Jun. 22, 2013 (TSR) – As another nail to U.S. dollar hegemony coffin, Zhou Xiaochuan, governor of People’s Bank of China (PBoC) and Mervyn King, governor of Bank of England (BoE) have signed an agreement to establish a reciprocal 3-year sterling/renminbi (RMB, or Chinese yuan) currency swap line, according to an announcement on the BoE’ website on Saturday night.
The maximum value of the swap is RMB 200 billion Chinese yuan/20 billion pounds. The swap line may be used to promote bilateral trade between the two countries and to support domestic financial stability should market conditions warrant, said BoE.
The Bank of England has long been hesitant to launch currency swaps with other countries. It has such arrangements only with the U.S. Federal Reserve and the European Central Bank, deals that were signed after the financial crisis.
It is the first deal of its kind between China and London, the first city in a G7 country to do so. Thus, this deal marks a breakthrough for the yuan.
Commenting, the Governor of the Bank of England said: “It is a testament to the outstanding working relationships between the Bank of England and the People’s Bank of China (PBoC) that this swap line has now been signed. The establishment of a sterling/renminbi swap line will support UK domestic financial stability.
The long-anticipated deal, signed by Bank of England governor Mervyn King and People’s Bank of China chief Zhou Xiaochuan, means the banks can draw on each other’s currencies directly in the event of a sudden shortage on the markets.
Shortages can occur because China restricts the flow of its currency overseas.
“In the unlikely event that a generalised shortage of offshore renminbi liquidity emerges, the Bank will have the capability to facilitate renminbi liquidity to eligible institutions in the UK. On behalf of the Bank, I am grateful to Governor Zhou and the staff at the PBoC, with whom it has been a pleasure to work,” he added.
The finalised agreement is merely ceremonial as the the Bank of England and the People’s Bank of China already agreed to facilitate discussions since 22 February 2013 during Governor Zhou Xiaochuan’s meeting with Governor Mervyn King in Beijing. They both agreed to collaborate and sign the final agreement thereafter.
Last year, Britain’s treasury announced plans to make London the leading international center for trading the yuan outside the Chinese mainland and Hong Kong.
But London has been slow compared some of its major competitors. As the world’s biggest currency-trading center, accounting for about a third of global flows, London is competing against Singapore, Tokyo and a handful of other financial capitals to capture growing demand for the yuan.
In 2010, Singapore signed a 150 billion yuan currency swap agreement with People’s Bank of China, the central bank.
Clearing banks for yuan settlement were already established in Taipei and Singapore in 2012, boosting the cities’ status in international yuan trade.
Despite yuan transactions in London growing to the second largest in the world in 2012, trailing only Hong Kong, settlement still has to be made through the clearing bank in Hong Kong.
A few days after the Chinese government decided to loosen some restrictions on trading of the currency, the City of London Corp. formed a working group in 2012 with five leading banks (Bank of China, Barclays PLC, Deutsche Bank AG, HSBC Holdings PLC and Standard Chartered PLC) as well as the U.K. Treasury, the Bank of England and the Financial Services Authority to support growth of yuan business in the city.
Consequently, the City of London Corp. initiative on London as a centre for renminbi (RMB) business was launched on 18 April 2012 to provide leadership to the wider financial markets on technical, infrastructure and regulatory issues, to advise the U.K. Treasury on maximizing London’s capacity to trade, clear and settle renminbi and to articulate practical next steps and long-term aims for the further development of the market in London.
London’s bid came as HSBC was considering issuing its first international yuan-denominated bond, or so-called dim-sum bond, to attract more interest from European investors.
Other U.K. banks are also hoping to become leaders in dim-sum bonds in London, given the overall dim sum market tripled in size last year to $16.8 billion, according to the Hong Kong Monetary Authority.
In addition to setting up the working group, London also published a report quantifying the city’s current capabilities as an offshore center for renminbi business, providing a base line for the future growth of the market.
London’s efforts to boost yuan business started in September 2011 when then Chinese vice-premier Wang Qishan, in his meetings with George Osborne, the British Chancellor of the Exchequer, welcomed private-sector initiatives for the development of an offshore renminbi market in London.
