Offshore RMB

Express Issue 49‧

March 2018

Contents

Part 3

Part 4

Part 1

Special Topics

Chart Book

Market Review

Part 2 Policy and Peers Updates 4

7

1

Editors：

Annie Cheung

Tel ：+852 2826 6192

Email : anniecheung@bochk.com

Kera Kong

Tel：+852 2826 6205

Email: kerakong@bochk.com

Sharon Tsang

Tel ：+852 2826 6763

Email: sharontsang@bochk.com

15

Market Review

Offshore RMB Express 1

1. Offshore RMB exchange rate

continued to rise

In February 2018, the U.S. dollar index

rebounded slightly. Meanwhile, the RMB

appreciated against the U.S. dollar, pushing

up the CFETS RMB exchange rate index

slightly as the RMB appreciated against the

basket currencies. Currently, the RMB’s

exchange rate has remained stable at

around 6.34. Although the RMB’s exchange

rate became volatile during the Lunar New

Year, its performance remained relatively

solid. On February 28, CNH appreciated by

0.52% for the month and closed at 6.331,

while CNY appreciated by 0.67% to 6.331.

Overall, the RMB’s exchange rate is

expected to stabilize in the short term, and

the cross-border capital flows will maintain

basically balanced. As for HIBOR fixing,

CNH HIBOR fixing rates were relatively

stable in February. On February 28, the O/N,

1-week and 3-month CNH HIBOR rates were

2.9645%, 3.4623% and 4.652%, respectively.

2. Major RMB business indicators

declined slightly

RMB deposits in Hong Kong decreased

by 2.3% MoM to RMB 546.4 billion in

January 2018. The total remittance of RMB

for cross-border trade settlement amounted

to RMB 373.4 billion in January, down by

RMB 55.3 billion from the previous month. In

Taiwan’s offshore market, RMB deposits

increased by 17% to RMB 377.6 billion in

January 2018 from end-2017. RMB deposits

in Singapore increased by 20.1% YoY to

RMB 152 billion as of end-2017.

In February, the exchange rates of both onshore and offshore RMB against the US dollar

(CNY and CNH) continued to perform strongly, major offshore RMB business indicators

recorded a slight decline, but offshore RMB bond markets showed signs of recovery. The rising

international usage of RMB and further opening of the domestic capital markets have provided

solid support for the long-term and steady development of RMB internationalization.

Offshore RMB Market Performed

Steadily

Market Review

Offshore RMB Express ２

SWIFT data in January 2018 showed that the

RMB maintained its position as the fifth most

used currency for global payments with a

market share of 1.66%. Besides, Hong Kong

continued to be the largest offshore RMB

center, accounting for 75% of the total

offshore RMB turnover. In February 2018,

RTGS turnover decreased by 19.9% MoM to

RMB 15.36 trillion.

3. Dim Sum bond market recovered

In February, the Macao SAR issued its

first offshore RMB bond (named "Lotus

Bond" at a total of RMB 4 billion). This "Lotus

Bond" was also the largest bond issuance

among the offshore RMB markets since the

"August 11" reform, reflecting the

strengthened investor confidence around the

globe and the surging demand for offshore

RMB asset allocation. As of February 2018,

the issuance of Dim Sum bond was RMB 6

billion, which increased substantially from

RMB 630 million in the same period of last

year.

4. International use of RMB continued

to rise

Recently, the National Bank of Pakistan

issued a statement, which approved traders

to use RMB as the settlement currency for

their bilateral trade with China. The French

central bank, the Bundesbank and the central

bank of Spain revealed their intention to

invest in RMB. The Belgian central bank and

the Slovakian central bank have already

Market Review

Offshore RMB Express 3

added RMB assets. The central banks of

China and Thailand have renewed a

currency swap agreement of RMB 70 billion

(equivalent to THB 370 billion). According to

the latest data released by the People’s Bank

of China, as of the end of January 2018, the

bonds held by overseas institutions in

China's interbank bond market increased by

145% YoY and exceeded RMB 1.25 trillion,

setting a new record and marking the 11th

consecutive monthly gain.

