IT is meant to be the great new market that will transform the City’s prospects. In April, London hosted the launch of the first renminbi (RMB) bond to be issued outside Chinese sovereign territories. George Osborne hailed it a “significant moment”, as he declared his ambition to see London play a key role in the emerging offshore market for China’s currency. But despite the competitive international advantage the City enjoys, it is unlikely to become an offshore centre for RMB trading in the near future.
Connected only indirectly to the onshore RMB market in mainland China – via Hong Kong – London’s role is best described as an offshore hub rather than an offshore centre. Three stumbling blocks limit London’s role.
Currently, a cross-border trade settlement scheme is driving liquidity into this nascent RMB offshore market. The size of the offshore RMB liquidity pool a financial centre can generate, therefore, largely rests on bilateral trading volume. Compared with Hong Kong, which had $283.5bn (£174.2bn) of bilateral trade with mainland China in 2011, the UK’s trade with China was only worth $58.7bn. Further, the RMB is barely used as a trade settlement currency in UK-China trade.
London is therefore limited by liquidity concerns, even though it hosts deposits of RMB109bn. This issue will remain a challenge until the RMB becomes fully convertible as an international currency. The City could perhaps attract a significant volume of RMB resources through its advantage in global foreign exchange trading. But, for as long as the cross-border trade settlement scheme remains the major pillar in China’s RMB strategy, the City must be patient.
A second stumbling block is the technical difficulty caused by the RMB clearing system. In the offshore RMB market, only Hong Kong is thoroughly equipped with both the RMB real-time gross settlement system, which allows swift, large fund transactions, and with a RMB clearing bank, Bank of China (Hong Kong).
London is lacking this critical RMB settlement system. It also doesn’t have a local RMB clearing bank. Even if the City is in the best position to gear up global demand, the majority of those offshore RMB transactions still have to be conducted via Hong Kong. As a result, market practitioners see less benefit in concentrating their RMB businesses in London. Multinational corporations can simply shift RMB deals to Hong Kong branches (or perhaps to Singapore). In other words, until London has the requisite financial infrastructure, it will struggle to be more competitive.
Thirdly, and perhaps of most concern, is the differing understanding of Beijing’s RMB internationalisation strategy in the Bank of England and the Treasury. China’s RMB strategy is a policy-driven process, with deep public sector involvement. The most evident example is the role of bilateral currency swap agreements. In Beijing’s view, a bilateral agreement between central banks has profound implications beyond the intrinsic value of the swap itself. It represents a will to jointly develop RMB offshore business at the level of officialdom.
However, the Bank of England sees limited value in establishing a line in currency swaps. The RMB is not yet fully convertible, and the size of its global offshore market is neither large or liquid. The Bank insists that the private sector should take the initiative. It therefore remains very reluctant to touch on the swap issue.
The Treasury, on the other hand, is making great efforts to initiate policy dialogue with Beijing and Hong Kong. It wants to push the City towards the front tier of the RMB offshore business, and thereby boost the economy through a closer relationship between China and the UK.
While the development of the offshore RMB market remains contingent upon China’s financial reform process, whether the Bank of England and the Treasury can take collective action will ultimately determine the City’s future in the RMB internationalisation game.
As an “offshore hub”, London is still a crucial connecting dot in China’s strategy, as Beijing seeks to make the RMB a truly international reserve currency. But if the chancellor’s ambitions are to be fully realised, these stumbling blocks – which restrict London from growing into an RMB offshore centre – must first be overcome.
Helena Huang is a researcher at Chatham House, and co-author of The Connecting Dots of China’s Renminbi Strategy: London and Hong Kong.