Gaining the Benefitsof RenminbiLiberalisationSunil Bhatia, Director, Senior Product Manager, Global Transactions Services, Bank of America Merrill Lynch

Nilesh Kothari, Director, Global FX Sales, Global Markets Group, Bank of America Merrill Lynch

Sarah Leung, Associate, Global FX Sales, Global Markets, Bank of America Merrill Lynch

The internationalisation of China’s currency, therenminbi, continues to gather pace. While it remainsunclear when the currency will be fully liberalised, the

direction of travel is certain. For companies that do businessin China — a group that includes both importers and exportersand is growing every year as a result of globalisation — theimplications of this liberalisation are significant.

China’s decision to begin to allow cross-bordersettlement of renminbi originated in the 2008 financialcrisis. As the dollar fell in value, reflecting concernsabout the global economic outlook, many largecorporations and small and medium-sizedenterprises (SMEs) lost money because theirinvoices were denominated in dollars. Thegovernment started to considerinternationalisation of the renminbi in order tolimit these firms’ exposures to the dollar.Since then, there has been a cautious but clear

advance towards the goal of liberalisation of therenminbi (see page 4 for additional details). Theuse of the currency —for both onshore andoffshore settlement — has become steadily morewidespread since 2009. Since 2011, renminbi

Executive Summary

As China’s currency, the renminbi, becomes steadily moreliberalised, international corporates that do business in thecountry — either as importers or exporters — havesignificant opportunities to lower costs and reduce foreigncurrency risk through hedging. However, complex rules andmultiple forms of the renminbi, in both spot and forwardmarkets, mean that careful planning and ongoing vigilanceare essential in order to gain the benefits of renminbiinternationalisation.

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settlement has covered all of China, andoffshore settlement has been extended tothe entire world: all cross-border importsand exports can now settle in renminbi.Data from SWIFT shows that the value

of renminbi trades has increased 17.4times from October 2010 to June 2012.SWIFT figures also show that in February2012 there were 2,318 renminbi letters ofcredit (L/Cs) sent and received outsideChina, with Hong Kong accounting for47% of these.Recent important developments

include the formation of an offshorerenminbi market in London. This centre isexpected to be a commercial rather thana settlement hub — the governmentfavours Hong Kong as the defaultsettlement location — but the ability totrade renminbi as a currency pairirrespective of time zone is a crucial stepon the road to creation of aninternational currency.Renminbi is traded both onshore in

China and offshore, primarily in HongKong. It is the same currency in thesedifferent trading locations, but traded atdifferent rates. This is intentional —regulation has explicitly kept onshore andoffshore trading separate, and respectivesupply and demand conditions result inseparate market-clearing exchange rates.This structure has necessitated thedevelopment of a new currency code,CNH, to represent the exchange rate ofrenminbi traded offshore in Hong Kong.Additionally, there is a traditionaloffshore renminbi market, the dollar-settled non-deliverable forward (NDF)market, which itself trades independentlyof either onshore CNY or offshore CNH.

Re-invoicing in Hong KongAt the current time the most importantdevelopment for many internationalcompanies that do business in China isthe emergence of Hong Kong as a re-invoicing centre. Re-invoicing in HongKong is attractive to companies becauseit enables dollars to be converted intorenminbi before they return to China.According to the Hong Kong MonetaryAuthority, in 2011, renminbi tradesettlement handled by banks in Hong

Kong amounted to RMB1.915tr or about92% of the RMB2.081tr total ofmainland China’s external trade settled inrenminbi.Re-invoicing means that a Hong Kong-

based centre buys or sells products to orfrom subsidiaries on the mainland andthen buys or sells them to its otherbusiness units worldwide. The re-invoicing centre acts as an intermediaryfor inter-company flows so thatmainland subsidiaries no longer have tomanage currency risk for invoicing andpayments or perform other treasury roles,such as liquidity management. The modelresults in FX cost savings for exportingand importing activities from and tomainland China. It also gives acorporation flexibility and the ability tohold renminbi as the store of value.Establishing a re-invoicing centre

requires a case-by-case filing with a localPeople’s Bank of China (PBoC) in writing,which is submitted by the company’ssettlement bank. This application mustdescribe the group and its onshoreentities — in terms of industry, businessscope, the relationship between entities,current settlement model, annual

settlement value, and the onshoreentities’ import and export values.Among other requirements, theapplication must also commit to amendrenminbi-denominated sales contractsand invoices between onshore andoffshore entities so that settlement isrouted to the account of the settlementhub. The application must also declarethat settlement will not involve nettingand provide evidence to verify theauthorised signatory.