5. Domestic capital markets opened

further

According to statistics from the State

Administration of Foreign Exchange (SAFE),

the approved quota for RQFII totaled RMB

612.4 billion as of February 27, up RMB 2

billion compared with a month ago, with a

total of 196 qualified foreign institutional

investors having been approved. At the same

time, the approved quota for QFII totaled

RMB 99.2 billion as of February 27, with a

total of 286 qualified foreign institutional

investors having been approved. In addition,

the approved quota for QDII totaled RMB 90

billion as of February 27, with a total of 132

qualified foreign institutional investors having

been approved. Both the approved quota and

the number of institutional investors were the

same as the previous month. No new quotas

were approved in the past 27 months.

Policy and Peers Updates

Offshore RMB Express 4

BOC Macau branch issued RMB 4 billion

bonds abroad

On February 26, Bank of China (BOC) Macau branch completed pricing of RMB 4

billion bonds issued abroad, including RMB 1.5 billion 1-year bonds and RMB 2.5 billion

3-year bonds. The funding costs were lower than those onshore bonds for the same

tenors. The issuance amount was the largest in the offshore markets since the “August

11” reform. There were active responses from international investors, implying that they

had more confidence in RMB internationalization and increasing demand for offshore

RMB asset allocation.

Sharjah of UAE issued RMB 2 billion sovereign panda bonds

On February 1, the Government of Sharjah, one of the members of the United Arab

Emirates (UAE), issued RMB 2 billion panda bonds with 3-year tenor in China’s interbank

market. Bank of China was the bookkeeper and one of the joint underwriters for the

issuance, joining with Industrial and Commercial Bank of China, HSBC (China) and

Standard Chartered Bank (China). Until now, the British Columbia Provincial Government

of Canada, Hungary, Poland and South Korea have issued sovereign RMB bonds in

China’s interbank bond market.

China will launch crude oil futures in late March

China Securities Regulatory Commission announced that preparations for the launch

of crude oil futures have almost done, and the futures contract will be listed on the

Shanghai International Energy Exchange on March 26. According to the Shanghai

International Energy Exchange, the RMB-denominated futures contract will be available

to foreign investors, exchanges and petroleum companies, facilitating the influences of

Chinese enterprises and exchanges on international oil prices.

Policy and Peers Updates

Offshore RMB Express 5

JPMorgan Chase became the second RMB Clearing Bank in the US

On February 13, the People’s Bank of China authorized JPMorgan Chase & Co. as

the RMB Clearing Bank in the US, making it the second RMB Clearing Bank in the US

following BOC New York branch. Some market views stated that competition among two

Clearing Banks would not be fierce, as the US is the world’s largest economy and

important financial center. On the contrary, they could complement each other’s strengths

and promote cross-border RMB settlement between China and the US.

Special Topics

Offshore RMB Express

At the beginning of 2018, spillover effects of monetary policies from major economies

triggered simultaneous fluctuations in global financial markets. Persistent systemic risks

revealed the intrinsic drawbacks under the existing global monetary system led by the US

dollar. Diversification of global monetary system should proceed at a faster pace.

Meanwhile, RMB internationalization has entered a new stage of development. In January

2018, the People’s Bank of China (PBOC) improved and optimized policies for cross-

border RMB business. The policies sent out positive signals, which would support cross-

border RMB settlement by enterprises, facilitate foreign institutional investors to use the

RMB for direct investment, and promote RMB business for individuals. Control measures

on cross-border fund flows, especially some temporary administrative measures, are

likely to ease gradually given receding depreciation pressure on the RMB. This will

provide favorable conditions for the resumption of RMB internationalization.

Dr. Zhihuan E,

Chief Economist, Bank of China (Hong Kong)

Risk Control is the Priority for the

Resumption of High-Quality RMB

Internationalization

7

Financial risk control determines the

potential of RMB internationalization

With deepening integration with the global

financial system, China’s financial markets will

engage complex global market environment

directly and be subject to a variety of external

shocks. As a result, risk control plays a crucial

role in financial market opening.

