Spring 2012

ASSET SERVICING: With the wind in its sails

Asian_boatAmong the currencies of the world’s six largest economies, China’s renminbi is the only one that is not a reserve currency. As it moves closer to attaining this prestigious status, Stefanie Eschenbacher asks what challenges the asset servicing industry faces. In the course of the next decade the renminbi will become a reserve currency, predicts the Brookings Institution, eroding but not displacing the dollar's dominance. The think-tank, based in Washington, DC, recently published a study by Eswar Prasad and Lei Ye, entitled The Renminbi's Role in the Global Monetary System. Rapid economic growth combined with a gradual opening of China's capital account will push the renminbi towards reserve currency status, Prasad and Ye conclude, but its low level of financial market development remains “a major constraint”. “A big advantage for China is that Hong Kong provides an effective platform for launching these measures in an experimental manner without full capital account opening,” they write, describing China's approach as “capital account liberalisation with Chinese characteristics”. These characteristics also have an impact on how renminbi assets are serviced for the offshore market, as new products are being introduced. The dim sum bond market, which has quadrupled in a year, is now showing signs of maturing as investors are focussing on yield and credit quality. Meanwhile, the first ever renminbi-denominated exchange-traded fund (ETF), the Hang Seng RMB Gold ETF, and the first ever renminbi-denominated real estate investment trust, the Hui Xian Real Estate Investment Trust, launched. Eric Chow, regional head of asset managers sector, sales and business development, Asia Pacific, at HSBC Institutional Trust, says while the potential is huge and regulatory changes have been smooth, it remains an premature market. “It is the same currency, traded in different markets with different exchange rates,” Chow says. Establishing the net asset value of a fund can be difficult for fund administrators, Chow says, because exchange rates are applied to onshore and offshore assets. Chinese wall
China has intentionally kept its onshore and offshore assets separate, with supply and demand forces creating different market clearing exchange rates in either location. To avoid confusion, a new currency code – the CNH – was created for assets in Hong Kong. Swift, a global provider of secure financial messaging services, says it recongises that the growth in the market and product innovation represent “operational challenges in achieving straight-through processing between counterparties”. Swift has recently issued draft best practice guidelines concerning the usage of Swift messages for offshore renminbi, aiming to provide clarity “before processing volumes reach an unsustainable level”. Andrew Smith-Plenderleith, a custody product manager at JP Morgan in Hong Kong, says market participants and regulators have been trying to make the offshore renminbi market as standardised and straightforward as possible. Smith-Plenderleith says another challenge apart from pricing, is that given the different exchange rates for onshore and offshore markets, investors have had a limited range of renminbi securities in which to invest. There is just one renminbi equity listed in Hong Kong to date - a real estate investment trust. If the Hong Kong Exchange moves ahead with its latest market initiative, however, companies would be allowed to list fungible shares in renminbi and Hong Kong dollar. Liquidity
“The focus has so far been on bonds,” says Smith-Plenderleith. “We see growth potential in the equity space and expect the Hong Kong stock exchange to broaden for renminbi-denominated equities.” Rex Wong, managing director, head of relationship management, North Asia, at BNY Mellon in Hong Kong, says the renminbi qualified institutional investor (RQFII) programme has already widened the investment channels of renminbi funds raised in the offshore market and will help attract more long-term offshore capital to the domestic market. “Most importantly it will be beneficial to the long term development of renminbi to become an international currency as it helps promote the flow of the currency back to the onshore market, although the currency is still not freely convertible,” Wong says. “The creation of RQFII funds, and the continual expansion and future relaxation of the programme will promote the development of diverse types of reniminbi products for investors and will become a new opportunity to asset servicing providers.” The Hong Kong Monetary Authority is also to extend the operating hours of the renminbi real time gross settlement system in Hong Kong to 11.30pm local time by end of June. “This will give financial institutions in London and other financial centres in the European time zone an extended window to settle offshore renminbi payments through the Hong Kong infrastructure,” he says. The settlement cycle of reniminbi equities traded in Hong Kong, however, is no different from other Hong Kong dollar equities. Cindy Chen, head of securities services at Citi in Hong Kong, says the “essence” of the service is similar. “The difference is the regulation governing the assets in the two jurisdictions,” she adds, pointing to the fact that there is no capital gains tax on renminbi shares in Hong Kong and the A-shares market is subject to a 10% capital gains tax for qualified foreign institutional investors. Liquidity is the biggest challenge when it comes to servicing renminbi-denominated assets. Even though deposits have been building up rapidly, they are far from the levels of other currencies. According to the latest statistics issued by the Hong Kong Monetary Authority, renminbi deposits amounted to Rmb576 billion ($91.4 billion) at the end of January. The total remittance of renminbi for cross-border trade settlement was Rmb156.4 billion. “It is not possible to use onshore renminbi deposits to settle offshore renminbi transactions because the two are not fungible,” Chen says. “Whilst there are no lending restrictions in Hong Kong, institutions in China are not allowed to loan their deposits to offshore institutions.” Limits
There is also a daily conversion limit, which mainly affects retail investors.  Even though there is no such limit for institutional investors, they still have to get approval for transferring offshore renminbi into China. “These restrictions allow China to maintain sufficient capital flow control to help ease pressure on the foreign exchange rate and control inflation,” Chen says. “China keeps such borders to separate the onshore and offshore renminbi markets and uses Hong Kong as a test ground for internationalisation of the renminbi." Asset managers need to manage liquidity carefully to be able to handle redemptions. “China is rather sensitive to cross-border flow,” says Fanny Wong, the head of custody at Bank of China (Hong Kong). “Transactions in renminbi attract more regulatory attention and more questions are being asked as to what the money is used for.” Wong says the market in Hong Kong is “very sophisticated” and whatever works in international markets can be replicated there. The challenge, Wong adds, is facilitating the enhanced usage and cross-border flows of renminbi within regulatory confines where she sees a competitive advantage. Bank of China (Hong Kong) entered the asset servicing space in 2006, a market that has been dominated by five global custodian banks – BNY Mellon, Northern Trust Corporation, State Street Corporation, JP Morgan Chase and Citigroup. Wong says the market is growing, which means there are still niches for smaller players. Singapore was poised to become the second offshore renminbi centre, but in recent months competition from London has intensified. “Mr Osborne should be pleased,” writes Swift in the January edition of its Swift RMB Tracker newsletter, outlining the deal signed by the UK chancellor with Hong Kong to turn London into an offshore trading centre. “According to data from our network, the City is at a better starting point than he may realise.” 
In the fourth quarter of last year, London executed 30% of all renminbi payments and 46% of renminbi foreign exchange transactions, not considering China and Hong Kong volumes in both cases. Hong Kong remains the world's largest renminbi offshore centre, accounting for 78% of all payments sent and received. Even though the renminbi's share of 0.29% in global payments is still small, at least compared to 43% for the euro, its growth has outpaced that of other major currencies. At the end of last year it became world payment currency number 15. Despite the challenges the asset servicing industry faces, the focus remains on the opportunities as the renminbi internationalises and moves closer to attaining reserve currency status. ©2012 funds global

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