London seeks leading role as Yuan bond trade goes global
Opposite the neoclassical pile of the Bank of England in the heart of the City of London stands an unprepossessing building that houses a Chinese bank.
Bank of China (UK) has been in the City since 1929, the year of the Wall Street Crash, but nobody much noticed the bank, or any Chinese presence in London’s financial markets, until two weeks ago.
What changed was the launch of one of the first London-listed bonds denominated in China’s renminbi (yuan) currency.
The deal, from banking group HSBC Holdings Plc, arrived with a fanfare. It coincided with Chancellor George Osborne’s launch of a working party with the City of London and five major banks – including Bank of China and HSBC – to develop London as an offshore yuan trading centre.
The move is an attempt by Britain to tap into trading in instruments denominated in the currency of the world’s second-largest economy.
“China and Britain are trying to push for more trade and investments, both ways,” said Janet Ming, who heads a newly created China desk at Royal Bank of Scotland in London. “The Chinese economy grew by 56 percent in five years … it’s very obvious Britain should sell more to China.”
London is hoping to build up its presence in the offshore yuan bond market, which started alongside the offshore yuan currency market less than two years ago in Hong Kong, used by mainland China as an international, or offshore, trading centre.
The offshore yuan bond market has grown far faster than most people expected, to reach 235 billion yuan (22.9 billion pounds), according to Thomson Reuters data. And there are predictions for that total to double by the end of this year alone.
Clearly it’s too big an opportunity for a financial centre like London to miss.
The question is – can it succeed? One reason may be that China wants it to. After all, creating an offshore yuan currency is part of China’s attempts to make its currency tradeable without removing onshore controls too fast.
China has a strong incentive as it needs to create another currency in which to invest.
The country holds $3.2 trillion in foreign exchange reserves, the bulk of that in dollars. But the dollar has been on a weakening trend in the last two years, while the euro’s future remains uncertain.
“The Chinese government is very long in foreign currency but very short in its own strong currency, that’s why the government needs to push for international use of the renminbi,” said Ming.
China’s decision to open up its currency for much more liberal offshore trade is seen as a testbed for future currency reforms on the mainland.
China has been gradually loosening those controls onshore too, through measures like allowing all companies in the country to pay for imports and exports in yuan, and, this month, the widening of the currency’s trading band.
“The pace of the deregulation of the Chinese market is quite breathtaking, in Chinese terms,” said David Pavitt, head of emerging markets foreign exchange trading at HSBC in London.
China has a goal of achieving a basically convertible yuan by 2015, though some economists see that happening even sooner. And London’s prominence as an international financial centre means China will likely look to raise its profile there.
Britain, meanwhile, is looking for opportunities to increase exports to China, and financial services are as good a focus as any. Exports rose 20 percent to nearly 9 billion pounds ($14.6 billion) last year but languish behind those of other European countries such as Germany.
“I believe that we can make Britain the home of Asian investment and Asian finance in Europe,” Osborne said in a speech earlier this year.
HOW DOES IT WORK?
Companies doing business with China and retail investors looking for new opportunities are holding deposits in the offshore yuan, mainly in Hong Kong.
To woo such yuan deposit-holders who seek higher-yielding investments, banks have brought a range of Chinese and international borrowers to the Hong Kong market with so-called “dim sum” or offshore yuan bonds.
Now London wants a piece of the action.
Osborne set the wheels in motion in January, when a visit to Hong Kong and China led the Hong Kong Monetary Authority (HKMA) to agree a five-hour extension of its settlement hours from June, allowing offshore yuan trades to be settled throughout the London day.
A biannual forum between Hong Kong and London is to follow, with the next meeting to take place in May in Hong Kong.
London may of course have its work cut out to rival Hong Kong as an offshore yuan bond centre.
Although the deal struck between Britain and the HKMA had the backing of the Chinese government, market participants expect most of the bond trade to take place in Hong Kong, as it has so far.
Clearing and settlement of trades is likely to continue to take place through Hong Kong, and 80 percent of all offshore yuan payments are currently made through Hong Kong, according to SWIFT, a payment system used by 10,000 banks and corporates globally.
Customer deposits in Hong Kong – the pool of capital available to invest in yuan bonds – total 589 billion yuan, compared with only 35 billion in London, according to a study commissioned for the London working group.
But when you add in interbank trade, London’s yuan deposit base already totals 109 billion yuan.
This isn’t the beginning of the London yuan market, market participants say, but the start of a much larger role for it.
Scroll back to June 2010, when China expanded a pilot scheme to allow many Chinese firms to settle trade worldwide in the yuan.
The announcement came as a surprise to financial professionals.
For HSBC, one of the biggest players in the market and the bank involved with most offshore yuan bonds so far this year, according to Thomson Reuters data, that was a turning point.
“Hong Kong quoted the first CNH (offshore yuan) FX rate on the first trading day after the announcement creating the market,” said HSBC’s Pavitt. “London started quoting CNH FX shortly afterwards.”
HSBC has two dedicated traders for the currency in London, plus one for options and – newly – one for bonds. By comparison, HSBC only has two dedicated sterling traders in London.