While external risks escalate, financial

risks in China’s economic development are

becoming more prominent. Total debt to GDP

ratio climbed to 284% in 2017 from 277% in

2016. It requires tremendous efforts to reduce

leverage ratio, while risks of shadow banking,

property finance and internet finance continue

to accumulate. Against the backdrop, there is

urgent need to prevent and resolve financial

Special Topics

Offshore RMB Express 8

risks through controlling leverage ratio,

enhancing the adaptability of financial

structure, increasing the capability of

financial services to support the real

economy, strengthening the development of

mandatory constraint system and controlling

systemic risks. The PBOC improved macro-

prudential policies on cross-border fund flows

and conducted counter-cyclical adjustments

on capital flows. Moreover, the PBOC

continued to deepen reform of the RMB

fixing mechanism, based on market supply

and demand dynamics and a basket of

currencies, as well as adopting a managed

floating exchange rate regime. Consequently,

the RMB would be more determined by

market factors with flexibility and maintain its

stable status in the global monetary system.

Apparently, China’s capability of

controlling external and internal financial

risks determines the potential of RMB

internationalization. During the second half of

2017, market sentiment turned neutral with

the RMB approaching equilibrium, and the

central bank adjusted its policy timely by

relaxing a series of "temporary" and

"transitional" cross-border macro prudential

management measures, including removing

the risk reserve ratio of foreign exchange and

the requirement for foreign banks to set

aside reserves for offshore RMB deposits in

China. In 2018, the expectation of RMB

depreciation has reversed. The PBOC

adjusted the counter-cyclical coefficient

incorporated in central parity fixing model

accordingly. The RMB fixing mechanism

would be more liberalized, with more

weighting on market supply and demand

dynamics. Theoretically, this would be

favorable for promoting businesses related to

RMB internationalization.

If systemic shocks occur in global

financial markets, the stability of the RMB will

be under new pressure, and the pace of

RMB internationalization will be adjusted

accordingly.

Four takeaways on the roadmap of

RMB internationalization

First of all, RMB internationalization is a

long-term strategy. Theory innovation and

exploring the way of implementation are

necessary regarding major topics on

developing a modern economy. A theoretical

framework should be built underpinned by

macroeconomics and finance perspectives

with a comprehensive and open approach.

The basic roadmap of RMB

internationalization is to persist in

liberalization reform in foreign exchange

market, maintain the RMB’s stable status in

Special Topics

Offshore RMB Express ９

the global monetary system, resolve the

systematic drawbacks under existing global

monetary system led by the US dollar,

provide an alternative option and new public

goods from emerging markets, and offer a

Chinese solution in order to promote a more

robust and fair global monetary system.

Next, create room for RMB

internationalization, following the trend of

China’s financial market opening, driven by

policy while guided by markets. Technically,

increasing the RMB’s proportion in global

exchange reserves and foreign exchange

market cannot be realized in a short period of

time. Instead, it is necessary to explore from

multiple perspectives, such as cross-border

trade and investment, encouraging third-

party usage, etc. Consequently, the

collaborating development of merchandise

trade, investments and financial transactions

will help formulate an effective roadmap for

RMB internationalization.

In addition, demand for global asset

management by domestic entities is likely to

rise for an extended period of time. In China,

the holding of foreign financial assets by

private sector amounts to 27% of GDP. The

ratio is significantly lower than 129% for the

US and 147% for Japan. Therefore, the scale

and structure of capital flows will continue to

adjust and optimize, and the factors affecting

RMB internationalization will be more diverse.

A bottom line mindset with core value of

controlling financial risks is needed. In-depth

analysis on relevant policies and potential

market impacts should be taken when

making major policies.

Finally, RMB internationalization is a

major topic of global monetary system. The

objective of RMB internationalization implies

that China will take more responsibility on

maintaining the stability of global financial

system and play a proactive role in global

financial governance. Accordingly, policy

collaboration between domestic and foreign

markets, taking into account the interests of

domestic and foreign entities, should be

emphasized in order to promote RMB

internationalization progressively.

12

Special Topics

Offshore RMB Express

The Scale and Structure of

China’s U.S. Treasury Holding

from TIC Data

Michael DAI, Senior Economist

In recent months, with trade frictions between China and the U.S. rising, the yield

on the 10-year U.S. Treasury also continued to rise. The data from U.S. Department of

the Treasury showed that in November 2017, China's U.S. Treasury holdings were

down by USD 12.6 billion from October, raising concerns about continued decline in

China’s Treasury holdings.

