china offshore market financial personnel

8/18/2019 China Offshore Market Financial Personnel

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CHINA’S OFFSHORE RMB MARKETAN OVERVIEW FOR MANAGERS ANDFINANCIAL PERSONNELBy Daniel Joseph, PNC’s International Treasury Management group

PNC offers a library of materialsdesigned to bring managers andnancial personnel in operatingcompanies up to speed relative to therecent development of the offshore RMBmarket. This library addresses:

What has changed and where thingsstand now

How the changes will impact/benetforeign companies

Why China has made these changesWhat developments you can expect inthe future

Prior to 2009, China’s currency, the renminbi (RMB),could only be used within China; cross-border owof the RMB was effectively prohibited. In 2009,China began changing regulations so as to facilitatethe development of an “offshore” RMB marketwhich effectively means RMB can be held outsideof China and can ow in and out of China for thepayment for goods and services and for certaininvestment purposes.

Over the short-term, this change can havea signicant impact on almost all nancialtransactions relative to China including thoserelated to sourcing, exporting or the movementof investment capital. Over the long-term, if seenas part of China’s overall currency and nancialliberalization program, the impact of the recentchanges is likely to be signicant not only forindividual companies but for the global nancialsystem and global economy.

EXECUTIVE SUMMARYThis paper describes the changes that haveoccurred including changes relative to the followingaspects of the RMB market:

Trade: Trade in goods and services in and outof China can be settled in RMB. Trade nancemethods are available in both onshore and offshore

markets.Accounts: RMB accounts can be opened outside ofChina, primarily in Hong Kong (HK) but also in othe jurisdictions. Foreign companies do not need tohave a legal entity established in China (or HK) inorder to open an offshore RMB account.

Capital Markets: A capital market (bonds, equities,etc.), referred to as the “Dim Sum” market, hasdeveloped to permit RMB held offshore to beinvested. Channels exist to raise CNH in Hong Kongand use it in the mainland. Hedging products arealso available and under development.

Exchange rates: CNH is freely traded in HK,although the exchange rate has so far mostlytracked that of CNY which is controlled by theChinese government.

WHAT CHANGES HAVE OCCURRED RELATIVTHE RMB?Some call it “yuan.” Others call it “RMB.” Traderscall it “CNY,” unless it’s offshore, in which caseit’s “CNH,” at least until it moves back onshore, at

which point it becomes CNY again (or does it?), allthe while having never lost its true identity, whichis RMB. Confused? Wondering who’s on rst andwhat’s on second? The good news is that, if you dobusiness in China, you’re probably already used tothat feeling.

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INTERNATIONAL SERVICES WHITE PAPER


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WHAT HAS CHANGED IN CHINA’S OFFSHORE RMB MARKET

Like many things in China, the currency systemis unique, unusual, and a bit more complicatedthan one would expect. Yet, also like many thingsin China, if you look beneath the surface andunderstand how and why China does what it does,it actually makes sense, at least more sense thanit does at rst glance.

The table on page 7 addresses the linguisticsource of confusion (which actually doesn’t exist ifyou speak Chinese). This document will attemptto explain the confusion created by the new “CNH”designation. Perhaps the best place to start wouldbe a comparison.

When China rst started to make the transitionfrom communism to capitalism in 1978, it didn’tchange the rules throughout the country. Rather,it started with one geographic area, Shenzhen, just north of Hong Kong, where it established a“special economic zone” (SEZ) that could engage inmarket-oriented economic activities that were notpermitted elsewhere. After testing and tweakingthe new rules in Shenzhen, China created SEZ’s in

a few more cities, and then a few more cities, anda few more after that until, 15 years or so later, theentire country was basically a SEZ.

Deng Xiaoping, China’s paramount leaderfrom 1978 – 1994 and chief architect of China’sliberalization program, used the idiom “Crossingthe river by feeling the stones” (muo zhi shi tou)to describe this gradual, step-by-step, trial-and-error approach to changing China’s economicsystem. Many, indeed most, aspects of China’seconomy, from price controls to agriculture to

equity markets, have undergone transitions in asimilar fashion.

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Perhaps the best way to understand the creation of theCNH market is that China has established Hong Kongas a “Special RMB Zone” with the possibility (perhapsprobability) of gradually evolving the rules until the RMBis fully convertible like other international currencies.

MILESTONES IN THE CNH MARKET

July, 2005: China allows RMB toappreciate.

July, 2008: After appreciating by 21%

against the USD since July, 2005, RMBpeg to USD reinstated due to globalnancial crisis.

