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January 26, 2010
The CNH market
• Ever since the global financial crisis, China is increasingly pushing for renminbi internationalization. Authorities are carefully building up avenues for circulation of the currency between onshore and offshore. Cross-border trade settlement in CNY is the cornerstone of these schemes, but portfolio flows and ODI are also being opened, be it at a very slow pace. • The CNH market, ie. the deliverable CNY market offshore in Hong Kong, is the most visible result of renminbi internationalization. CNH deposits in Hong Kong tripled last year, mainly on the back of cross-border trade, and are expected to rise further rapidly. CNH product development is growing fast, from a low base. Foreign investors and corporates can now access a variety of FX and rates CNH products. • This publication collects recent research notes on the CNH market. First, we explain how the avenues for CNH and CNY circulation fit together between onshore and offshore. Then, we make projections for growth in CNH deposits and trade settlement. Then, we categorize the FX and rates products that exist for foreign investors and corporates. Finally, we look at hedging and speculative opportunities available in the spot and forward CNH and CNY markets.
Chart: How CNY turns into CNH (and vice versa). For a larger version, see page 3.
Summary 1 How the CNH market fits in with RMB internationalization 2 Prospects of CNH business in Hong Kong 6 CNH and CNY products available for foreign corporates and investors 9 Opportunities in the spot and forward CNH market 11
Exchange traded bonds CNY DF
(852) 2800 8325 email@example.com
Exchange traded shares
Yen Ping Ho
(65) 6882 2216 firstname.lastname@example.org
Interbank bond market
Interbank bond mkt pilot program
(852) 2800 8329 email@example.com
HK residents and tourists
shareholder loan, equity capital injection, ('dim sum' bond proceeds)
Cross border trade
(852) 2800 7002 firstname.lastname@example.org
CCY swap lines
(86-21) 5200 2833 email@example.com
Other central banks
CNH bond market
Singapore, New York, London, ...
Source: JP Morgan Legend: Financial product Central Bank Corporate Bank Investor CNH market
CNH-CNY flow, or CNY-USD flow
The certifying analyst(s) is indicated by the notation “AC.” See last page of the report for analyst certification and important legal and regulatory disclosures.
Macau. Depositors were initially retail who wanted to hold some renminbi in a bank account. since mid-2009 cross-trade settlement picked up significantly. (4) Width and depth of the offshore RMB market is enhanced. The first three steps are meant to build up the circulation of RMB between onshore and offshore markets. Crossborder trade settlement in CNY is the cornerstone of these schemes. there is a clear strong link between the two. (2) RMB circulates offshore. This program was expanded in June 2010 to allow for RMB settlement between 365 corporates in 18 additional mainland provinces and all countries. PBoC lauched another pilot program of opening China interbank bond market for three kinds of overseas institutions. The five steps of RMB Internationalization Ever since the global financial crisis. and ASEAN. As a result. the number of mainland exporters that is allowed to particpate in cross border CNY settlement was raised to 67. When comparing the growth in trade settlement with CNH deposits in HK. Table 1: Milestones in RMB internationalization Date Jul-09 Jun-10 Jul-10 Aug-10 Jan-11 Program Pilot program of RMB trade settlement Step 2: RMB circulates offshore Banks in Hong Kong have been allowed to accept CNY deposits since 2003. In December 2010. and Hong Kong/Macau/ASEAN on the other hand. 2011 Asia Markets Research Simon Song (86-21) 5200 2833 Bert Gochet (852) 2800 8325 How the CNH market fits into the internationalization of the renminbi • China is carefully building up avenues for circulation of renminbi between offshore and onshore • The CNH market in Hong Kong is the most visible result of this process.J. The final two steps towards the opening the capital account are much more involved and have barely started. Details pilot program first launched in Shanghai and 4 cities of Guangdong province. the scope now covers services trade. be it at a very slow pace. nearly CNY 300bn has flowed out of China through net imports in the last year and a half. Amended Clearing agreement Pilot program for opening bond market Pilot program for RMB ODI settlement PBoC amended the Clearing Agreement with BoC (HK). the vast majority traded in Hong kong (and Singapore). Chart 2 on page 4 shows how deposit growth in the early days was off to a slow start.P. PBoC announces another pilot program which allows qualified corporates to settle in RMB in overseas direct investment (ODI). Pilot program expansion previous pilot program expanded to 18 additional provinces. and. finally (5) Capital account is opened. expanding the scope of RMB business and increasing flexibility in RMB-denominated financial services. but portfolio flows and ODI are also being opened. Mostly as a result of the RMB settlement pilot program. the scope for RMB trade settlement was expanded to cover not only trade in goods.359 from 365. (3) RMB returns to the Mainland.Morgan Securities (Asia Pacific) Ltd The CNH market January 26. and 80% was used for import of goods. but also to trade in services and other current account transactions. versus only 20% for export. These are relatively small steps towards RMB internationalization and have been implemented in Hong Kong as a test market that is available for a vaariety of counterparties and with certain quotas. for cross-border trades with all countries. We show how all the pieces of the CNH and CNY market fit together. Corporates in Shanghai and 4 cities of Guangdong province on the one hand. Also. and reached a cumulative total of about CNY 500bn at the end of 2010 (our estimates). China’s full process of RMB internationalization will proceed in five steps: (1) RMB leaves the Mainland. In addition. for cross-border trading with Hong Kong. deposit growth was slow as there was nothing you could really do with the RMB except keep it on deposit (at a very low deposit rate). China is increasingly pushing for renminbi internationalization. Until two years ago. Of this number. Authorities are carefully building up avenues for circulation of the currency between onshore and offshore. Step 1: RMB leaves the Mainland A so-called “pilot program” to allow direct settlement of RMB transactions for cross-border trade was launched in July 2009. Broadly speaking. and we can conclude that the main driver of deposit growth has been merchandise trade so far. 2 .