Treasury International Capital System

(TIC) of the U.S. Department of the Treasury

is the most official statistics provider for

foreign investor holdings of USD securities

assets, including Treasury. The statistics are

specific to asset categories such as

government bonds, agency bonds, corporate

bonds and equities that provide global

comparable data. These statistics can

provide a useful reference but should not be

considered comprehensive for USD

securities assets held by foreign investors,

as their data come from filings and surveys

by domestic custodians (including banks,

brokers, investors, issuers, etc.), and there

are thresholds for reporting amount (for

example, the amount of cross-border

transactions has to reach more than USD 50

million). The identity of foreign investors may

not be accurately reflected in the TIC

statistics if they trade and hold USD assets in

offshore markets. In addition, the foreign

investor statistics are not subdivided into

official and private investors. Nevertheless,

the statistics are still the most important

series for market tracking and analysis.

11

Special Topics

Offshore RMB Express

According to its statistics, China’s U.S.

Treasury holdings actually decreased by

USD 12.6 billion in November 2017 from the

previous month, but one should not read too

much into the one-month change. Firstly, the

statistics show that China added USD 8.3

billion of U.S. Treasury in December again.

In 2017, there were three months of decline

and nine months of increase in China's U.S.

Treasury holdings. The largest monthly

increase is USD 44.2 billion in June. For

2017 as a whole, the total amount of China’s

U.S. Treasury holdings increased by USD

126.5 billion from the end of 2016. Secondly,

according to TIC statistics, the balance of

U.S. national debt held by foreign investors is

calculated based on the market value of the

Treasury bonds and notes (short-term

government bills are denominated in face

value but do not change the conclusion due

to their low shares). In 2017, the U.S. 10-

year Treasury yield dropped slightly from

2.44% to 2.41%, so the long-term Treasury

bonds should slightly appreciate, but the

magnitude is small and not big enough to

change the conclusion that China is

increasing its holdings of U.S. Treasury.

As mentioned above, TIC statistics do

not subdivide foreign investors into official

and private investors. However, based on the

foreign exchange management system in

China, the vast majority of the U.S. Treasury

owned by China should be the holdings of

official foreign exchange reserves. Firstly,

China’s international investment position

released by State Administration of Foreign

Exchange in the third quarter of 2017 shows

that, of the foreign assets held by China, the

size of reserve assets totalled USD 3204.4

billion (the vast majority of which was foreign

exchange reserves), while privately held

foreign securities assets amounted to only

USD 453.8 billion, of which only USD 171.9

billion were in bonds. As a result, China's

increasing instead of declining holdings of

U.S. Treasury become more prominent, as

China's official foreign exchange reserves

rose by USD 129.4 billion in 2017, almost

equal to China's increased holdings of U.S.

Treasuries (USD 126.5 billion). It shows that

not only official but private investors are also

increasing their holdings of U.S. Treasury.

12

Special Topics

Offshore RMB Express

Secondly, the bottoming of China's

foreign exchange reserves in 2017 was due

to the factors of balanced cross-border

capital flows, depreciation of the USD and

the rise in the valuation of non-USD assets in

foreign exchange reserves. The People's

Bank of China’s funds outstanding for foreign

exchange dropped in the first eight months of

2018, rose slightly in September to

November and fell again in December. The

central bank’s funds outstanding for foreign

exchange fell by a total of RMB 463.7 billion

for the whole year. The decline was

significantly narrower than the RMB 4,644.1

billion decline in 2016. In addition, as G10

currencies appreciated against the USD in

2017, with the Euro, British Pound and the

Japanese Yen up by 14.2%, 9.5% and 3.8%

respectively against the USD, non-USD

assets converted into USD in China’s foreign

exchange reserve would appreciate. While

this was an accounting gain, the increase of

US Treasury holdings has to be paid for by

real money, corroborating China’s increasing

instead of reducing US Treasury holdings.

The situation is similar with longer

historical data. China’s official foreign

exchange reserves peaked at USD 3,990

billion in June 2014 and dropped to USD

2,998.2 billion by January 2017, for a drop of

USD 991.8 billion or by 24.9%. During the

same period, TIC showed that U.S. Treasury

held by China was reduced from USD

1,268.4 billion to USD 1,051.1 billion, for a

decrease of USD 217.3 billion or 17.1%.

Judging from the asymmetrical decline of

China’s official foreign exchange reserves

and U.S. Treasury held by China, China was

very cautious with reducing holdings of U.S.

