Robert Elsen: Internationalization of the Renminbi with a Focus on Frankfurt

2015-10-09 IMI

Robert Elsen: Representative, Federal Financial Supervisory Authority (BaFin); Financial Counsellor, German Embassy in Beijing I.Introductory Remarks While the first three decades of reform and opening up were mainly characterized by the impressive economic growth without focusing much on the Chinese currency we could witness a tremendous expansion of the international use of Renminbi in the last few years. A key driver for the internationalization was the international financial crisis which was triggered by the US Subprime crisis. Another reason for this process is the “going global” of the Chinese economy with lots of investment all over the world. Recent initiatives like “one belt, one road” and also the founding of the Asian Infrastructure Investment Bank (AIIB) have the potential to further accelerate this process. The Renminbi has started following suit of China’s role as economic powerhouse and leading trading country. Given ongoing restrictions on the usage of Renminbi due to capital account regulations the RMB’s internationalization has not been able to lead to a full convertibility of the currencyyet. We currently witness a hybrid constellation of “onshore RMB” in mainland China and “offshore RMB” in Greater China and beyond. Given the tight relationship and its role of a leading international financial center it was only consequent to start with Hong Kong as the first hub for offshore RMB. China then gradually expanded the concept of RMB hubs to other financial centers while the use of the Yuan in international trade continued to pick up. Studying international data such as the ones from SWIFT statistics clearly underline the expansion of the RMB as international trade currency. The recognition as international currency also calls for its usage as investment currency on an international scale and as a reserve currency though. Compared to its use in trade, the RMB share in international investment is still comparatively low. China has expanded foreign direct investment rapidly – outgoing investment meanwhile even exceeding the incoming amount of investment. The going global strategy is underpinned by government initiatives such as the “one belt, one road” but also private capital to a larger degree. Since China is already the prime trading partner for a variety of countries it may appear as the next step that they get more accustomed to the use of RMB as investment currency instead of using third currencies such as the USD. The third aspect, i.e. acceptance as international reserve currency is widely considered to as the ultimate goal when promoting the internationalization of one’s currency. A clear indicator is the growing usage of the currency by foreign reserve banks. Several reserve banks across the globe have already announced to take the RMB on board as reserve currency or their readiness to do so in the foreseeable future. The introduction of the RMB in the IMF’s currency basket underlying the Special Drawing Rights (SDR) is considered a milestone in this development since it would endow the Renminbi the official touch of an internationally recognized currency. This would send a strong message to financial markets –especially given the fact that the composition of the basket follows rules of predominantly western origin. The official seal would automatically lead to an expansion of the usage as reserve currency and would generally give the internationalization a major boost. II.Expansion of RMB Offshore Hubs The creation of an offshore hub for RMB usually follows a certain sequence. In a first step the People’s Bank of China (PBoC) and respective central bank establish a currency swap agreement. Though the agreement usually has the function of a backstop only and it is not expected to be used it enhances market confidence. The PBoC has undertaken stricken such currency deals with a multitude of central banks. The agreement between the European Central Bank (ECB) and the PBoC has a swap line of 350 billion Yuan or 45 billion Euro. In order to further set up the financial hub bilateral negotiations usually then focus on the establishing a clearing bank in the financial metropolis and granting a Renminbi Qualified Foreign Institutional Investors (RQFII) quota to the respective jurisdiction. There is no specific sequence – some countries concentrated on the clearing bank first (such as Germany) while others received a quota first (such as Great Britain and France). The clearing bank is designated by the PBoC allowing for access to refinance from the PBoC. Thus the clearing bank is responsible for the RMB payment process. After a general agreement on designating a clearing bank in a particular financial center the PBoC selects a bank that will be entrusted with this role. So far one of the big state-dominated Chinese banks has been selected. The appointed bank varies from country to country. The RQFII scheme allows foreign investors to use offshore RMB in order to invest in the capital market and the inter-bank bond market in mainland China. Before investors may make use of this scheme, one has to follow a certain sequence. At first the governments of China and the respective partner country have to agree upon a certain quota. Once the quota is granted prospective investors need to apply individually for the licence as such (China Securities Regulatory Commission, CSRC) and thereafter the amount (State Administration of Foreign Reserve, SAFE). If the investor intends to target the inter-bank bond market, the PBoC needs to be involved. III.The RMB hub in the “Middle of Europe” 1. Features of Frankfurt Frankfurt is located “at the heart of Europe”. The central position is not only true for the geographical location but also its role of financial hub in the continent. The town hosts more than 200 foreign banks including branches of five major banks from China. The Frankfurt stock exchange is operated by