New York. equity capital injection.J.P. 2011 Asia Markets Research Simon Song (86-21) 5200 2833 Bert Gochet (852) 2800 8325 Chart 1: How CNY turns into CNH (and vice versa) China onshore CNY Exchange traded bonds CNY DF Corp Exchange traded shares PBOC Corp Interbank bond market Corp Interbank bond mkt pilot program HK residents and tourists Corp BoC shareholder loan.Morgan Securities (Asia Pacific) Ltd The CNH market January 26. ('dim sum' bond proceeds) Cross border trade Conversion quota QFII CCY swap lines ODI Corp Investor Corp Corp HKMA BoC(HK) Corp Participant bank CNY NDF Other central banks CNH Investor CNH bond market Corp Singapore.. CNH DF USD HK bank Hong Kong Offshore Source: JP Morgan Legend: Financial product Central Bank Corporate Bank Investor CNH market CNH-CNY flow. . or CNY-USD flow FDI 3 . London..
The pace of deposit growth over that period was broadly in line with the growth of China net imports settled in RMB. as long as they simply open a settlement account with BoC (HK). with CNY4bn for the first quarter.ie. Since mid-2010. expanding the scope of RMB business. In the days after the pilot progam announcement the access to RMB in HK was only available to a limited amount of counterparties. As part of that amendment. a de facto “central bank for RMB in Hong Kong”. and 4bn for 1Q11). he will need to purchase the CNH in the market or from his banker.has been able to do RMB business in HK. Since then. CNH deposits started ballooning. In July.J. The second is to let selected offshore banks buy onshore bonds. Interbank CNH deposits and CNH deliverable forwards started trading in the market. At the same time. 2011 Asia Markets Research Simon Song (86-21) 5200 2833 Bert Gochet (852) 2800 8325 Chart 2: RMB deposits in Hong Kong RMB deposits in Hong Kong bn yuan 300 250 200 150 100 50 0 2004 2005 2006 2007 2008 2009 2010 For the last six months. mutual funds. All their transactions are closely monitored by HKMA. Bank of China (HK) started to play a special role in controlling the flow of RMB in Hong Kong. “letting RMB enter back into the Mainland”. These limits were the topic of discussion late last year when it turned out that the CNY8bn conversion quota for 2010 had been exhausted ahead of year-end. Meanwhile. From chart 2 you can tell how deposits picked up pace from mid 2009. It was appointed as the clearing bank for all transactions in the territory. non-trade related transactions can only be squared in the CNH inter-bank market. In other words. After all. and depository institutions (for attracting deposits). the CNH liquidity in the Hong Kong market will become self sustainable and the quota approach will eventually be scrapped. 4 Step 3: RMB returns to Mainland For obvious reasons the third step in the internationalization of the currency. The 2009 pilot program for cross-border trade kicked CNH deposits up a notch. BoC(HK) thereby became the lender for all RMB transactions. Say for example. a mainland based importer can pay in CNH for as many imports as he likes. In addition. The first is through a “Mini QFII” program. But there is a restriction on clearing . It is believed that this will be sufficient for now. This flow of CNY out of China into CNH happens without quota. regardless of whether or not they relate to trade settlement. and also all RMB held by other banks was to be deposited with BoC. and is the main reason why CNH deposits in Hong kong have picked up so strongly in 2010. corporates were now allowed to open RMB accounts and transfer funds across accounts for any purpose. but the reverse is not true. goods and service trade in the current account were the main source of RMB in HK over that period. and insurance products. and the quota had already been filled. There are two different approaches that are being taken to make progress on this front. any retailer or corporateregardless of its country of domicile. holding RMB in HK became meaningful for exporters and importers. the pace of development stepped up another notch. there had been more demand for CNH from non-China based corporates than authorities had expected. Over time though. But there is improvement. such as CDs. subject to a quota (which was CNY8bn last year. . corporates (for trade settlement). The quota for this year has been increased. and for a well defined set of purposes: retail customers (for RMB deposits and bonds). ie. PBoC amended the Clearing Agreement with BoC (HK). and eventually that position will need to be squared via BoC(HK) subject to the conversion limits set by PBOC.banks can only square open positions of RMB with BoC(HK) for settlement of cross-border trade. banks were allowed to introduce RMB-linked products. But a non-China based buyer of Chinese goods is not necessarily guaranteed to be able to obtain CNH to pay for his purchases. This raises the important point that CNY can freely leave China and enter the CNH market as long as it is backed up by trade documents.P. deliverable forwards. albeit at a small scale. Deposits increased on the back of cross-border trade.has been the slowest step to develop so far. Effectively. During this initial stage.Morgan Securities (Asia Pacific) Ltd The CNH market January 26.