Why invoice in renminbi?For companies outside of mainlandChina, there are many advantages tousing renminbi. For exporters selling tomainland China, using renminbi offersthe ability to sell in local currency andtherefore expand their customer base. Byeliminating FX risk for mainlandimporters, such companies may alsopotentially achieve better pricing ongoods and services. They can also reduceDays Sales Outstanding.Importers buying from mainland China

can expand their supplier base (to includeMainland Designated Enterprises, whichare companies eligible for renminbi cross-

Figure 1 – Rernminbi flows

Sunil Bhatia

Nilesh Kothari

Sarah Leung

border settlement) by having an ability topurchase in renminbi. FX risk formainland exporters is reduced, whichmay help importers buying from China toobtain better terms for goods andservices. In addition, by invoicing inrenminbi companies can benefit fromsimplified documentation and customsrequirements that are less onerous thanfor dollars.Larger international entities are well

placed to set terms for a transaction andtherefore choose whether they want tosettle in renminbi. However, smaller

entities inevitably have less flexibility andmay have to accept terms set by Chineseexporters. Nevertheless, in the long termthe expectation is that both exportersand importers will move towards usingrenminbi as their settlement currency.Before deciding to use renminbi as an

invoicing currency, companies need firstto check with their trading partners inmainland China that they are ready topay and receive renminbi funds for tradesettlement. They must also confirm withtheir trading partner that their banks canaccept cross-border renminbi payments

and that they accept renminbi paymentswith the account name in English.

Deciding how to makerenminbi paymentsFor importers buying from mainlandChina and agreeing to take renminbi risk,an important decision is whether tomaintain an account in renminbi orsimply to convert to renminbi whenpayments need to be made.When liberalisation of the renminbi first

began, there was strong enthusiasmamong companies to maintain positionsin the currency as it was widely expectedto appreciate strongly: the decision waslargely speculative. As expected,appreciation occurred. While the renminbiis expected to continue to appreciateagainst the dollar, the speed of thatappreciation has slowed considerably andit is likely that there will be somevolatility over the medium term.Consequently, the financial benefits

from maintaining a renminbi position areno longer a key driver of the decision tohave a local currency account. Instead,most companies’ decisions to open a localcurrency account are based on theirbusiness needs: those companies thatexpect to have inflows (from collections)— rather than simply the need to makepayments — are most likely to have arenminbi account and maintain a positionin the currency.Other companies may find it simpler to

make payments from a USD account andconvert to renminbi as necessary. Makingsuch a payment is straightforward: the FXcomponent can be done automatically.However, the FX conversion must be doneonshore and the payment must havedocumentation to prove that it is relatedto trade in goods or services (see figure 1).If an international company decides it is

advantageous to open a renminbiaccount, it must then consider how tofund that account. Often companieschoose to fund renminbi accounts fromtheir USD account through the offshoremarket, which can offer rates that aremore attractive and which does notrequire documentation, unlike theonshore market.

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Figure 2 – Forward curve chart

The location of the renminbi accountcan be in the US or Hong Kong:depending on companies’ bank providers’functionality it may be possible for eitheraccount to operate through the bank’sstandard global platform but with localcustomer service. Ultimately, the decisionmay be down to time zoneconsiderations: if a corporation is makingpayments from Hong Kong then themarket will already be closed when theUS business day begins. Equally, if theaccount is based in San Francisco, fundswould not come into the account untilafter the US business day.

Hedging benefitsAs well as offering opportunities to lowercosts, invoicing in renminbi creates risksthat need to be closely monitored andmanaged. Fortunately, internationalcompanies have numerous possibilitiesfor hedging different types of exposure

when using Hong Kong as a re-invoicingcentre.Hedging renminbi is complex because

of China’s two spot markets — CNY, CNHand three forward markets — CNY, CNHand NDF. Each market has a differentcurve — the onshore CNY spot isanchored by the PBoC and can only moveplus or minus 1% from fixing rate. Theonshore forward curve is relatively stablewhile the offshore CNH spot market andNDF markets are driven by supply anddemand and could therefore be morevolatile. Corporations that haveexposures simultaneously in either of thetwo markets are exposed to basis risk.Different types of renminbi hedges are

applicable for different types of entitiesin different circumstances: restrictionscan be complex so it is essential forcorporations to seek advice. The onshoremarket is primarily used by onshoreparticipants and onshore banks. CNY

onshore forwards can be rolled over orrolled back, based on changes in paymentflow.Over the past year, despite the

unsettled global economy and signs ofslowdown in growth in China, there hasbeen a rise in demand from Europeanexporters — in the car industry, forexample — to hedge CNY exposure. Upuntil around 18 months ago, manyEuropean corporate clients broke theirEUR/CNY exposure down into EUR/USDand USD/CNY. The EUR/USD componentwas managed as part of the overallEUR/USD exposure while the USD/CNYcomponent was in many cases leftunhedged as CNY was expected toappreciate until the value date of thetransaction. Some clients used CNY/NDFsfor occasional hedges during periods ofuncertainty. The local subsidiary wouldexecute spot USD/CNY onshore on thevalue date or occasionally enter into

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Development of Renminbi Cross-Border Settlement