Up to 25 percent of offshore yuan trade is going through London, with the rest in Hong Kong, Pavitt says, compared with 35 to 40 percent of global trade in London for other currencies.
London’s strength over Hong Kong is in its position as the world’s largest trading centre in the $4 trillion a day foreign exchange market, and as the world’s largest bond trading centre.
HSBC’s bond this month wasn’t even strictly the first London-listed bond, just the first London-listed bank bond, since oil company BP Plc launched a London-listed bond in September 2011.
Other British companies with business in China, namely Tesco Plc and Unilever Plc, have also issued offshore yuan debt through the Hong Kong market, as has Lloyds Banking Group Plc.
UK TO LAUNCH?
So how will London show itself as a real contender to Hong Kong? One way – promoted by Standard Chartered Chief Executive Peter Sands – is for Britain to issue a yuan-denominated bond.
But market participants are doubtful Britain would issue a bond denominated in a currency which is not fully convertible.
The Treasury poured cold water on the idea, saying its objective was to minimise risk, which “is normally best served by the government meeting its financing needs exclusively through sterling gilt issuance,” according to a Treasury spokesman.
Instead, market players suggest government-owned RBS, an active lead manager in the yuan bond market, or Lloyds, which has already issued yuan debt, might prefer to set the ball rolling for the government.
Chinese companies are less likely to try to issue via the London market and find favour with European investors unless they promote themselves through investor roadshows, but they could borrow here.
Meanwhile, Chinese banks could emerge both as issuers and as strong competitors to international banks in the yuan bond market in London.
The top five Chinese banks — Industrial & Commercial Bank of China, Agricultural Bank of China, China Construction Bank and Bank of Communications – as well as Bank of China — all have branches in London, several having opened in the last year.
Bank of China is already the third most active lead manager of offshore yuan debt this year, while Agricultural Development Bank of China, China Development Bank and Export-Import Bank of China are planning to launch London-listed bonds, according to Thomson Reuters news and markets information service IFR.
“Everyone who has any interest in China will be looking at this market,” said Adam Tyrrell, head of capital markets at Standard Chartered in London.
“London is a financial centre and the major FX centre, the effort between London and Hong Kong means a lot of issues are going to come through London.”
But there are two things which London lacks – a natural customer base, and liquidity.
While Hong Kong has businesses which are happy to trade with China and accept payments in the yuan, European businesses are more reluctant.
A survey by Western Union showed one in five Chinese exporters added an average of 3 per cent to their prices to allow for the currency risk in receiving dollars. But bankers say companies are nervous about making the switch into China’s currency.
“The whole industry needs to put an effort into educating people, to build confidence,” said Yan Wang, treasurer of Bank of China in London. “The use of renminbi by corporates is picking up, but it takes time.”
Banks who want to sell yuan-denominated bonds in London and elsewhere in Europe need that customer base of those who are natural holders of yuan. It’s particularly the case since many of the original more speculative buyers of yuan bonds, who looked to the yuan as an appreciating currency, have now lost their appetite.
That’s because a rising yuan is no longer a one-way bet.
While analysts are divided about whether China will endure a hard or soft landing, they agree growth in China will slow, which is likely to cap the strength of the currency.
That outlooks means you are more likely to buy a yuan bond for the yield it will pay you, rather than to make a quick profit on the rising currency.
The lack of currency appreciation has deterred many institutional funds from buying these bonds, as has the bonds’ small size and lack of inclusion in major bond indexes tracked by global emerging debt investors.
“Most people think there are better places to put your risk chips,” said Edwin Gutierrez at emerging market fund manager Aberdeen Asset Management.
Lack of liquidity in London also deters many institutions from getting involved.
The swap market, which enables holders or issuers of yuan bonds to swap them into a different currency, barely exists so far in London.
There is also no London Interbank Offered Rate (LIBOR) for yuan, a prerequisite for many derivatives markets.
“For there to be an investor base, there needs to be a pool of liquidity; one of the challenges is to build that pool,” said Standard Chartered’s Tyrrell.
Although HSBC sold 55 percent of its 2 billion yuan bond to European investors, many of the buyers were private banks, which market participants say are likely to offer the bonds to retail investors.
Reflecting investor caution, most bonds do not have maturities longer than three years.
These kinds of constraints mean the market could take a few years to really get off the ground, particularly outside Asia.
As well as vying with Hong Kong, London will also have to face down competition from other aspiring yuan trading centres including Singapore, Sydney and New York.
But with China looking to expand the use of the yuan and Britain looking to increase trade with Asia, it seems there is little turning back.
“The process is off and running,” said Nigel Pridmore, partner at law firm Linklaters. “It would be hard to put the genie back in the bottle now.”
- Shanghai Pudong Development Bank says to issue up to 1 bln yuan dim sum bond (uk.reuters.com)
- Fitch Cuts China Yuan Debt Rating on Local Government (bloomberg.com)
- BOE Plans to Sign Yuan Swap-Line Arrangement With China Shortly – Bloomberg (bloomberg.com)
- Power Investment, Fufeng, Finance Ministry: China New Bond Alert – Bloomberg (bloomberg.com)
- China’s money supply passes US$16.7 trillion (wantchinatimes.com)
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