As far as we know. (2) the RMB clearing banks in HK and Macau. the bond investment needs an approval from PBoC. Under this scheme. the PBoC announced yet another pilot program which allows qualified corporates to settle overseas direct investment (ODI) in RMB. Last week. Fourth. but in our view it is too early for that to happen. those banks who are the participants in RMB cross-border trade settlement. In our understanding. and (3) “overseas participation banks” ie. only HKMA. In the future. each overseas institution can open only one RMB nostra account with one of the eligible onshore banks to do bond trades. HKMA officials have also hinted that this program is pending China’s top leaders’ approval. This is an important milestone in the opening of the capital account. bond. some officials have also started to suggest offshore companies use RMB for FDI too. The central banks and clearing banks would be able to access the Chinese interbank bond market directly or go through an agent bank such ICBC or BOC. 5 . but will be used for small size soon to kick off this program ). forward. They are unused so far. 2011. three kinds of overseas institutions will be allowed to buy bonds onshore: (1) central banks who are already in cooperation with PBoC (such as through a currency swap line). On Jan 13th. approval and setup of operations. The impact of this pilot program on the onshore markets (spot. First. Shang Fulin. this program will improve the circulation of RMB between onshore and offshore. although ODI settled in RMB will still need approval on a one-off basis. BNM and ICBC (Asia) have received an approval so far. Third and perhaps most important. but on a trial basis. Chinese media have reported on Mini QFII several times since last year. This channel can be considered the first tentative step toward an “eventual” opening of the capital account. Step 5: Opening of capital account Opening the capital account will be the last and most cautious step of the internationalization of RMB. and link together the RMB markets in the Mainland and HK. since time is needed for application. Secondly. USD gets echanged for CNY and invested in mainland exchange traded products). this would not be more than a few billion CNY to start. etc) is limited in the near term. The second approach is letting selected offshore institutions buy CNY bonds in the onshore interbank bond market. But even for this limited amount of institutions restrictions apply. as one would perhaps expect. or (2) cash from RMB cross-border trade by “participation banks”. 2011 Asia Markets Research Simon Song (86-21) 5200 2833 Bert Gochet (852) 2800 8325 The “Mini QFII” is a program would allow CNH funds flow back into capital markets in China (including A shares) through the channel of financial products provided by HKbased Chinese security firms and asset managers (Note that Mini QFII is different from the plain “QFII”: in the latter.P. the Chairman of CSRC again said that Mini QFII will be launched soon.J. a quota will apply. the source of RMB funds for the bond investment should be either (1) from currency swap lines with PBoC (note PBoC has opened up a total of CNY 800bn of swap lines with eight central banks since 2008.Morgan Securities (Asia Pacific) Ltd The CNH market January 26. however. But an official approval has been delayed by concerns about hot money flows. or (3) from proceeds from investing in RMB business. The participation banks will have to go through an agent bank and cannot access the interbank market directly. Lately.
While Hong Kong is special administrative region of China. “Internationalization of the Renminbi”.6-3. both the private sector and public sector. has been pushing harder for the progress of RMB internationalization since the crisis. Hong Kong’s role as offshore RMB centre For the private sector. RMB is set to play a bigger role in international trade and finance. Indonesia. FDI and portfolio flows Since the onset of the global financial crisis in 2008. it is well-recognised as a vibrant financial centre with free flow of international capital. Argentina. for both residents and non-residents. 2011 Asia Markets Research Grace Ng (852) 2800 7002 grace. an international currency has to play the roles of store of value. into the banking system outside of mainland China. along with PBoC policy liberalisation • Critical mass of offshore renminbi. public sector level. • Notable scope of RMB internationalisation through merchandise trade.P. It is not difficult to understand the Chinese authorities’ decision to explore and expand offshore RMB business in Hong Kong. As the financial crisis reveals the pitfalls of existing international monetary arrangements. March 2009. with the total amount of swap arrangments accumulating to more than 800 billion yuan. denominated in RMB. by Gao Haihong and YU Yongding. with central banks from other Asian and emerging economies. RMB internalisation has become an increasingly important policy target for the Chinese authorities. Malaysia. medium of exchange and an unit of account. which arises from real economic activities such as Chinese tourist spending overseas.5tri in five years time. particularly in Asia. including Korea. services. giving developing economies a bigger say in the new international financial order. since the onset of financial crisis. RMB internationalisation would help to reduce exchange rate risks for Chinese firms. the Hong Kong banking sector’s RMB deposit taking since early 2004 has been an early step to officially incorporate RMB circulating offshore.h. 6 . At the official. RMB deposits in Hong Kong bn yuan 300 250 200 150 100 50 0 2004 2005 2006 2007 2008 2009 2010 Hong Kong banking sector deposits HK$ bn 4000 3500 3000 2500 2000 1500 2004 2005 2006 2007 2008 2009 2010 Non HK$ deposits HK$ deposits Mainland visitor spending in Hong Kong HK$ bn 70 60 50 40 30 20 02 03 04 05 06 07 08 09 Total Mainland visitor spending Mainland visitor spending per capita HK$ 7000 6500 6000 5500 5000 4500 4000 In practice. will increase rapidly. In addition. China has signed a number of bilateral swap arrangements.Morgan Securities (Asia Pacific) Ltd The CNH market January 26. from China’s point of view. 1. Hong Kong. most of which likely residing in Hong Kong.ng@jpmorgan. especially the People’s Bank of China. In addition. strengthen the international competitiveness of Chinese financial instititutions (given their vast pool of RMB assets) and preserve the value of China’s international savings1. BOK-BIS Seminar.J. We forecast deposits in Hong Kong to rise to CNH 2. China joined other emerging countries to urge the International Monetary Fund to push ahead with reforms. and with almost half of bank deposits in the form of nonHK$ currencies. the Chinese government recognises that as China’s importance in the global economy and financial system increases. Against this background. Russia. etc. the Chinese government.com Prospects for CNH business in Hong Kong • The Chinese authorities have pushed harder for RMB internalisation since the global financial crisis • RMB deposits in Hong Kong jumped significantly last year.
