Q+A-How quickly can Hong Kong’s yuan market grow?

By Saikat Chatterjee and Michelle Chen

HONG KONG, Oct 28 (BestGrowthStock) – The offshore market for
China’s yuan in Hong Kong has grown rapidly in the past three
months since its birth, reflecting heavy demand abroad for the
currency for trade and investment.

Though China ultimately controls the amount of yuan
available outside the mainland, banks and companies are
optimistic about the outlook for the offshore market, or the
CNH (Chinese yuan in Hong Kong) market as it is popularly
known, with many predicting a surge of yuan activity in the
territory in coming months.

Here are some questions and answers about the offshore yuan
market.

HOW QUICKLY IS THE MARKET GROWING?

As of August, yuan deposits in Hong Kong were up 30 percent
from a month earlier to a cumulative 130.4 billion yuan ($19.5
billion), or 2.3 percent of total deposits. Yuan deposits were
63 billion at the end of 2009.

Bankers said much of the recent surge in the deposit base
is due to companies bringing yuan into the territory to make
import-related payments because the yuan is more expensive in
Hong Kong.

Goldman Sachs expects total yuan deposits in Hong Kong to
grow to 3 to 5 trillion yuan in the next 3 to 5 years, while
Standard Chartered forecast the share of Chinese imports
settled in yuan would rise to 20 percent by 2015 from a paltry
1 percent now.

Out of that, Hong Kong could easily be the counterparty to
60-70 percent of these yuan-invoicing flows, the bank said.

WHAT IS LIQUIDITY LIKE?

Reflecting the relatively small yuan deposit base in the
territory, interbank spot, bond and forwards markets for the
yuan are just beginning to develop.

Volumes in the spot market average around $3 to $5 million
daily, compared with $2 to $3 billion in the non-deliverable
forwards market and $20 to $30 billion in the mainland’s
markets, Goldman Sachs said in a research note.

The deliverable forwards curve is also illiquid and trades
at a premium to the NDF and the onshore curve, reflecting
strong demand in Hong Kong is outstripping the supply of yuan.

This opens up a window of opportunity for banks and
companies to exploit the differentials in the three markets,
though the relatively small volumes mean such trades are tiny.

Banks have started to trade yuan derivatives in Hong Kong
in the hope of kickstarting new markets, but trading activity
has been sluggish because of a lack of conformity when it comes
to what assets underlie the derivatives.

Deutsche Bank (DBKGn.DE: ) and HSBC (0005.HK: )(HSBA.L: )
completed their first interest rate swap deal in Chinese yuan
(CNY=CFXS: ) and Standard Chartered Bank (STAN.L: ) was the first
to manage a yuan bond sale in Hong Kong by an overseas
non-financial firm.

WHAT PRODUCTS ARE GOING TO BE LAUNCHED NEXT?

Investors are eagerly waiting the launch of
yuan-denominated stocks in Hong Kong, which would would reduce
volatility in the Hong Kong dollar interbank market and divert
funds into other yuan-denominated assets.

Hong Kong could see initial public offerings denominated in
yuan as early as next year, the chief executive of the
territory’s stock exchange said this month. [ID:nTOE69405V].

Banks and financial companies are also waiting for a
so-called “mini QFII” pilot scheme that would allow
institutions in Hong Kong to invest their yuan in mainland
assets, encouraging them to offer more products like floating
rate bonds and structured notes to investors here.

While offshore investors would love to see more stock
quotas, Beijing might not oblige and instead hand out bond
investment quotas.

WHAT WILL HAPPEN TO THE NDF MARKET?

As of now the NDF market is in no danger, until yuan
liquidity in Hong Kong can grow more. Large trades can be
executed relatively quickly in the NDF market, and a wide
variety of market participants mean there is adequate
liquidity.

But still, some opportunities are beginning to emerge.

Given that the NDF curve is purely reflecting bets on yuan
appreciation and the CNH curve is a partially market determined
forward rate, companies could consider buying forward yuan in
this market as it is cheaper than hedging their payables in the
NDF market.

WHY IS THERE A DISCREPANCY BETWEEN ONSHORE AND OFFSHORE
YUAN?

The key reason is there is a lack of fungibility between
onshore and offshore markets. In other words, there is no free
flow of yuan between the two markets.

Since the announcements earlier this year that essentially
created the yuan market in Hong Kong, spot yuan in Hong Kong
(CNY=D3: ) has consistently traded at a premium to onshore yuan
and all recently issued bonds or “dim-sum” bonds as they are
beginning to be popularly known trade at a premium to their
issue prices.

The premium for spot yuan in Hong Kong over yuan in
mainland China has averaged between 1-2 percent and last week
hit a record 2.7 percent.

Moreover, companies issuing bonds in Hong Kong have a long
waiting period of between 1-2 months before they can repatriate
their yuan proceeds into the mainland.

Also any non trade-related activity has to be settled
within Hong Kong.

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For a graphic on growth of yuan deposits in HK, click:

http://link.reuters.com/zej37p

For a FACTBOX of offshore yuan bonds, click:

[ID:nSGE69I0DE]

For a PDF of stories about HK’s yuan market, click:

http://r.reuters.com/zuk63n

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(Editing by Kevin Plumberg)

Q+A-How quickly can Hong Kong’s yuan market grow?