June, 2009: Pilot offshore RMBprogram established covering tradeamong 359 companies (referred to as“Mainland Designated Enterprises” or“MDE”) from 5 Chinese cities and HKand Macau.

June, 2010: Cross-border settlement

program extended to 20 provinces andall foreign countries. Also expanded tocover services.

July, 2010: China again allows thecurrency to appreciate.

July, 2010: First Dim Sum bond fromnon-nancial Chinese issuer.

August, 2010: First Dim Sum bondissued by a foreign enterprise.

December, 2010: MDE list expandedfrom 359 to roughly 67,000.

April, 2011: First CNH IPO issued inHong Kong.

June, 2011: Use of CNH for settlementreaches 10% of China’s totalmerchandise trade. CNH deposits inHK reach 554 billion (approx. USD 90billion).

March, 2012: Announcement thatMainland Designated Enterprise (MDE)list will be eliminated in near future.


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The box on page 2 lists some of the milestonesin the development of the offshore RMB (i.e.,CNH) market over the last few years. In additionto obviously following the “crossing the river…”pattern, the other notable aspect of the programhas been its comprehensiveness. Imports andexports. Goods and services. Accounts andcash management. Trading and hedging. Debtand equity capital markets. The new offshoresystem applies to just about everything one cando with a currency. Granted, the CNH market isfar from fully developed. Some activities are stilloff-limits and the mechanisms for conductingtransactions are not yet fully developed. But formost foreign companies, dealing in CNH is goingto feel more like dealing with other fully liberalizedcurrencies (EUR, JPY, etc.) than dealing in CNY.This is a welcome and positive development. For

those looking to the future, the fact that Chinaseems to be building a balanced, well-roundedoffshore market that is actually user-friendly andadvantageous enough to encourage both Chineseand foreign companies to participate, is perhapsa positive sign that China is serious about gettingthis right.

WHERE DO THINGS STAND NOW?The table on page 7 provides a brief description ofwhere things stand currently (as of 12/31/2012).

Trade SettlementTrade is almost completely liberalized and is the mostliberalized part of CNH market.

Settling trade with China (imports and exports)is easily the most developed aspect of the CNHmarket. At this point virtually all imports andexports related to China can be settled in CNH,including both goods and services. For foreigncompanies exporting to or importing fromChina, CNH is very likely already an option worthconsidering, perhaps on its way to becoming abusiness requirement. The latest change to thetrade settlement rules is the planned eliminationof the MDE designation which is described below.

Trade nanceSwitching to CNH does not require any change intrade nance methods.

For those trading with China, prior to the creation

of the offshore RMB market, letters of credit andother such common trade nance methods were,for the most part, available not only in foreigncurrencies but also in CNY. The CNH market alsooffers access to the same range of products, withCNH denominated letters of credit being one ofthe fastest growing asset classes in the new CNHmarket in HK. For foreign businesses switchingto CNH there should be no need to alter the type oftrade nance that may have been used previously.The only requirement is to nd a bank that canissue or settle letters of credit in CNH which is notgenerally difcult to nd.

MDE List to be EliminatedThe Mainland Designated Enterprise status was usedto control the number of Chinese companies dealingin CNH. The MDE status has been phased out whicheliminates a bothersome administrative step.

When the CNH market was initiated in 2009,China instituted a requirement that Chineseexporters who wished to receive RMB had to applyfor a special designation which it referred to as“Mainland Designated Enterprise” status. Chinathen controlled expansion of the offshore marketby controlling the number of Chinese companieswith MDE status. By December of 2010, Chinahad expanded the MDE list to almost 70,000companies, which China said represented roughly90% of China’s trade.

In March of 2012, China announced that the MDElist will be replaced by a “surveillance list.” Thiswill be a list of Chinese companies that cannotparticipate in the CNH market because of nancialconcerns that might be related to taxes, solvency,etc. It is expected that the surveillance list,focused on those excluded as opposed to thoseincluded, will be a much smaller list and thatthis move in effect throws open the CNH marketto all Chinese companies. It will also eliminatea bothersome administrative burden for foreigncompanies.

AccountsMost CNH accounts are held in Hong Kong. Otherrecently created options include overseas branchesof Chinese banks and Non-Resident Accounts withinChina.

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For foreign companies that have two-way tradeows with China, opening a CNH account could bea logical step in terms of netting cash ows andutilizing the natural hedge that exists under suchconditions.

There are actually several new ways to open RMB

accounts that have emerged since the offshoreprogram began in 2009. Brief descriptions follow:

CNH accounts in Hong Kong are probably the easiestoption now. Most CNH accounts that exist todate have been opened in Hong Kong due to theterritory’s status as the primary clearing centerfor HK transactions. CNH accounts can be openedat both foreign and Chinese banks with branchesin HK.

