Offshore CNY Trading — Where Next?

Singapore and Australia could be the next places for offshore CNY tradingCNY-KRW and CNY-TWD trading may take longer to occur due to offshore trading issues As offshore supply of CNY increases， Chinese exports may increasingly be settled in the CNYIn recent months， two emergingmarket (EM) currencies， the Malaysian ringgit (MYR) and the Russian rouble (RUB)， have begun to be traded on the China Foreign Exchange Trade System(CFETS). Meanwhile， the Chinese yuan (CNY) is now quoted in Malaysia and Russia. Based on China’s trading patterns and the interest of other countries in allowing offshore trading of their currencies， the Singapore dollar (SGD) and the Australian dollar (AUD) could be the next currencies quoted on CFETS， while the CNY could start to be quoted in Singapore and Australia. Despite China’s sizeable trade with Korea and Taiwan， bilateral CNY-KRW and CNY-TWD trading may take longer given the reluctance of the Korean and Taiwanese authorities towards offshore trading of their currencies. In Q3-2010， we estimate that 2.10% of China’s total trade was settled in CNY， 0.34% of its exports and 3.73% of its imports. This compares to 0.97% of total trade， 0.18% of exports and 1.86% of imports in Q2-2010. As the number of Mainland Designated Enterprises (MDEs) expands and offshore CNY liquidity gradually improves， it is likely that Chinese exports， especially to Asia， will also increasingly be settled in CNY. Finally， the fact that the CNY is now quoted against an increasing number of currencies may have limited impact for CNY management as long as the daily trading bands for CNY versus non-USD currencies are relatively wide.Where has China allowed offshore trading of the CNY?China has clearly been accelerating steps to promote local-currency settlement of trade， particularly with other developing countries. Recently， two EM currencies have been added to the CFETS – the MYR on 19 August and the RUB on 22 November 2010. These are the sixth and seventh currencies to be traded on the system after the US dollar (USD)， Hong Kong dollar (HKD)， euro (EUR)， Japanese yen(JPY) and British pound (GBP).Both MYR-CNY and CNY-RUB are allowed to rise or fall 5% on a daily basis compared to their mid-points. This compares to the existing daily trading band for USD-CNY of +/- 0.5% compared to the central parity fixings and the +/- 3% daily trading bands for EUR-CNY， CNY-JPY， CNY-HKD and GBP-CNY. Alongside the quoting of MYR-CNY at the CFETS， the CNY is now quoted in Malaysia on a deliverable basis. On 15 December， the Moscow Interbank Currency Exchange(MICEX) began to quote CNY-RUB.The People’s Bank of China(PBoC) has specifically flagged the advantages to enterprises of trade settlement directly in local currencies rather than the USD. In the case of the RUB， PBoC Deputy Governor Ma Delun said that “Local-currency settlement between China and Russia will help banks and enterprises in both nations reduce costs and exchange rate risks.”Currently， the repatriation of trade proceeds between China and Russia (or any two countries other than the US where trade is denominated in USD) requires two FX transactions where there is not an actively traded cross-rate market. In this case， the export of goods from Russia to China requires the importing side to sell CNY and buy USD in order to pay the invoice， which is denominated in USD. The Russian exporter then converts its USD proceeds into RUB. This decreases efficiency and raises the costs of the transaction (by paying two spreads)， and also likely adds to the administrative burden and risk of the transaction. Creating a liquid cross-rate market ?eliminates the middleman’ and improves global trade efficiency.In the case of the MYR， trading of the CNY in Malaysia appears to be closely related to Malaysia‘s own ambition of facilitating offshore settlement of the MYR for international trade in goods and services. The announcement that the MYR would be quoted on the CFETS followed Bank Negara Malaysia’s (BNM’s) announcement of FX liberalisation on 18 August to facilitate offshore settlement of the MYR for international trade in goods and services(for more details， see FX Alert - Malaysian ringgit， 19 August 2010， ‘ MYR– More details on FX liberalisation’).Who could be the next in line?As we consider other potential currencies which could potentially be quoted in China and vice versa， we note that the Chinese authorities so far have concentrated on the currencies of major trading partners， or which are major components of the international financial system. The USD， EUR and JPY easily fit both criteria; Hong Kong also has a large natural total trade exposure， with the sum of its total exports and imports since the beginning of 2008 following close behind G3. The driving force behind China’s ambitions to allow use of the CNY for trade settlement is to promote trade and mitigate the costs of foreign exchange volatility.Table 1 list China’s largest trading partners. Based solely on trading patterns， China may have an interest in having the Korean won (KRW) and Taiwan dollar (TWD) traded on CFETS and allowing offshore CNY trading in Korea and Taiwan. This could be followed by AUD， SGD， and Indian rupee (INR). Currently， trade between China and these economies is typically settled in USD. Hence， China and these economies could benefit from settling trade in CNY or their domestic currencies.Another consideration for offshore trading of the CNY， and for which currencies could be traded on the CFETS， is current offshore trading of the CNY and the interests of other countries in allowing offshore trading of their currencies. Table 2 lists the countries with the largest average daily turnover of USD-CNY. Note that this is based on data from April 2010， before the CNY deliverable in Hong Kong (CNH) market was created in July. The data clearly illustrates Singapore’s role as a major financial centre for CNY trading， alongside China and Hong Kong.A key issue is whether a country will allow its currency to be traded offshore. Given that the KRW and the TWD are not currently allowed to be traded offshore on a deliverable basis， the Korean and Taiwanese authorities may be more reluctant to allow their currencies to be traded in China. In addition， the Korean and Taiwanese authorities may have limited interest in allowing the CNY to be traded in Korea and Taiwan. However， the success of the CNH market may present a challenge for Korean and Taiwanese authorities in the coming years.In the case of Taiwan， the need for a CNY-TWD clearing and settlement system is high on the agenda of cross strait relations. However， little progress appears to have been made so far. There could also be concerns about risks to TWD stability， a long-held policy objective of Taiwan’s central bank. Instead， Hong Kong may be a convenient and neutral position to facilitate CNYTWD clearing to facilitate CNYTWD clearing. (See On the Ground– 13 September 2010， ‘Taiwan –CNH challenges and opportunities’). In the case of Korea， it is possible that the CNY will be quoted in Korea before the KRW is quoted in China.The bottom line is that although Korea and Taiwan are substantially larger trading partners for China than Singapore and Australia， the SGD and AUD may be quoted on the CFETS before the KRW and TWD. Singapore’s role as a centre for foreign exchange trading and its relatively deep financial markets increase the likelihood of the CNY deliverable being quoted in Singapore and the SGD being traded on the CFETS. In addition， the SGD and AUD are deliverable currencies， which imply that the authorities are likely to be more tolerant of offshore trading of their currencies whereas Korean and Taiwanese authorities may be more reluctant.Where are we with CNY settlement?China has clearly been accelerating steps to promote settlement of trade in the CNY， in particular with other developing countries. As of Q3-2010， the value of international transactions settled in CNY totalled CNY 126.5bn， up from CNY 48.65bn in Q2 – a rise of 160% (see Table 3).Table 4 lists the percentage share of China’s 2010 total trade， exports and imports in 2010 settled in CNY. It shows that China’s imports are increasingly being settled in CNY， while the amount of Chinese exports settled in CNY remains relatively small. This may partly reflect China’s trading pattern –exports to the US and EU account for 38% of the total， whereas imports from the US and the EU only account for 19% of China’s total imports. US and(to some extent) European corporates that currently settle trade with China in their domestic currencies are likely to be less willing to shift to trade settlement in the CNY than Asian corporates that currently settle trade with China in a third currency， the USD.Another explanation may be the limited eligibility of Chinese exporters to participate in the trade settlement scheme， compared to Chinese importers. For a Chinese exporter to invoice in CNY， it must be a Mainland Designated Enterprise (MDE). An approved MDE can settle exports and imports in CNY whereas a non-MDE can still settle imports in CNY but not exports. On 6 December， the PBoC expanded the number of MDEs to 67，359 from 365 and with CNH liquidity gradually improving in Hong Kong， offshore corporates should be able to source CNY to pay for their imports from China. A bigger hindrance (for now at least) may be whether overseas banks are quick enough to open nostro accounts and start providing CNH services to offshore corporates. However， as the number of MDEs expands and as offshore CNY liquidity gradually improves， the amounts of exports settled in CNY will increase.Implications for CNY managementThe question arise what this imply for CNY management. Does the fact that China is now quoted against an increasing number of currencies imply that CNY is moving to 1) a wider trading bands for all deliverable currencies， including the USD and 2) that the CNY will increasingly be managed according to a nominal effective exchange rate (NEER)? Currently， the daily trading band for USD-CNY is +/- 0.5% relative to the central parity fixings.EUR-CNY， GBP-CNY， CNYJPY and CNY-HKD have a daily trading band of +/- 3% relative to the central parity fixings; and MYR-CNY and CNY-RUB are allowed to rise or fall 5% compared to their central parity fixings. The central parity fixings of CNY against EUR， JPY， GBP and HKD are derived by the central parity fixings of USD-CNY and the cross rates. The central parity fixings of CNY against MYR and RUB are based on prices from liquidity providers in MYR and RUB.Chart 1 and Chart 2 illustrates the daily percentage changes for the different currencies which the CNY is quoted against. For simplicity， we compare the daily changes to New York closing levels rather than to central parity fixings. Since China depegged the CNY from the USD on 21 July 2005， the number of occasions where the daily changes in EURCNY， GBP-CNY and JPY-CN Y have been beyond 3% are 2， 7 and 9 times， respectively. The daily changes in HK D-CN Y and CNY-MYR have never been more than 3% and 5% respectively whereas the daily change in CNYRUB has on one occasion been more than 5%.As such， the fact that the CNY is now quoted against an increasing number of currencies may have limited short-term impact on CNY management as long as the daily trading band for the CNY versus non-USD currencies are relatively wide. There is still limited evidence that the CNY NEER is driving CNY management and the increased number of currencies which the CNY is quoted against may not have much impact on this in the near term.(Authors:Economists Standard Chartered Bank)