollars and yen today, it makes sense that some of that could go into RMB-denominated fixed income or equity products as that becomes a bigger portion of the world pie. The investment side will drive a larger portion of the flows.
Schmidt, Commerzbank: Especially at the moment. Three-year renminbi yields are sitting around 3.5%-4%, which is a significant pick up [to bank deposits or US Treasuries]. For our last dim sum transaction we saw healthy demand from low yielding Swiss accounts, and significant Swiss institutional money going into the RMB market.
One of the reasons is the yield pick-up, but also certain global portfolios have introduced the RMB as a must have world currency and are increasing their proportion accordingly. Not all of them want to buy Chinese-based equities, so they are happy to get some bonds in their portfolios as well.
Wohlin, Deutsche Bank: Take that back into German corporates who may be high yield, in other words have a rating that is below investment grade. They may have more and more exposure selling into China. Against that asset they may want to put a liability, to borrow in an RMB-denominated bond transaction, and this results in an investment opportunity.
It is easy to imagine a scenario where you might have an issuer, a German Mittelstand company for example, and you may have an investor, who might be, as an example, Allianz. We believe that a lot more flow can be expected as that bond market develops. Even at the moment the volume numbers in this bond market are staggering, albeit they have come from a very small base and the market is very young, but we are starting to see real benchmark issue sizes.
AM: China auctioned its first 30-year dim sum bond transaction at the end of June. How important is it that the dim sum credit curve has been going out?
Wohlin, Deutsche Bank: The offshore renminbi market used to be very short and not particularly exciting – small deals with shorter maturities. Deutsche Bank has predicted for some time not just that the curve would extend out to 30 years, but that the size of deals would also increase: €500 million and above, as opposed to €100 million give or take. Soon companies should be able to do subordinated and convertible transactions and raise bank capital there too. You will probably start to see more sovereigns borrowing in this market and you will see more high yield deals too.
Nagel, Deutsche Bundesbank: This process can also be supported by central banks. For now, only a few central banks have started to add renminbi-denominated assets to their reserve portfolios, although the amounts are believed to be marginal at the current stage. But, as far as I know from surveys, more than 10% of reserve managers are already invested in the renminbi and more than 35% are interested in investing in the renminbi within the next five years.
As you can see, this is a developing market. But it is more than that. As the renminbi is currently in transition to being an investment currency, there should and hopefully will be various financial centres where investors can do every kind of renminbi related business – not only in Hong Kong, Singapore or London. Frankfurt could also be one of these places. Why not?
AM: We have talked about what Europe needs to do. What does China need to do now?
Nagel, Deutsche Bundesbank: The Chinese government has been following a defined path for the internationalisation of the renminbi. The Chinese began by creating a new model, a unique separation of having an onshore and an offshore currency. So far it looks like it might be a successful model. After the Chinese government chose Hong Kong as the first offshore centre and made positive experiences, other financial centres are now becoming more important for the renminbi, too. It seems like politicians in China are planning further steps towards liberalisation.
Wohlin, Deutsche Bank: Let’s step back for a moment and see what the Chinese have actually done. They have done something extraordinarily positive. Slowly but surely they are changing the world’s geopolitical landscape. This is a huge, huge thing and it is to their credit that they are moving step-by-step and checking that each stage works before they do something more dramatic.
A number of our clients, however, complain that it is frustrating to get money onshore in China. As a German corporate trying to invest in China there are a number of hurdles. If you count the various regulators and government agencies that you need to deal with, you can quickly get a headache because you can run up against seven or eight institutions. There is quite a lot of frustration around. This should be streamlined to the best of the Chinese government’s ability.
The predictability of the regulatory machine could also improve. I am thinking of Chinese central bank moves in June around interbank lending to try to make sure that the credit supply did not run out of order. The predictability of some of those moves could have been communicated better. The central bank could also signpost the road map a little more clearly.
All China-watchers know where the central government is going with capital liberalisation et cetera, but the communication around PBoC’s various policy initiatives could improve. The long term communication is all positive, but perhaps a little more communication would help further.
Schuknecht, Federal Ministry of Finance: In a macro context, what is happening is huge. It is difficult for us to give advice as we have mismanaged similarly far-reaching processes in many of our countries. Take a look at the plan that the Chinese government has communicated: in three to five years, the reduction of credit controls in the context of trade. In five to 10 years, the opening of credit markets for capital in and outflows, real estate bonds, shared trading, and a move from a quantity-oriented to an interest-oriented monetary policy. These are all extremely important, but also ambitious steps. This will take time.