6 21.3 0.000 Chinese corporates from 16 provinces and cities by December 2010. capital and financial account surpluses % of GDP 12 10 8 6 4 2 0 2004 2005 2006 2007 2008 2009 2010ytd Current account surplus Capital and financial account surplus 1-3Q 1-2Q China: merchandise trade US$ bn.9 USD 71. a relevant benchmark for comparison is the use of JPY in merchandise trade settlement by Japanese corporates. outstanding RMB deposit in the Hong Kong banking sector came in at 280 billion yuan. the overall scale of offshore RMB in Hong Kong is still very modest. which was then expanded in various stages to cover more than 67.2 11. figures on RMB trade settlement so far last year suggest the majority is done on the import front (third chart).6 7 .3 0.9% of of Hong Kong’s total M2 money supply.4 AUD 1. elvated “twin surpluses” in the BoP current account as well as capital and financial accout (first chart) cast some doubt on the prospect for expanding the international use of RMB.8 0. China’s sustained.2 0. In addition.0 0.3 0.4 CHF 0. However.9 49.0 71.0 0. and with growing expectations on yuan appreciation in recent months.1 48.3 0. On the current account. in addition to the likelihood that an increasing share of overseas spending by Chinese tourists could be transacted in RMB.8 GBP Others 0.3 0. allowing eligible institutions outside the mainland to use their RMB funds to invest in China’s domestic interbank bond market.1 0.Morgan Securities (Asia Pacific) Ltd The CNH market January 26. to rise rapidly in the coming years.0 26.1 0.6% of Hong Kong’s total M2 supply. Meanwhile.2 2.7 0.1 15. 2011 Asia Markets Research Grace Ng (852) 2800 7002 grace.com As of November 2010.6 0.3 CAD Others 0. outstanding RMB deposit in Hong Kong banks jumped by 212% since June 2010. Given the notable progress on policy liberalization.0 4. especially in the form of RMB deposits in Hong Kong.2 2.0 14.h.2 0. China: BoP current account. as China continues to amass foreign currency assets via the “twin surpluses” in the external accounts.2 0.J. there is significant scope for expanding the size of merchandise trade settlement in RMB.1 0.5% of total onshore yuan deposit in the mainland.0 0.7 JPY 41.7 78. in aggregate.8 EUR 6. 12mma 140 120 Exports Critical mass of offshore RMB rises rapidly So far. the PBoC introduced a pilot scheme in August 2010. there are good reasons to expect the critical mass of offshore RMB. however. equivalent to 3.6 85. While such figures could serve as a benchmark for 100 80 60 40 20 2004 2005 2006 2007 2008 2009 2010 Imports RMB cross border trade settlement RMB bn 200 150 100 50 0 1Q10 2010 3010 Imports to China Exports from China Japan: breakdown of currency used for trade settlement % share Exports from Japan Total exports To US To EU To Asia Imports to Japan Total imports From US From EU From Asia USD 48. especially starting from Chinese importers paying their import bills in RMB. as of end 2010. in practice it is indeed reasonable to perceive rather rapid increase in the use of RMB offshore. Despite the recent notable expansion. 41. and the ratio on the import front stands at 23.9 49. According to latest data gathered by our fx strategy team in Tokyo. Indeed.1 58.1 30.6% (table). the size of total RMB deposit in Hong Kong is equivalent to only 0.0% of Japan’s exports are now settled in JPY.P.3 0. the Chinese authorities introduced the RMB trade settlement scheme in July 2009.0 0.1 JPY 23. At the first glance.ng@jpmorgan. to reach 280 billion yuan by November.2 0. equivalent to 4.4 0. Going forward.6 EUR 3.4 28. To gauge the potential scope of RMB trade settlement.