the Deutsche Börse Group – a renowned institution with international exposure offering a broad value chain from trading and clearing to settlement and custody. Moreover Frankfurt is not only the place for the national institutions Bundesbank (central bank of Germany) and BaFin (Federal Financial Supervisory Authority in charge of banking, insurance and securities supervision) but also the European players ECB (European Central Bank with European Systemic Risk Board attached) and EIOPA (European Insurance and Occupational Pensions Authority). The ECB is a key player in the European market as the guardian of the European single currency Euro and also assumed supervisory tasks in November last year (Single Supervisory Mechanism, SSM). The Frankfurt area is also a very attractive region for foreign companies who choose the area for their German and occasionally also European headquarters. They can benefit from a sophisticated infrastructure with high-level education and in terms of transport plenty of railway connections, highways and the huge Frankfurt airport offering direct connections to several Chinese cities. Given these assets the Chinese government decided to set up an office of the China International Investment Promotion Agency (CIPA)that was opened in Frankfurt last year. 2. The Rise of Frankfurt as RMB Hub The ECB started the initial stage by signing the currency swap agreement with PBoC in October 2013. The backstop liquidity facility was considered the starting point for the promotion of selected financial centers in the Euro Area to become offshore RMB hubs since it reassures Euro Area banks with the continuous supply of Yuan. In the case of Frankfurt the Hessian State government has taken a pro-active role even before the ECB – PBoCagreement in order to further develop Frankfurt as financial center and to cater for the needs and expectations of Chinese financial institutions as well as other companies interested in German / European investment. This was underlined in particular by high-ranking delegations paying visits to China and seminars and other events. On the federal level the government and the central bank started a fruitful dialogue with the Chinese counterparts in order to take the necessary steps for the RMB hub. During the visit of Chinese President Xi Jinping the two central banks signed a memorandum of understanding to intensify their collaboration in clearing and settlement of RMB payments and to lay the groundwork for establishing a clearing bank on 28th March 2013. Thus Frankfurt was the first European financial center designated to get a Renminbi clearing bank. Thereafter the selection process among Chinese banks took place. The Bank of China (BoC) was selected to become the clearing bank on June 19th. The clearing bank resumed business operations in November. Since then the BoC can process RMB payments directly with China rendering its services to various banks and other financial institutions. The next step was the granting of the RQFII quota in July 2014. The quota allows registered qualified investors to invest up to 80 billion Yuan in the Chinese capital markets and inter-bank bond market. The tool is considered major gateway to gain market access in the Chinese mainland. As also pointed out by PBoCGovernor ZhouXiaochuan in spring the RQFII regime is the right concept but implementation could be facilitated in order to attract more investors. Envisaged reforms in this area will probably boost this investment channel in future. The High-Level Financial Dialogue between China and Germany which started in March 2015 will further enhance mutual understanding and co-operation and is also designed to further promote market access and to support the RMB offshore market. More interaction between the capital markets has the potential to further accelerate the usage of RMB. The opening up of the Chinese capital market has taken a new step by introducing the Shanghai Hong Kong stock connect last November. The Shenzhen Hong Kong stock connect is expected to follow later this year. The Deutsche BoerseGroup has engaged in a strategic alliance with Bank of China – the RMB clearing bank in Germany –and is also preparing a joint venture with the Chinese exchanges China Futures Exchange and Shanghai Stock Exchange. The joint venture (“China Europe International Exchange”) will provide German and other international investors with Chinese financial instruments denominated in RMB. Business operations are likely to start in the fourth quarter of 2015. Thus Deutsche Boerse is the pioneer of the internationalization of the Chinese capital markets outside Greater China. The German development bank KfW (KreditanstaltfürWiederaufbau) issued the first RMB-denominated bonds (Goethe bond) in Frankfurt in May 2014. The Agricultural Bank of China issued the first RMB-denominated bonded loan for the Deutsche Leasing group in April 2015. A recent press release (dated 8th of June) of the German central bank indicates “strong growth” in the RMB business. Accordingly German-issued RMB-denominated securities have jumped from 5 billion in spring last year to currently over 21 billion RMB. RMB-denominated deposits in Germany amount to 12 billion RMB. Turnover figures for foreign exchange transactions varied from 300 billion to 1.4 trillion RMB per quarter. Some tools such as the RQFII is still at an infant stage but once bureaucratic hurdles are taken they will fuel further growth. The biggest driving force though will be the intense bilateral trade relations between Germany and China (about 154 billion € in 2014). The connectivity between the financial center and real economy in Germany is and will remain the backbone of our bilateral economic relationship and distinguishes Frankfurt from other financial centers around the globe.

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Robert Elsen: Internationalization of the Renminbi with a Focus on Frankfurt

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