CNH accounts with the overseas branches of ChineseBanks are less common as Hong Kong is more directand accounts can be opened with a foreign bank. CNHaccounts can also be opened with the overseasbranches of Chinese banks, such as the NewYork branches of the Bank of China, Industrial &Commerce Bank of China, etc. Any transactionsconducted via such accounts will be routed throughHong Kong. In practice, the decision as to whereto open the CNH account comes down to a foreigncompany’s preference to work with a foreign bankwith branches in HK or the overseas branch of aChinese bank.

Non-Resident AccountsDue to administrative burdens, there are relativelyfew of these accounts.

In the past, only companies with legal entitiesestablished in China could open a bank account inChina. The NRA is an account opened by a foreignentity that does not have a legal entity establishedin China. Funds in an NRA can be used to settletransactions in China. The administrative burdenis fairly high such that it can be difcult to managean NRA without having personnel on the ground

in China (in which case you would likely have alegal entity in China and could open a regular bankaccount). NRA’s have proved to be far less popularthan CNH accounts in HK.

FX Trading and Exchange RatesUnlike CNY, CNH is freely traded. Yet it tends to trathe CNY exchange rate because generally CNH has become CNY again to be used. However, signicantdeviations between CNY-USD and CNH-USD rateshave occurred and might be indicative of futuretrends.

The Chinese government maintains a tradingband in order to control the exchange rate in theonshore market (CNY). This band does not applyto CNH which means that CNH is freely tradedand market-priced in HK. However, becauseChina continues to tightly control how CNH canbe repatriated to the onshore market, and usesoutside of China remain limited, we can expectCNH to trade close to the CNY value over the nearterm because holders of CNH know that ultimatelythey will have to use it at the CNY value.

Having said the above it should also be notedthat signicant deviations have already occurredbetween the CNY-USD value and the CNH-USDvalue, suggesting that, over the longer term, theCNH market will be a catalyst for a more free-market orientation for the RMB (see below for

more on this topic).

Also worth mentioning is that the People’s Bankof China (PBOC; China’s central bank) recentlyannounced that the trading band for the USD-CNYvalue has been widened from +/- 0.5% per dayto +/- 1% per day. The announcement includedseveral other small regulatory changes thattogether would seem to constitute another smallbut important step toward making the RMB afreely-traded currency and also suggests that,even in the shorter term, greater volatility in the

CNY-USD exchange rate is possible.

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Foreign companies do not need to open a CNH accountin order to make or receive CNH payments. A bank withCNH capability can make the USD-CNH exchange onthe way in or out of China such that the foreign companydoes not have to actually hold the CNH in an account.



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HedgingThe ability to hedge directly (i.e., DF instead of NDF),in a freely traded market, should in the end make theCNH hedging market more exible and cost-effective.

Prior to the development of the offshore market,there was no way to directly hedge RMB fromoutside of China. Instead, a hedging productknown as a “Non-Deliverable Forward” (NDF)had to be used (see box on the right). Due to thelack of restrictions in the CNH market, a broaderarray of hedging products is available, includingdeliverable forwards (DF). As a direct hedge, a DFcontract is likely to be less expensive for foreigncompanies than a comparable NDF which meansformal hedging will be more affordable for foreigncompanies.

For currency markets in general, and for hedgingproducts (forwards, options, etc.) in particular,the more volume in the market the better, as itis easier to match buyers with sellers. The CNHmarket, while having fewer restrictions in termsof regulations, is still relatively early in terms ofdeveloping volume. At this point the market isfairly liquid out to 1 year, but needs to build morevolume to be able to support a greater varietyof hedging products at longer durations. Giventrends relative to the growth of the RMB market,it would seem only a matter of time before longerduration hedges are more readily attainable.

Capital MarketsForeign corporations can issue bonds in the CNHmarket. CNH IPO’s have occurred, but only byChinese companies thus far. Borrowing CNH frombanks in HK to be used in mainland China remainshighly restricted.

Technically, China could have liberalized crossborder payments in RMB without supporting thecreation of an offshore RMB capital market. Butthat would have been short-sighted. Without

opportunities to invest RMB offshore, there wouldhave been no incentive to hold RMB in offshoreaccounts which would have severely limitedthe attractiveness of the entire offshore RMBproposition.