• Assuming the share of China’s total imports settled in RMB will rise steadily towards 10% by 2015. and assuming average 10% annual growth in China’s imports.com the long term potential scope of RMB trade settlement.500 billion yuan in five years.J. the pool of total trade-related RMB deposits. for the medium term we have come up with more conservative scenario analysis regarding RMB trade settlement for the coming five years. the Qualified Domestic Institutional Investor (QDII) program. the pool of total trade-related RMB deposits in Hong Kong could potentially rise to as much as 3. The potential shift of every 1% of China’s domestic deposit to RMB-denominated investment products in the Hong Kong financial market would amount to the equivalent of 700 billion yuan. Indeed. along with a more modest share (up to 3%) of exports settled in RMB. which includes.111 billion as of November 2010. including non-Japan Asia. most of which will likely reside in Hong Kong. which would likely be keen to receive RMB for FDI-related transactions. This is a significant amount compared again the outstanding size of Hong Kong’s M2 money supply at HK$ 7.P. Part of this could be invested in RMB-denominated investment products offered in Hong Kong. China: imports from emerging economies US$ bn. with 87% going to the emerging market economies. • In an alternative scenario. and the fact that China has in general held a trade deficit with this group). Latin America and Africa. China could further open up avenues for domestic investors to invest overseas. In addition. but would not be restricted to. going further ahead.h. in order to diversify the investment channels for the private sector. with the focus on expanding RMB settlement on the import front at this early stage. that would see a notable rise in the share of their exports to China settled in RMB (given their closer economic ties with China.firstname.lastname@example.org billion yuan in five years. 12mma 60 50 40 30 20 10 0 2004 2005 2006 2007 2008 2009 2010 Africa Latin America Asia ex-Japan China: outward direct investment US$ bn 60 50 40 30 20 2006 2007 2008 2009 Potential capital account RMB settlement In addition to current account transactions regarding merchandise trade and services. 8 . China’s outward FDI has risen notably in recent years.Morgan Securities (Asia Pacific) Ltd The CNH market January 26. In particular. and assuming the share of China’s total imports from this group to be settled in RMB will rise steadily towards 20% by 2015.5 billion in 2009. the PBoC announced two weeks ago that outward foreign direct investment could now be settled in RMB. if we assume that it is the group of emerging market economies. could potentially rise to as much as 2. 2011 Asia Markets Research Grace Ng (852) 2800 8325 grace. registering at US$56. going forward some capital and financial account transactions could be settled in RMB.
0 0 2 4 6 8 10 12 9 % CNY Deposit CNY ND-IRS (7d Repo) CNY IRS (7d Repo) CNY Govt CNH CNY ND-CCS CNH Deposit CNH Forward FX Implied CNH CCS CNY ND Forward FX .0 1. 2011 Asia Markets Research Jason Mortimer (852) 2800 8329 jason.0 4. and 3-month SHIBOR) are traded onshore as well. they are available in ND-form offshore.0 -3.0 CNY T-Bill 2.600 6.500 6. CNH.Morgan Securities (Asia Pacific) Ltd The CNH market January 26.0 -4.0 -2. However. Offshore deliverable CNH (blue). The exchange-traded onshore bond market (which is much smaller than the interbank market) is in theory already accessible from abroad by ‘any’ QFII holder. 6.J. bonds.700 6. and swaps.0 -5. however a very limited amount of government bonds is held through QFII.j. & NDF CNY 6. For foreign investors.0 0. and Offshore NDF CNY (grey). but sometimes closing the gap. Interest rate swaps (based Aug-10 Dec-10 Mar-11 Jun-11 Sep-11 Jan-12 Apr-12 off the 7-day repo. Offshore deliverable CNH market. in August 2010 a pilot program was launched whereby a select group of financial institutions will be given approval by PBOC to use their offshore RMB to participate in the onshore interbank market (see pages 4-5). CNH deliverable forwards Chart 2: Composite yield curves in Onshore CNY (green).800 6. Chart 1: Spot/FWD FX markets in CNY.0 3.0 5. Offshore CNH yields generally trade intermediate to Onshore CNY and Offshore NDF yields. 1-year deposit.0 -1.P.com CNH and CNY products for foreign investors and corporates • In this piece we provide an overview of CNY and CNH products for offshore investors and corporates. and the’dim sum’ market Deliverable CNH spot FX began trading in August email@example.com CNY Onshore CNY Onshore FWDS CNH Offshore CNH Offshore FWDs CNY NDF FWDS Onshore CNY rates and FX products The interbank onshore bond market is traditionally closed to offshore investors. tending to trade with a USD-discount to onshore CNY spot. Onshore deliverable FX Forwards are not accessible for offshore investors. including FX.
