In the span of three weeks from late June to early July 2014, the central bank of the People’s Republic of China (PRC) appointed three new RMB clearing banks successively for London (China Construction Bank), Frankfurt (Bank of China), and Seoul (Bank of Communications). The three new clearing banks join the existing group of RMB clearing banks of the Industrial & Commercial Bank in Singapore: and the Bank of China for Hong Kong, China; Macao, China; and Taipei,China.
It has become increasingly apparent that the People’s Bank of China (PBOC) sees the internationalization of the RMB as unfolding through the creation of a global network of offshore RMB clearing banks, currency swap agreements, integrated e-infrastructure, and related regulatory underpinnings for backing-stopping the RMB transactions by market actors and official reserve managers.
The recent appointments of the clearing banks for Germany, the Republic of Korea (henceforth, Korea), and the UK received impetus from the delays in official PRC efforts to create the China Integrated Payments Systems for direct offshore-onshore payments and clearing with the mainland.
Big steps toward RMB internationalization
In the eyes of Beijing, London took two big steps forward in this global network for RMB internationalization when the PRC named China Construction Bank (CCB) as the RMB clearing bank for London in June, and subsequently authorized the China Foreign Exchange Trade System to launch direct trading between the RMB and the British pound on the interbank foreign exchange markets.1
London’s ambition, and that of the UK Treasury, is for the UK capital to be “a” hub for the international use of the RMB, the so-called “Western hub” for the RMB, including the European market and beyond.
However, London already had access to offshore-onshore RMB clearing through Hong Kong, China, and many of the leading London-based banks and PRC banks in London have well established RMB clearing arrangements in their networks that stretch back to the mainland, and so it remains to be seen what will be the impact of CCB receiving the official status for the UK from PBOC.
Much will also depend on CCB’s capacity to make the business case, especially for European-based traders and investors, to use CCB’s newly established clearing channel rather than going through existing channels in Singapore or Hong Kong, China.
Beyond the CCB, the most prominent banks in London—especially those geared to emerging markets, and have a strong presence in Hong Kong, China, and the Asian region—are looking beyond Europe, and eyeing how to link from London further westward to North America and South America, southward to Africa, and with the Gulf states in between—in short, to offer 24 hours a day, 7 days a week, RMB services. This is no small ambition.
London surely has some structural advantages. It is the largest foreign exchange trading market in the world, with an average daily turnover in traditional foreign exchange market transactions (spot transactions, outright forwards and FX swaps) totaling $4.4 trillion in October 2012.2 This accounted for 37% of global foreign exchange trading at that time. Twice as many dollars are traded on the foreign exchange market in the UK than in the US, and more than twice as many euros are traded in the UK than in all the euro-area countries combined. Worldwide, foreign exchange is the most traded financial market, and London has captured a growing share of this market.
London handled 62% of RMB trading3 conducted outside of the PRC and Hong Kong, China, in October 2013, according to data from SWIFT, the global payments company. At that time, volumes in London were around $5 billion per day, up from about $2.5 billion in October 2012. SWIFT data also shows, however, that Singapore regained the lead for RMB payments and offshore clearing (outside of Hong Kong, China) in February 2014, surpassing London. The value of RMB payments rose by 375% from March 2013 to March 2014.
Nonetheless, many analysts suggest that London’s standing as the main global center for currency trading for the dollar and euro—strong asset management skills, highly developed financial e-infrastructure, strong rule of law, and legal systems, English as the language of business, its strengths in trading generated by prime brokerage, investment banking, and hedge funds—means that London will have a strong role to play in internationalizing the RMB outside of the PRC and Hong Kong, China.
The case for Frankfurt is compelling. The Bank of China in Frankfurt is situated in a context where real economy linkages between Germany and the PRC are deep and broad. A number of the leading German multinational corporations, including Volkswagen, are using RMB to settle a growing portion of their exports to the PRC. A large number of small and medium-sized German companies engaged in high value-added manufacturing and design, are looking to strengthen their partnerships with PRC counterparts—the RMB will likely feature as the currency for a portion of these transactions. The Bank of China in Frankfurt can tap into the BOC’s well-established RMB trade financing tools, e-infrastructure and related payments arrangements, and clearing channels for international use of the RMB, which include the bank’s ties to a plethora of domestic companies in the PRC.
A key variable for Frankfurt is whether Germany’s most powerful banks will opt to transact in RMB via Frankfurt, or whether they will prefer to operate through their London branch, or via Hong Kong, China’s established arrangements. London remains the transaction center for 250 foreign and UK-based banks; continues to handle the financial services for many European exporters and importers, including trade-related foreign exchange business for banks from other European powerhouses, including Germany.
The case of Seoul is most perplexing. Trade and investment between the PRC and Korea are high and continue to grow. The two economies are highly integrated. However, although Korean finance officials have approached RMB internationalization with the requisite political will, central bankers have been cautious (perhaps understandably) in introducing the technical arrangements to facilitate the growth of a pool of offshore RMB in the financial sector in Seoul. Perhaps most important, Korean traders and investors are hesitant about engaging in RMB-based transactions due to concerns about having ready access to a supply of RMB to settle trade accounts over the medium term. Dollar inertia is strong in the Korea case, despite the structural rationale for transitioning to a variety of international currency options.
Financial centers compete to create RMB infrastructure
Each financial center is now competing to create RMB-supportive banking infrastructure and regulation in the hopes of capturing a greater share of the profits as the RMB’s international use continues to grow. From a systemic perspective, rising competition between the financial centers competing as offshore RMB hubs could help generate new products and could induce more efficient regulation. At the same time, this competition could generate either inefficiencies in clearing arrangements, or even global financial stability concerns if the RMB centers clash over clearing arrangements or regulatory innovation—or end up in a race toward high risk financial innovation. Market actors have noted that the size of the pool of offshore RMB is a constraint, a source of liquidity concern for the offshore RMB hubs (except perhaps Hong Kong, China). The latest statement a few weeks ago in Shanghai from PRC officials was that the total pool of offshore RMB has grown to about RMB 1.5 trillion (about RMB 900 billion RMB in Hong Kong, China, and the rest mainly in London, Singapore and Taipei,China). However, the PRC maintains controls over the cross-border flow of RMB. Competition between the hubs on financial product innovation can go some way to helping to provide additional liquidity. As long as the various RMB hubs remain as segmented and discrete pools of RMB, rather than agglomerating into a globalized pool of offshore RMB—and the capital controls remain in place—then the liquidity concerns persist for many of the hubs.
A greater degree of coordination between the offshore hubs on clearing infrastructure and regulations—and with the PBOC—would help to facilitate the integration of the pools of offshore RMB into a larger global pool of RMB. It would also be helpful if the regulators could help steer the competition between the RMB hubs toward developing longer-term RMB-denominated investment products that can attract Asian pensions and other large-scale asset managers in need of long-duration products.
To the degree that we see significant advances in RMB transactions in London, Frankfurt, and Seoul—including the growth of a secondary market—and the continued growth of Singapore, Taipei,China, and other European financial centers and, of course, Hong Kong, China, as RMB platforms, then we are really talking about the globalizing of the RMB, in the sense that the geography of offshore and onshore RMB transactions are becoming increasingly global in scope, rather than merely cross-border (internationalized), or confined to the Asian region alone (regionalized).
1 The People’s Bank of China. 2014. www.pbc.gov.cn:8080/publish/english/955/index.html
2 TheCityUK. 2013. London increases lead in foreign exchange trading as global turnover drops 7%. 29 January.
3 Financial Times. 2013. Fed Explores Overhaul of Key Rate. 8 October