CNH bonds to appeal over cash for London clearing collateral

The usage of dim sum bonds rather than RMB cash as a form of collateral with NYSE Euronext’s new London central counterparty is expected to gain traction due to the assets’ ample liquidity and buoyant secondary market activity.

  • 25 Oct 2012
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The pace of renminbi internationalisation seems to be lagging behind the launch of new initiatives by exchanges around the globe. This could impede on the pace of adoption of the Chinese currency, not only as a form of trade currency, but also as a form of collateral.

NYSE Euronext intends to work with the Bank of China (BoC) to take advantage of the increasing importance of the renminbi in capital markets by jointly developing renminbi-denominated financial products.

The two institutions will explore the potential for renminbi to be used as collateral for NYSE Euronext’s new London central counterparty (CCP), according to the memorandum of understanding published on October 17.

“The renminbi in the long-term, as we all know, will become fully convertible in the foreseeable future and will play a major part in the global financial market,” said Cecelia Zhong, head of Greater China for NYSE Liffe, the derivatives business of NYSE Euronext, to Asiamoney PLUS in a telephone interview on October 22. “As an international exchange operator, this is something we need to do and is in response to market demand.”

This is viewed as a positive development as market participants acknowledge that this collaboration will encourage players to use the Chinese currency as a form of collateral in the early stages of its market development in the western world.

“It’s a first step and London wants to take that step because it wants to promote itself as an offshore renminbi centre,” said a Hong Kong-based capital markets partner at British law firm. “It’s not limiting itself to just renminbi, but adding the currency to a pool of eligible collateral.”

Moreover, NYSE Euronext will provide guidance to BoC which will establish itself as a general clearing member of the London market for NYSE Liffe, which is the stock market operator’s European derivatives market.

“I think BoC will become the bridge between the European and American market, and the Asian market,” said Zhong. “They will help us develop our Asian market expansion and also introduce our western counterparts to Asian market.”

RMB cash versus securities

There is an overall shortage of high-quality collateral G4 cash and G7 sovereign bonds with ‘AAA’ or ‘AA’-rating, say experts. This is why global exchanges, including the London Metal Exchange (LME), have been making a consistent effort to offer more flexible margin programmes to their clearing members.

One such recent provision is accepting renminbi as collateral for cleared over-the-counter (OTC) derivatives.

But one question that exists in experts’ mind is whether cash or renminbi-denominated products will be used as collateral.

Out of the three broadly defined renminbi denominated securities – bonds, equities and exchange traded funds (ETFs) – dim sum bonds have the highest chance of being used as collateral. The opposite is true for the equity space.

“Currently investors buy and hold these positions [dim sum bonds] in custody, so there is an opportunity to mobilise these securities and use them as collateral, especially because of the relative comfort with fixed income trading in the region,” said O’Delle Burke, Asia Pacific senior product manager for collateral management at J.P. Morgan on October 24. “In the equities space, once we see more issuance and an active secondary market, we could see an uptick in the use of renminbi denominated equities as collateral by global broker-dealers.”

Dim sum bond issuance has totalled 179 deals worth US$30.6 billion since the market launched in 2010, but so far renminbi-denominated listings number is only two, according to data from Dealogic.

On the other hand, the usage of the renminbi in ‘cash’ terms for collateral is limited given the restrictive nature of the currency with regards to convertibility, especially in sizable quantities, note market participants.

As a result of this, experts do not see the proliferation of the renminbi as a form of collateral in the short term, especially in London given the inadequate amount of liquidity available in the European market.

As of December 2011, London only has around Rmb35 billion (US$5.6 billion) worth of renminbi deposits, which is minimal when compared to Hong Kong’s level of Rmb552 billion as of August 2012.

“The renminbi would be one form of eligible collateral but I would not expect that to play a large part of overall eligible collateral in the immediate future,” said the partner. “In the immediate term, I would expect the US dollar, sterling, and euro to play a more prominent part in the collateral pool.”

Wilson Li, a Shenzhen-based bank analyst from Guotai Junan Securities believes that the usage of renminbi as a collateral will be limited to Chinese companies with overseas operations or foreign companies with presence in China.

BoC’s penetration into the foreign local market is going to be small, he notes. The same theory applies for other banks as well.

“It is a good start, especially for the Chinese banks as they can afford to use the renminbi as collateral because it’s a major part of their business in China. But for foreign banks, it’s difficult for them to accept renminbi as collateral because there are still some liquidity constraints,” said Li.

Boosting London’s liquidity

Despite the problem of limited liquidity, experts are confident that the appeal of the renminbi will remain for the foreseeable future, especially as the Chinese authorities continue to gradually relax its control on the capital account and as other market players in the region aid this development.

For example, in June, the Hong Kong Monetary Authority (HKMA) signed bilateral agreements with Euroclear Bank and J.P. Morgan Worldwide Securities Services respectively, to cooperate in delivering a cross-border collateral management service.

The impetus behind this particular initiative was to facilitate more liquidity especially for global institutions that are trading in Hong Kong. This in turn will help boost London’s profile as an offshore renminbi hub and its liquidity.

“If you are a broker-dealer participating in the Hong Kong market and want to participate in renminbi products, a direct source would be the local banks using a repo trade – an obvious choice in terms in terms of executing a secured and collateralised transaction,” said J.P. Morgan’s Burke. “The programme attempts to address the market infrastructure challenge, especially for local banks which might not have the technology or the custodian network to support offshore assets as collateral.”

Additionally, the change in Hong Kong’s cutoff time for processing renminbi has been extended from the end of the working day to as late as 11pm. Prior to this change in June, transactions used to be done on a T+1 basis, which was not conducive for the development of London’s offshore renminbi market.

“The extension will facilitate more intraday trading activity for parties in London that want to trade the renminbi currency,” said Burke. “With respect to the launch the HKMA repo programme, a lot of the broker-dealer that would be participating in the programme are London-based.”

London’s keeness to become the next offshore renminbi centre will not go unnoticed. And while market participants would like to see the rapid development of the Chinese currency into the western hemisphere, this phenomenon is unlikely to reach the shores of the United States.

The key obstacle is the difference between London and US regulations.

“I think offshore renminbi [securities] are not issued on a RegS basis, so they are not issued or purchased by US investors, which means that if they were to be, they would have to be issued on a 144A basis. Those are US security rules,” said a lawyer. “At present, the renminbi structured products market or dim sum bond market is larger or more important in London than it is in New York.”

  • 25 Oct 2012

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