000 3 2.90 12/23/15 800 5 3.45 9/22/11 1.000 3 3.000 10 2.40 9/30/12 2.40 9/26/11 20 1 1.60 12/1/13 2. and given their one-way nature these rates are significantly lower than onshore deposit rates. Bond issuance in the CNH market has increased sharply since the lifting of restrictions on trading CNH in mid-2010.68 9/28/12 200 2 2.85 12/24/12 200 2 1.80 1/10/13 500 2 1.000 40.000 3 3.45 11/11/13 3.5 1.000 5 3.25 9/24/12 1. The ‘dim sum’ bond market refers to CNH-denominated bonds that were issued offshore.60 9/24/12 1.90 7/23/11 4. Graph 1: Composition of bullet CNH bonds by issuer type FINANCIAL SUPRA.00 8/22/11 2.30 12/1/15 2.000 2 2. but some other bonds are ‘linked to CNY’ (but paid in USD). government agencies (25%).95 9/16/13 200 3 3.000 2 2.000 3 2.000 2 2.500 3 2.48 11/19/13 700 3 2. CNH deposit rates are based on quotes from BoC(HK).200 2 2.95 12/14/11 190 4 0.63 2/17/11 114 1 2.90 11/12/15 1. as they are commonly used as a CNY-appreciation proxy.000 20.00 1/20/14 100 3 1. China’s CNHdenominated benchmark sovereign bond curve is currently comprised of a single issue each of 3y.40 12/2/12 1.50 12/23/13 1.ELEC 1% BANK 29% Graph 2: CNH bond notional issuance increased dramatically since August 2010 mln CNH 60.ELEC INDUSTRIAL INDUSTRIAL BANK BANK GOVT AGENCY GOVT AGENCY GOVT AGENCY INDUSTRIAL BANK BANK INDUSTRIAL BANK BANK BANK BANK BANK SUPRA-NATIONAL INDUSTRIAL BANK INDUSTRIAL BANK SPECIAL PURPOSE FINANCIAL Issue Date 12/23/10 12/23/10 10/21/10 12/24/10 9/22/08 9/30/10 9/30/10 7/23/09 1/10/11 9/24/10 12/1/10 8/20/09 11/11/10 9/10/10 9/13/10 9/13/10 10/27/09 10/27/09 12/20/10 12/1/10 10/27/09 12/1/10 12/1/10 11/19/10 12/23/10 11/12/10 11/12/10 7/20/10 9/28/10 9/4/08 12/2/10 12/2/10 12/16/10 8/17/10 11/19/10 7/13/10 9/14/09 9/24/10 9/24/10 10/22/10 10/22/10 1/14/11 9/16/10 1/20/11 10/29/10 11/22/10 12/23/10 12/14/07 Maturity Notional Date (mil CNH) Tenor Coupon 12/23/11 500 1 1.HK BK TOKYO-MIT UFJ CATERPILLAR FINL CHINA DEV BANK CHINA DEV BANK CHINA DEVELOP BK CHINA DEVELOP BK CHINA DEVELOP BK CHINA GOVT BOND CHINA GOVT BOND CHINA GOVT BOND CHINA GOVT BOND CHINA GOVT BOND CHINA GOVT BOND CHINA GOVT BOND CHINA MERCHANTS CHINA POWER INT CHINA RESOURCES CHINA RESOURCES CITIC BANK INTL DEUTSCHE BANK AG EXP-IMP BK CHINA EXP-IMP BK CHINA EXP-IMP BK CHINA GALAXY ENTERT GP HONG & SHAN BANK HONG & SHAN BANK HOPEWELL HIGHWAY HSBC BANK CHINA ICBC ASIA ICBC ASIA ICBC ASIA ICBC ASIA INT BK RECON&DEV MCDONALD'S CORP ROYAL BK SCOTLND SINOTRUK HK LTD UBS AG HK VTB CAPITAL SA FUNG CHOI MEDIA Issuer Type BANK BANK SUPRA-NATIONAL BANK BANK BANK BANK BANK BANK BANK FINANCIAL GOVT AGENCY GOVT AGENCY GOVT AGENCY GOVT AGENCY GOVT AGENCY GOVT NATIONAL GOVT NATIONAL GOVT NATIONAL GOVT NATIONAL GOVT NATIONAL GOVT NATIONAL GOVT NATIONAL INDUSTRIAL UTILITY .800 3 2.Morgan Securities (Asia Pacific) Ltd The CNH market January 26.80 10/29/12 2.2% NATIONAL 3% INDUSTRIAL 14% SPV 2% UTILITY .95 9/13/12 500 2 2.00 Offshore CNY NDF The offshore traded CNY NDF is the grand dame of all China products for foreigners.000 3 1.000 2 2.j.000 2 1.P.20 12/24/12 500 2 1.000 GOVT NATIONAL 24% GOVT AGENCY 25% 0 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 10 .80 12/1/20 1.00 5/19/11 90 0.700 2 2. The current total of outstanding issuance is CNY59bi.000 3 2.70 12/20/12 3.000 2 1.000 2 2.70 9/12/11 100 1 1. Their yields are significantly below mainland government yields. and has been actively traded for years.65 12/16/13 1.20 11/12/13 firstname.lastname@example.org 1/14/13 500 2 0.10 10/27/11 3.000 2 2.000 2 2.com started trading around the same time.10 9/13/12 1.40 10/21/20 1.00 9/4/11 3.000 3 2. Table 1: Composition of bullet CNH bonds by issuer Name AGR BK CHINA(HK) AGR BK CHINA(HK) ASIAN DEV BANK ANZ BANKING HK BANK OF CHINA BANK OF CHINA BANK OF CHINA BEA CHINA LTD BK OF COMM .98 12/1/12 1.200 10 2.30 10/22/13 47 3 2. The majority of ‘dim sum’ bonds are denominated in CNH. The CNH interest rateswap market has gotten off to a false start: initial deals were based on (onshore) SHIBOR but this proved impractical and such swaps are no longer actively quoted.98 9/14/11 2.00 10/27/14 500 5 3.75 7/20/11 500 1 2. as the forwards imply a strengthening of the CNY.000 5 1.95 12/2/13 4.380 3 4.95 11/22/12 200 2 2. These bonds were issued by the Ministry of Finance.380 2 2. The interest rates implied by the NDF and NDS curves are negative up till 5 years. and sovereigns (24%).25 10/22/12 117 2 2. The non-deliverable cross currency swap (NDS) curve extends from the NDF curve.000 2 2. 5y.25 10/27/12 2. 2011 Asia Markets Research Jason Mortimer (852) 2800 8329 jason.J.65 9/30/13 2. in the Hong Kong market in December 2010. The greatest issuers are banks (29%).80 7/13/12 1. and 10y CGBs.