In the first half of 2012, the use of yuan for trade settlement in London increased by 390 percent year-on-year to 2.2 billion yuan. London also saw a few yuan bond issues in 2012 including one by HSBC bank and another by China Construction Bank.
The report into London’s current capability as an offshore yuan center found that London is already a growing center for renminbi business, especially for corporate clients. Overall, London’s share of spot Chinese yuan trading already represents 26% of the global offshore spot yuan foreign-exchange market, with an estimated $680 million traded through London on average every day.
The Redback is making great impressive and deliberate strides since 2008
China has made similar agreements with more than 22 countries, including the Republic of Korea, Malaysia and New Zealand, with total capital amounting to over 1.7 trillion yuan, in a bid to promote the use of the yuan in global trade and investment.
Currency swap agreements started in the 1970s between trading institutes, which used them to hedge the risk of foreign exchange fluctuations and lower the cost of borrowing. Now it is widely used by various central banks to facilitate regional financial cooperation.
There are now more than 10,000 financial institutions doing business in the currency, the pool of offshore yuan is swelling rapidly and cross-border capital flows are surging.
Internally, China is also speeding up reform steps to make its financial markets function more effectively.
On the equity market, for example, Chinese regulators have suspended new IPOs since November to address rampant poor accounting quality and fraud.
The following is a list of similar agreements and measures passed since 2008:
The PBOC and the Bank of Korea announced the establishment of a bilateral currency swap arrangement for up to 180 billion yuan, or 38 trillion South Korean won, in December 2008. The agreement was followed later in the year by a currency swap pact between the PBOC and the Monetary Authority of Hong Kong.
The PBOC launched an 80-billion-yuan (40 billion Malaysian ringgit) currency swap arrangement with Malaysia in February 2009 to promote bilateral trade, as well as inked a similar agreement with Bank Indonesia in March to provide short-term liquidity for the stabilization of financial markets.
The State Council, or China’s cabinet, in April 2009 announced a pilot program to allow exporters and importers in selected Chinese mainland cities to settle cross-border trade deals in yuan with economic entities in Hong Kong, Macao and regional trade partners, such as the Association of Southeast Asian Nations (ASEAN).
In June 2010, China expanded the pilot program to most of the country, as well as allowed it to cover trade with any country.
In 2010, a bilateral currency swap arrangement was launched by China’s central bank and the financial authorities of Singapore with an amount totaling 150 billion yuan, or 30 billion Singapore dollars.
On June 9, 2010, Iceland’s central bank, Sedlabanki, signed a currency swap agreement with China worth 66 billion krona ($500 million). The country was seeking to improve access to foreign currency since the country’s banking sector collapsed in October 2008, leading to an economic rout and a depreciation in the krona. The agreement with the People’s Bank of China has a three-year maturity and can be extended if both parties agree.
The PBOC and the Reserve Bank of New Zealand announced a currency swap arrangement with an effective period of three years in April 2011.
In June 2011, the PBOC signed a bilateral local currency settlement agreement with the Central Bank of the Russian Federation under which economic entities from both countries are able to conduct settlements and payments using either yuan or rubles.
In 2012, the PBOC signed bilateral local currency swap agreements with the Reserve Bank of Australia and the National Bank of the Ukraine, respectively, for the purpose of promoting bilateral financial cooperation.
Efforts to globalize the yuan have also been made by Hong Kong and Singapore, which are both offshore yuan centers, offsetting the fact that the yuan is not a fully convertible currency.
On August 31st, 2012, Taiwan and the People’s Republic of China signed an agreement on currency swap, notably the memorandum on Currency Clearing Cooperation across the Straits, which came into force on November 1st, 2012, after three years of negotiations . This historical agreement between the two countries counts as a landmark for their future economic relations. Already today, China is Taiwan’s first trade partner, while Taiwan is one of the most important Foreign Direct Investment (FDI) contributors in China.
By the end of 2012, China had entered into currency swap arrangements with 19 trading partners, including Hong Kong, South Korea, Malaysia, Belarus, Indonesia, Argentina, Mongolia, Iceland, Singapore, New Zealand, Uzbekistan, Kazakhstan, Japan, Thailand, Pakistan, United Arab Emirates, Turkey, Australia, Brazil and Ukraine, involving a total amount of 2.01 trillion yuan (US$320.3 billion).