Treasury to cope with outflows and the

decline in foreign exchange reserves. The

ratio of China’s holding of U.S. Treasury to

China's foreign exchange reserves rose from

31.8% to 35.1%, as any reductions of

holdings were conservative and passive. In

addition, the reduction of China's foreign

exchange reserves during this period was

due to the outflow of capital as well as the

strong U.S. dollar causing the impairment of

the non-USD portfolio. However, the impact

of the latter is relatively small and will not

change China's positive attitude of holding

U.S. Treasury.

13

Special Topics

Offshore RMB Express 14

There are long-term and short-term U.S.

Treasury securities. More than 99% of

China’s holdings are long-term Treasury

bonds and notes. In horizontal comparison,

China and Japan are the largest holders of

official foreign exchange reserves and U.S.

Treasury in the world. Interestingly, however,

TIC data show that Japan’s holding of U.S.

Treasury outnumbered China’s from October

2016 to May 2017, by more than USD 50

billion in some months. Considering that

Japan's official foreign exchange reserves

amount to only 40% of that of China, this

implies that a certain part of Japan's holdings

of U.S. Treasury are held by the private

sector rather than the Bank of Japan, which

is partially the result of Yen convertibility and

Japan as the world's largest creditor. In

addition, short-term U.S. Treasury bills held

by Japan are over 5.0%, obviously different

from China’s less than 1.0%.

In addition to Treasury, the broad

definition of long-term USD securities assets

includes agency bonds, corporate bonds and

equities. TIC data show that the size of these

four types of assets held by China in

November 2017 were USD 1173.1 billion,

USD 174.3 billion, USD 16.4 billion and USD

197.6 billion respectively, with an aggregate

amount of USD 1561.4 billion, equivalent to

50% of USD 3119.3 billion of foreign

exchange reserves in the same period. As

for Japan, it held USD 1,021 billion of long-

term U.S. Treasury, USD 247.6 billion of

agency bonds, USD 206.3 billion of

corporate bonds and USD 526.5 billion of

equities over the same period, with an

aggregate amount of USD 2001.5 billion,

equivalent to 167% of USD 1198.9 billion of

Japan’s foreign exchange reserves in the

same period, reflecting the considerable size

of its private holdings.

Due to the involvement of private

investors, in long-term USD securities assets,

Japan holds more than ten times of

corporate bonds than China and more than

twice of equities than China. The proportion

of Treasury is therefore less than that of

China, reflecting official and private investors’

different mandates on security, liquidity and

risk and return. In 2017, long-term U.S.

securities assets held by China and Japan

both increased significantly, but China's

growth mainly came from U.S. Treasury,

while Japan’s growth all came from other

three types of assets except treasury.

Therefore, for international investors of U.S.

Treasury, it is still reasonable for the market

to scrutinize China.

Chart Book

Offshore RMB Express

Market Indicators

15

Hong Kong RMB Deposits (in RMB bn) RMB Cross-border Trade Settlement (RMB bn)

USD-CNH and USD-CNY Exchange Rates

Source: HKMA Source: HKMA

Source: Bloomberg

Chart Book

Offshore RMB Express 16

CNH HIBOR Fixing (%) Hong Kong Offshore RMB Bond Issuance (RMB bn)

CNH & CNY China Sovereign Curve (%, 28 Feb 2018)

FTSE-BOCHK Offshore RMB Bond Composite Index

Source: Bloomberg

Source: Bloomberg Source: Bloomberg

Source: BOCHK Global Market estimate

End of Feb:

End of Feb:

Chart Book

Offshore RMB Express

January 2016 January 2018

42.96% USD #1

EUR 29.43% #2

GBP 8.66% #3

JPY 3.07% #4

1.66% CNY

EUR 32.75% #2

GBP 7.22% #3

JPY 2.80% #4

#5 2.45% #5 CNY

CAD #6 1.74%

USD #1 38.53%

1.51% #6

CHF

CAD

#7 1.42%

AUD #8 1.38%

17

RMB Clearing Transaction Value (RMB tn)

SWIFT World payments currency ranking & market share

Source: HKICL

Source: SWIFT

Disclaimer: This report is for reference and information purposes only. It does not

reflect the views of Bank of China (Hong Kong) or constitute any investment advice.

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