Banks. Insofar as the Chart 1: USD/CNH trading at USD discount to onshore spot 6. b) Corporate flow as a force for convergence.60 6. this is not expected anytime soon. Hence. this is far from a risk free trade (and not strictly an arb). still thin CNH liquidity conditions are still far from sufficient to absorb global demand shocks. Taken together with the risk that offshore spot may not actually converge. In the lack of free capital flow and amid global investor access. While a move to a free capital account would allow offshoreonshore convergence. we view the move as a knee-jerk reaction to HKMA regulatory refinements. Regulatory reforms are needed to correct the imbalance. We would view USD/ CNH-USD/CNY spot convergences as potential opportunities to be short USD/CNH. this may motivate banks to position for convergence. • In principle.70 6. the scarcity of CNH liquidity suggests risk that the bank may be unable to cover the forward delivery leg of the sell/buy USD/CNH swap. but an overhaul not expected anytime soon. the PBoC remains extremely sensitive against allowing offshore investor (or speculative) demand to impact onshore spot. USD/CNH spot to stay in discount vs USD/ CNY USD/CNH to stay largely in USD discount to onshore spot. but an overhaul not expected anytime soon. where RMB accrued from payments by Mainland buyers could be offloaded at a more favorable USD/CNH spot.30 through 2011. but move is temporary and event driven. However.ho@jpmorgan. However. However.85 6. Corporates receiving CNY cash from bilateral trade may find it more profitable to buy USD against RMB via a lower offshore USD/CNH spot rather than the clearing rate through the Clearing Bank. They remain 2 separate markets (and arguably more so following the HKMA refinements).Morgan Securities (Asia Pacific) Ltd The CNH market January 26. a lack of pure arbitrage does not stop convergence trades in spot: a) When a wide gap opens between onshore and offshore spot USD/RMB. can open CNH accounts and access CNH products as long as they comply with normal banking regulations in Hong Kong with no additional approvals from SAFE or HKMA Mainland capital account remains closed and RMB funds cannot flow freely from Mainland to HK and to global markets.65 6.40 Aug-10 USD/CNH spot USD/CNY spot 1. Particularly.J. Imperfect convergence in spot CNH and CNY The lack of strict arbitrage suggests CNH and CNY will remain fundamentally different markets. USD/CNH is expected to stay in USD discount against onshore spot. even those who are not funded by CNH deposits. the details of the regulations do not alter the fundamental elements driving the USD/CNH-USD/CNY spread. In particular. USD/CNH-USD/CNY converged late-2010. they fundamentally roll to a different spot rate • All corporates and institutions. 2011 Asia Markets Research Yen Ping Ho (65) 6882 2216 yenping.55 6. Mainland 11 Sep-10 Oct-10 Nov-10 Dec-10 . the lack of free arbitrage should leave USD/CNH biased to a negative spread against onshore USD/CNY. USD/CNH-USD/CNY converged late-2010. While USD/CNH rallied into USD premium against USD/CNY late-2010. Fundamentally. regardless of nature of business or investor type. there is a large overlap in participants who can access the offshore NDF and offshore USD/CNH DF. headlines surrounding position limits on CNH had triggered a one-off readjustment of USD/CNH exposures. but move is temporary and event driven. That said.com Opportunties in the spot and forward CNH market • USD/CNH to stay in discount to onshore spot. In light of this. With spot USD/CNY expected to trend lower to 6.45 6.P. USD/CNH has tended to extend below onshore spot especially when CNY appreciation fervor rises.80 6.75 6.50 6. USD/CNH is similarly expected to gravitate lower with some additional downside bias Regulatory reforms are needed to correct the imbalance. may fund CNH cash via sell/buy USD/CNH swaps and buy spot. non-resident corporates could migrate their RMB billing centre to Hong Kong.