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FORWARD CONTRACTS: DF VS. NDF

Forward contract: Buyer (seller) of the forwardcontract agrees to buy (sell) a certain amount ofa currency at a specic value at a specic date inthe future. For example, a contract to buy RMB 1million in 90 days at a rate of 1 USD to 6.23 RMB.The forward contract is designed to protect theparties involved against unanticipated changesin the exchange rate. Two important distinctionsamong forward contracts are whether they are“deliverable” or not. The main difference is asfollows:

Deliverable Forward (DF): When the contractcomes due, the buyer actually uses thedesignated currency (for this example, USD)

to buy the purchased currency (RMB); buyeractually takes delivery of the purchased currency(RMB).

Non-Deliverable Forward (NDF): Used insituations where currency restrictions make itimpossible for the buyer to actually take deliveryof the purchased currency. Often used whendealing with the currencies of China, India,Brazil and other emerging markets. Whenthe contract comes due, instead of the buyerreceiving the purchased currency, the buyer

receives (or has to pay), in USD, the gain (orloss) that occurred due to any movement inthe exchange rate. Using the same exampledescribed above, if the USD-RMB exchangerate at the maturity of the forward contract was6.13 to 1 (as compared to the contract strikeprice of 6.23 to 1), the buyer of the contractwould receive $2,618.49 RMB 1MM/6.23 – RMB1MM/6.13), which would compensate for thechange in the exchange rate that occurred afterthe initiation of the forward contract.



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China has yet to signal a willingness to allo

CNH to be borrowed from banks in HK foruse in the mainland. This will likely happeover time and it will be worthwhile to keepan eye out for steps in this direction.

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These materials were prepared for general information purpo ses only and are not intended as legal, tax or accounting advice o r as recommendations to engage in any specic trans action,including with respect to any securities of PNC, and do not purport to be comprehensive. Under no circumstances should any information contained in these materials be used orconsidered as an offer or commitment, or a solicitation of an offer or commitment to participate in any particular transaction or strategy. Any reliance upon such information is solelyand exclusively at your own risk. Please consult your own counsel, accountant or other advisor regarding you specic situation. Any opinions expressed in these materials are subject tochange without notice.

PNC is a registered mark of The PNC Financial Services Group, Inc.

© 2013 The PNC Financial Services Group, Inc. All rights reserved.

“Dim Sum” is the nickname that has been given tothe capital market activities denominated in CNHin HK. The Dim Sum bond market is theoreticallyopen to any issuer, although, if the proceeds are tobe used in China, permission must be obtained totransfer the funds across the border.

To date the Chinese government and Chinesebanks have been the most frequent issuers in theDim Sum bond market, but there have been many

corporate issuers as well. The corporate spacehas been dominated by Chinese companies butalso includes foreign rms such as McDonald’sand Caterpillar.

Recent coupon rates have been in the 3-4%range which compares favorably to the primaryalternative RMB credit source for foreigncompanies, bank loans within China, for which thebenchmark lending rate has recently been roughly6.5%. Certainly for any large corporate alreadyactive in the bond market with funding needs inChina, the CNH market is worth consideration asan alternative to bank loans in China.

For foreign companies interested in bank debt, itwill be worthwhile to follow developments relativeto RMB bank loans in HK. Banks in HK can lendRMB. The borrower has to obtain permission totransfer the funds to the mainland. Any such RMBtransferred into China has to meet all of China’sexisting regulations relative to borrowing and theuse of capital for foreign enterprises in China.While such transactions have been approved, itwould be an overstatement to say that this channel

is wide open. Given the restrictions and challengesrelative to the Chinese banking environment, thepossibility of foreign banks entering the RMB loanmarket via HK holds the promise of better creditalternatives for foreign companies. Use of thisfunding option will likely broaden over time and itwill be worthwhile to keep an eye out for steps inthis direction.

Recent steps taken to broaden the CNH capitalmarket include increasing the amount of offshorecapital that can be invested in China’s onshorecapital markets (the “Renminbi Qualied ForeignInstitutional Investor” program (R-QFII), whichis further evidence that China is committed tomaking it attractive to hold RMB offshore.

ABOUT THE AUTHORDan Joseph is an international cash consultantwithin PNC’s International Treasury Managementgroup. Prior to joining PNC, Dan lived in Chinafor 12 years and has been doing businessthere for almost two decades. He has directexperience in sourcing, market development, FDI,manufacturing, and banking in China and is uentin Mandarin Chinese.

For more information please contact yourRelationship Manager or Dan Joseph [email protected] or visit pnc.com/ideas.

China’s commitment to supporting an offshore capitalmarket can be taken as yet another sign that, althoughthe CNH market started small, from the outset China hasbeen committed to developing a balanced, well-roundedoffshore market that could serve as a natural steppingstone to a fully liberalized currency.



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