In July 2009, the Chinese government launched a pilotscheme to allow renminbi cross-border settlement. Thescheme was originally restricted to the trade of goods andinvolved 400 Mainland Designated Enterprises (MDEs) inShanghai and four cities in Guangdong province. Offshoreparticipants in the pilot had to be located in Hong Kong,Macau or 10 ASEAN countries. Documentary evidence wasrequired and the use of offshore renminbi proceeds wasrestricted.In June 2010, the scope of the pilot scheme was expanded

to include service trade ( such as royalties and managementfees) and other current account items (such as dividends).The geographical range of the pilot was also enlarged toinclude exporter MDEs from 16 provinces and all importercompanies/entities in 20 provinces. The range of offshoreparticipants was expanded to include all countries worldwide.Just a month later, a supplementary memorandum

published by the PBoC, the country’s central bank, and theHong Kong Monetary Authority, which fulfils the same role inthe special administrative region, authorised institutions inHong Kong to open renminbi deposit accounts for corporatecustomers for general purposes. It also permitted transfersacross offshore renminbi accounts. In December that year, theMDE list was expanded, with 67,724 MDEs approved.The pace of reform accelerated further in 2011. In January,

a new scheme for settlement of overseas direct investment in

renminbi was established and mainland China enterpriseswere allowed to conduct direct investments overseas usingrenminbi (with approval). In June that year, foreignenterprises were permitted to remit offshore renminbi back tomainland China in the form of foreign direct investment (FDI)with PBoC approval.In August 2011, renminbi cross-border settlement expanded

to all the provinces and cities in mainland China. All Chineseenterprises became eligible for renminbi settlement forimport of goods, service trade and other current accountitems while approved MDEs were allowed to use renminbisettlement for the export of goods. In October, newregulations on renminbi FDI in mainland China wereintroduced: capital injections were allowed (subject toapproval by the Ministry of Commerce or its local branch andregistration with the PBoC). Renminbi cross-border loans(from shareholders, affiliate companies or financialinstitutions) were also permitted, with no need for case-by-case pre-approval by the PBoC.In June 2012, renminbi settlement for exports was extended

to all of China. In addition, China’s government said it wouldcreate a special renminbi zone in Shenzhen (where thecountry’s economic reforms began in 1980) called QianhaiBay, which is adjacent to Hong Kong. Banks from Hong Kongwill be able to lend renminbi directly to companies in thezone.

As well as

offering

opportunities

to lower

costs,

invoicing in

renminbi

creates risks

that need to

be closely

monitored

and

managed.

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onshore outright transactions.The hedging behaviour of many

European exporters has changed andhedging volumes have risen significantlyfor several reasons. Firstly, CNY exposurehas increased because European exportershave made rapid gains in market sharewithin a fast-expanding Chinese market.Secondly, there is a risk of CNYdevaluation: corporates are aware of thetwo-way risk of USD/CNY. Thirdly, theintroduction of deliverable CNH meansthat CNY exposure management can nowbe part of the head office riskmanagement process for deliverablecurrencies. Finally, the growing liquidity of spot

and forward markets in deliverable CNHallows some corporates with largeexposures to start hedging the exposureat parent level as the market can finallytake their volume. As a result, a growingnumber of corporations are hedging theirCNY/CNH exposure in the same way asthey hedge G10 currency exposures: CNHhas become just another deliverablecurrency in the risk management process

at parent level.Hedges for trade and operational flows,

such as payables and receivables, shouldbe based on actual underlying exposureor forecast payments: speculative tradesare not permissible. Currently, Chinasubsidiaries typically hedge around 75%of total exposures. The balance sheets ofChina assets can be hedged to mitigateunrealised FX P&L on accounting reports.The tenor of hedges should match thetenor of the exposure and can be rolledover at maturity for the next accountingperiod.Onshore CNY forwards cannot be

booked under the name of any offshoreentities. Instead, they can either useoffshore NDF hedges — with the net USDdifference settled against the PBOCfixing rate — or the deliverable offshoreCNH market. However, availability of CNHforwards is subject to liquidity conditionsin the market. Inter-company loans inrenminbi can be hedged using CNHforwards or NDFs and then injected intoChina in the form of renminbi. For inter-company loans in USD, the post-

conversion must be done with the bankthat holds the FX account for thecompany.

Hedging flexibilityWhile the existence of three forwardmarkets adds complexity, it also offersflexibility. Companies with the ability toaccess all three renminbi forward marketscan decide which market to use forhedging (based on the relativeattractiveness of each curve) and underwhich entity (onshore or offshore). Suchcompanies can choose to hedge offshorein Hong Kong in order to consolidate andhedge exposure in a single offshore entity.An international exporter might want to

sell dollars against CNH if it offers a betterrate than CNY or NDFs. Alternatively, anentity wishing to sell against the dollarmay find CNY spot or forwards or NDFsmost attractive, depending on marketconditions at the time. As curves changeon a daily basis, it is important forcorporations to work closely with theirbank to ensure their choice of currencybest meets their needs. �

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