In today’s advanced economies, many of these liberalisation steps have resulted in financial instability because they were mismanaged. We would all hope that the Chinese will learn from this, because they are so big and so important in today’s world economy. A financial crisis originating in China would have dire effects on all of us. To do what is necessary is in the interest of our economies and of China. But they need to do it in a way that is not destabilising and does not create too many hiccups. The good news is that China has a lot of examples and country cases from which it can learn, even though every country is different.
It will also be challenging for us to manage this transition towards the renminbi becoming a reserve currency. For much of the last decade, the US has financed a part of its current account deficit through the reserve accumulation of dollars. We know from history that a shift in reserve currencies, such as the shift from the pound to the dollar, can be a very turbulent process. In China’s case the opening process so far has been very smooth, but we are only at the beginning. It will be a formidable challenge for our general macro and micro policies.
Countries in Europe must have sound public finances so that there are no repercussions on the public sector and sustainability concerns. But Europe also needs to have a sound micro-economic and financial market environment so that this transition can be absorbed. Bear in mind that any changes are unlikely to be linear; we have learnt from this financial crisis that little in this world is linear. The more distortions and more imbalances there are, the more non-linear their economic effects can be.
AM: Do you have concerns about the process?
Nagel, Deutsche Bundesbank: If you look at the current five-year plan of the Chinese government, the goals include a promotion of the foreign direct investment market in renminbi supporting the domestic banks, in issuing renminbi-denominated loans outside China, and in facilitating the gradual development of cross-border renminbi settlement for private investors. Achieving these goals would constitute important steps towards liberalisation. It has to be recognised that the world financial markets are not in calm waters yet, indeed in some regions we are still in heavy seas. Even so, the renminbi looks as though it is managed rather smoothly and so hopefully this will continue in the future.
Wohlin, Deutsche Bank: In terms of the evolution of the liquidity centre, the renminbi liquidity started in Hong Kong and added Singapore and has since then also move to include London. But in the Hong Kong and Singapore cases this was followed with the establishment of clearing banks.
With London, the PBoC has taken a different approach it seems, so far at least. If you want to trade an offshore renminbi bond in London, then you settle it in Hong Kong, regardless of who you are. The question that is then worth thinking about is whether there could be an upside or benefit to have clearing banks in Frankfurt for our German clients who want to do so locally. It would obviously be on behalf of the PBoC, but this is something to go away and think about.
Schmidt, Commerzbank: It is not enough just to have a renminbi market. For a market to function properly you also need to have traders. And for that we need Chinese banks to open up in Frankfurt. They should be encouraged to have a look at Germany not just from a banking perspective but to install permanent offices here.
Some Chinese companies have already set up permanent representative offices here in Germany. Germany is, after all, wide open. There is no political debate every few years like there is in other countries about whether China is going to keep its most favoured trading nation status. In Europe you don’t see that discussion turning up every couple of years. A market can only be efficient for all of us, whether corporates, customers or ourselves, if there are enough market participants.
Sometimes you can say that a market is overbanked, but I do not believe that the banking relationships between China and Germany, between China and Europe are overbanked.
Wohlin, Deutsche Bank: We thrive on competition and we like to beat it, but the point is that this a rapidly growing currency and perhaps [it will] one day [be] just like the dollar potentially so competition will indeed be strong.
Nagel, Deutsche Bundesbank: Competition, as always, is a good thing. Generally speaking, it is important that if you want to facilitate offshore renminbi trade in a certain place you have to set the scene. A clearing house is an important step in that regard. If there are banks that are active in that business, this is a good thing and a good starting point.
As long as I have been a central banker, China has never done anything in a dramatic and fast way. It is a gradual development process that will take time. From a central banker’s perspective, when I look back at what we have discussed so far, and considering that Germany is one of the most important trading partners for China, Germany should have a place for the financial settlement of renminbi transactions.
I believe that Germany has an advantage here. But now it is our task to develop that in a smart way. What we are doing today is just the starting point.
Schuknecht, Federal Ministry of Finance: I am optimistic that Frankfurt would be a great place for a renminbi hub and I would hope and expect that this would go ahead.
Let me stress a few things that speak for Germany and Frankfurt. There is a strong political dialogue at the state and federal level with Chinese counterparts. We have a lot in common in terms of long term relations, long term growth and long term stability orientation. China appreciates this. Frankfurt is a central banking, regulatory and supervisory hub thanks to the European Central Bank, the Bundesbank and the European Insurance Regulator EIOPA, and it will evolve even further with European financial integration.
Something else that those who know Frankfurt understand and I think speaks for it is that it is a very liveable city. You don’t have two-hour commutes every day. It provides an affordable and healthy living environment. There are large Chinese and international communities here – even a bi-lingual Chinese-German Kindergarten; a Dragon Boat festival… All told, Frankfurt offers a very high quality of life.