Conversely.55 6.P. liquidity constraints to trading the offshore DF has limited the convergence trade. 2011 Asia Markets Research Yen Ping Ho (65) 6882 2216 yenping. In addition. This suggests offshore USD/CNH will tend towards a USD discount to onshore spot. as a means to channel CNH payments to offshore subsidaries as an alternative for offshore financing. but in the lack of pure and unrestricted arbitrage offshore RMB will still be vulnerable to global demand shocks.J.com entities may also establish re-invoicing centres in Hong Kong. These suggest an underlying bid for offshore USD/CNH insofar as it trades at an USD discount to onshore. which remains far from a risk-free arb. convergence trades will anchor USD/CNH to the general trend of onshore USD/CNY. We would view USD/CNHUSD/CNY spot convergences as potential opportunities to be short USD/CNH. may find it cheaper to generate RMB cash via USD/CNH if it trades above the onshore rate. Overall. amid fixing risks.Morgan Securities (Asia Pacific) Ltd The CNH market January 26. USD/CNH forwards peeling off the deposit curve NDF USD/CNY depo implied CNH 6.50 6.45 6. liquidity risks and wide bid-offers on USD/CNH 2. the offshore deliverable leg settles with CNY notional while NDFs are settled only in Chart 2: Summary of notable flows across USD/RMB curves (numbers correspond to the text) USD/CNY (4) "cross-border" hedging (1) global CNH demand (3) onshore-offshore arb (1) Corporates (4) "cross-border" hedging (2) CNH vs NDF convergence trades USD/CNY onshore DF USD/CNH offshore DF (3) onshore-offshore arb USD/CNY NDF 12 *dashed arrows represent limited/restricted convergence flows . That said. as the 2 remain fundamentally separate markets. we still expect USD/CNH to remain biased to the downside against onshore spot. unwind risks and wide bid-offers on CNH DFs also feature to some part. However. For a start.65 CNH 6. This is apparent particularly at the longer-end of the USD/CNH curve where forwards are in USD discount and substantially off implied pricing from the deposit curve. there is a large overlap in participants who can access the offshore NDF (non-deliverable forward) and offshore DF (deliverable forward) curves. Offshore CNY NDF vs offshore CNH DF In principle. And this implies basis risk when trying to cover the delivery leg of USD/CNH.40 spot 3M 6M 12M USD. Trading the NDF vs CNH would hence constitute taking views on 2 different underlyings. To be sure. This means that participants cannot enter long USD/ CNH offshore DF unless they are already long CNH cash or can easily fund in CNH.ho@jpmorgan. The inability to transact in large enough sizes. However. corporates requiring RMB for payments to merchandise trade counterparties in Mainland. both forward curves roll into different spot rates.60 6. there is technical appeal to being on the short USD/CNH side of the CNH vs NDF convergence trade given the tendency for offshore spot to trade below onshore.
the onshore-offshore arbitrage flow has helped anchor the NDFs to a spread against onshore. CNH will remain susceptible to demand-side shocks. Corporates can only sell USD/CNY onshore up to sizes prescribed by underlying invoices. But in a world of unrestricted CNH access. To some extent. and limited credit lines Summary Current regulations ensure offshore USD/CNH remains a fundamentally different market from onshore. If anything. the market has so far been happy to acquire CNH via a lower USD/CNH spot. The trades can been aggregated in accounting books as a pure arbitrage gain. 3. Mainland corporates with both export and import operations would typical net out export and import invoices to negate foreign exchange risks.P. However. 4. the small subset of entities able to execute these trades and limited ability to bring the positions on balance sheet have constrained the flow impact of such deals. from trading counterparties constrain the scope to position in the NDFs. there may be scope for some cross-border hedging by naturally hedged entities. as CNH in HK can be deployed in positive return assets as opposed to negative carry in the NDF curve. and USD/CNH will be biased lower against onshore. The recent regulatory changes by SAFE may also have reduced the ability of Mainland corporates to take on such trades.Morgan Securities (Asia Pacific) Ltd The CNH market January 26. However. those with entities outside Mainland could migrate the import invoicing centre offshore where long USD/RMB hedging can be accrued at the lower USD/CNH rate. Given that the NDFs trade at a persistent USD discount to onshore forwards. onshore-offshore arb have had only limited ability to compress the onshore-offshore spread. trading volumes on the offshore DF have extremely thin. See summary chart 2 (flows numbered as outlined by text in preceding pages).com DFs. corporates registered Mainland may sell onshore USD/CNY forward as a hedging transaction with underlying documentation. Onshore CNY forwards vs offshore CNH DF In theory. 2011 Asia Markets Research Yen Ping Ho (65) 6882 2216 yenping. but at the same time buy USD/CNY NDFs via a separate but same name entity registered offshore. To be sure. though leaving the underlying USD receipt as a FX unhedged position. Given the depth of NDF trading liquidity offshore. Such demand dynamics may also leave a wedge between markets.J. the curves could converge increasingly as offshore CNH liquidity improve in Hong Kong.ho@jpmorgan. the market is not expected to achieve the threshold needed to anchor the offshore NDFs anytime soon. Even factoring strong growth. However. For example. Leakages across the 3 forward curves suggest some scope for arbitrage or convergence across markets. Convergence trades may narrow the difference. risk reward is attractive only on wide spreads of USD/ CNH against NDFs. 13 . Onshore CNY forwards vs offshore NDF Onshore-offshore arbitrage across the forward curves has been going on for some time.
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