The likelihood of having renminbi-denominated commodities in the future is high given that China can easily use its bargaining power as the largest commodity consumer in the world. However, the change will only come when the currency achieves full-convertibility.
Most global commodity firms already have offices in Singapore, which can offer attractive tax rates as low as 5%-10%. But Shanghai has the strong potential to become the next commodity trading hub in Asia, and also third in the world after Geneva and the Lion City, says London-based Jean-Francois Lambert, global head of commodity and structured trade finance at HSBC.
“China has become a juggernaut of commodity business,” he said to Asiamoney PLUS in Hong Kong on July 11. “It is now the largest world buyer of so many . China’s power of negotiation vis-à-vis the producer could therefore actually shift in their favour and that is what the Chinese government would actually strive for.”
Mainland China is the biggest buyer of many commodities, including copper, crude oil, iron ore and rubber.
In 2012, data from Chinese customers revealed that imports for crude oil rose 6.8% to 271 million tonnes and copper imports grew 14.1% to 3.4 million metric tonnes – both rising faster than the previous year. Iron ore imports were up 8.4% at US$95.6 billion, standing at 743.6 million tonnes, increasing at a slightly slower pace than in 2011 but still faster than the overall economy.
However, the nation is only able to successfully position itself competitively against its fellow regional rival Singapore if certain factors are in place.
"As long as commodities are quoted in US dollar or in pounds, Chicago and London will still remain the key commodity markets. But my take is that Shanghai will become a major commodity hub with a very large commodity exchange, at least for the commodities where China is a dominant buyer,” said Lambert. “But this is of course predicated on the convertibility of the renminbi.”
With currency convertibility, China’s commodities exchange would not be disconnected from the rest of the world, and that market participants could eventually see the quotations of some of the goods denominated in the renminbi.
“We already have settlements in renminbi, but what will happen is that we will probably see some of the key commodities quoted in renminbi,” said Lambert. “With a full renminbi convertibility, there is no reason why such differences remain: Where China is the largest buyer, not only you probably will have one price but the likelihood it is a renminbi denominated one is high."
Key commodities include iron ore, crude oil, gold, palm oil, rubber and steel.
The disconnection between commodity exchange in China and the rest of the world is a serious issue and would not be helpful for the Mainland’s ambitions in becoming the next commodity trading hub.
In fact, traders note that clients who deal with both the world’s second largest economy and other jurisdictions, experience two different market dynamics.
For example, the global aluminium market is currently in ‘contango’, which is a market condition wherein the price of a forward or futures contract is trading above the expected spot price at contract maturity.
But domestically in China, the aluminium market is in ‘backwardation’, which is the opposite – a market scenario wherein the price of a forward or futures contract is trading below the expected spot price at contract maturity.
“China’s market is disconnected from the real markets. The only reason why these two markets can’t talk to each other is because of the convertibility,” said Lambert. “Once you have that convertibility in place, suddenly you have a very strong exchange market which is connected and working in sync with other world exchanges.”
In May, HSBC voiced its confidence that the renminbi will likely become fully convertible within five years.
RMB swap line
In order to maximise value in the supply chain, large commodity exporting countries such as Brazil and Argentina should learn how to utilise their renminbi swap lines established with the People’s Bank of China (PBoC) back in 2012 and 2009 respectively, especially given the fact that China is their biggest customer.
And while it is believed that these lines have not been used, HSBC is in talks with commodity companies on both ends and discussing the feasibility in setting up a renminbi-based supply chain.
For example, a Sao Paolo-based exporter would benefit by seeking funding in the renminbi and subsequently, swap it into the Brazilian real, which can then be used to pre-finance its commodity contracts. Then the company’s China-based customers can pay for the goods delivered in the Chinese currency, which can be used to unwind its renminbi-funding position.
“There is no incentive to use [the swap line] because commodities are still denominated in US dollars. But we are working very proactively around the potential of setting up renminbi-based commodity supply chains,” said Lambert. “This can be a huge differentiating factor for a Latin American commodity supplier to sell in RMB when dealing with Chinese buyers.”
“Financially, it might be attractive at various part of the chain. By doing that you can negotiate with your Chinese buyer better terms – longer contracts and possibly premiums. Many players are interested,” he added. “The overall conditions by combining financial terms with the commercial ones can be very differentiating and overall very rewarding.”
Brazil and Argentina has a renminbi swap line total of Rmb190 billion (US$31 billion) and Rmb70 billion respectively, according to PBoC data.