The implementation of direct trading between the currencies of two of the world’s largest economies will set a good example for other currencies to follow suit in the next year.
Local traders in Shanghai estimated there was an average daily turnover between the yen and renminbi of about Rmb3 billion (US$481.7 million) or ¥2.4 trillion (US$29.2 billion), in Shanghai and Tokyo respectively according to ANZ in a report released on December 6. Anecdotal reports put the trading volume in Tokyo at roughly one fifth of Shanghai’s, indicating that direct trading between the two currencies has not taken off despite almost six months of developments.
The current daily turnover volume is also too small. It is only 3% of China’s total CNY/USD spot market, which had an average daily turnover of US$14.6 billion in 2011. It is even more minuscule than the daily turnover of JPY/USD spot of US$249 billion, according to the Bank for International Settlement Triennial Central Bank survey.
“The lack of awareness among market participants, compounded by the latest political tensions, suggests the direct trading between the yen and the renminbi has experienced a false start,” said Raymond Yeung, Greater China senior economist at ANZ. “We believe this slow start will also provide an opportunity for other currencies to take lead.”
The next most promising currency to form direct ties with the Chinese renminbi would be the Australian dollar. Globally, the Aussie dollar is the fifth mostly traded currency and the AUD/USD is the fourth most liquid pair.
Also, the Aussie dollar is the ninth foreign currency allowed to trade in the Chinese onshore market using the US dollar cross rate only.
“The strong Australia-China trade link has provided a strong case for using renminbi in bilateral trade and investment,” said Yeung. “Using renminbi and Aussie dollar directly in trade invoicing and settlement can be cost-saving by reducing foreign exchange volatility. It will be a very natural move to establish a direct AUD/CNY quote in the foreseeable future.”
Based on the experience of JPY/CNY, onshore players may be able to source a cheaper Aussie dollar when the renminbi hits the strong side of the USD/CNY trading band.
This is because the USD/CNY is only allowed to be traded in a tight band of +/- 1% after April 2012 while the JPY/CNY trading is allowed to fluctuate in the Shanghai market at a range of within +/- 3% of the daily fixing.
“Whenever the renminbi is not allowed to strengthen further against the US dollar because of the People’s Bank of China (PBoC) interventions, there could create an opportunity for arbitrage because the same restriction of renminbi does not apply to its rate against Japanese yen under a much larger trading band allowed,” said Yeung.
“In recent weeks, the strength of renminbi was restrained by the trading band and the same renminbi could not have converte more US dollars,” he added.
As a result, ANZ finds that the direct conversion of Japanese yen and Chinese renminbi can result in a lower JPY/CNY fixing or a cheaper price for a long position of yen as compared with a counterfactual scenario under the old fixing methodology.
Previously, the JPY/CNY fixing was set with reference to the cross rate between the fixing of USD/CNY and the spot rate of JPY/USD at 9:00am in the world market.
On average, the gap – fixing under the direct scheme minus the cross rate method – was -38 FX points (pips) after June and it was -13 pips before the start of the conversion scheme. In November when the renminbi strengthened sharply against the US dollar, the average gap was -167 pips, notes ANZ.
This is one of the reasons why Australia is seeking to establish direct trading with China. As stated by Wayne Swan, deputy prime minister and the treasurer, Australian dollar would like to seek the status of being the third currency to be traded directly with the renminbi.
In addition to Australia, the Bank of Korea has stated its intention to expand the role of the Chinese currency in their bilateral economic relation with China.
“Given its strong economic link with China, we believe that China will also respond to this proposal in kind and develop a direct conversion with its neighbouring economy,” said Yeung. “We think some key Asean (Association Southeast Asian Nations) currencies could also be the potential candidates in the near future.”