In 31 January 2013, a group of 15 banks signed an agreement to offer loans to Shenzhen’s new Qianhai enterprise zone, opening the door for offshore participation in China’s domestic lending market for the first time since 1949.
The Pearl River Delta, just over the border from Hong Kong, has long been the test bed for Chinese economic reform. Experiments which started in Shenzhen, ranging from the Mainland’s first Special Economic Zone in 1979 to renminbi trade settlement in 2009, have formed the foundations of China’s transformation.
Qianhai, formally known as the Qianhai Shenzhen-Hong Kong Modern Service Industries Cooperation Zone, is physically and economically a relatively small experiment: the development is just 15km² and media reports have indicated that inbound loans are likely to be limited to a total of RMB50 billion, but its impact is likely to be profound. The local authorities describe it as “a useful exploration for China to create a new opening up layout with a more open economic system”.
Not only will Hong Kong banks be allowed to extend commercial renminbi loans to Qianhai-based onshore Mainland entities, but the PBoC has also indicated that such loans will for the first time not be subject to the benchmark rates set by the central bank for all other loans in the rest of China.
The Shenzhen authorities are predicting that Qianhai will generate GDP of RMB150 billion by 2020, helped by the loosening of the capital account restrictions.
Anita Fung, CEO of HSBC Hong Kong said this year that when it is fully developed, Qianhai will form a bridge where the Mainland can try new accounting and legal measures, and a protected environment where international service industries can learn more about doing business in China.
“In financial terms, Qianhai presents a series of challenges and opportunities to banks on both sides of the border. HSBC believes that fears that the project will drain Hong Kong of RMB liquidity are misplaced,” she said.
“We believe that the Qianhai experiment will help boost both the RMB loan business and cross-border RMB liquidity. The cost of RMB loans in Hong Kong, currently between 4 and 5 per cent, is typically 100-200 basis points cheaper than on the Mainland,” she noted.
Qianhai offers a valuable hold in the Mainland markets for Hong Kong banks, and the new measure on cross-border lending will enhance the co-operation between Hong Kong and Shenzhen, the co-operation between Hong Kong and Guangdong, and accelerate cross-border convergence.
“Qianhai represents significant progress in China’s three-step programme towards full convertibility of the renminbi. The ongoing relaxation of capital controls, represented by Qianhai and the Renminbi Qualified Foreign Institutional Investor programme, signal that it is well on its way to becoming a global investment currency,” Fung said.
The total volume reaches 190 billion yuan, or 31 billion US dollars. Both countries are also vowing to increase financial cooperation to facilitate bilateral trade, and safeguard the stability of their respective financial systems.
In April, China and Australia has recently started with $30 billion direct trading of their currencies.
Yuan is also directly traded with the US dollar.
Luxembourg is also looking at the possibility of becoming offshore yuan hubs.
France is another major developed country trying to position itself as a major offshore yuan trading hub in Europe with plans to set up a currency swap line with China, China Daily has reported, quoting Bank of France Governor Christian Noyer.
“The Bank of France has been working on ways to develop a RMB liquidity safety net in the euro area with due consideration of a supporting currency swap agreement with the People’s Bank of China,” said Noyer, according to the report.
The facility will encourage the use of yen in trade settlement and investment in the euro area. Further, it will ensure the availability of yuan even in extreme situations.
The availability of a “liquidity safety net in RMB in the euro area” will further foster growth in RMB products and services in the eurozone, the governor added.
With the new arrangement, Paris is looking to compete with London in the yuan trade. The French capital currently has 10bn yuan ($1.6bn, £1bn) of deposits in the same currency, the second largest pool in Europe after London. Moreover, nearly 10 percent of trade between the countries is currently settled in yuan.
China’s efforts to turn the yuan into an international currency have accelerated in recent months.
Indeed, with China’s deliberate strategy, the renminbi (RMB) – the official currency of China – is poised and expected to join the US dollar and the euro as one of the world’s top three global trading currencies in terms of volume by the end of 2015, and within five years, it could be fully convertible as what HSBC London Chief anticipates.
