Offshore RMB Market and

Shanghai-Hong Kong Stock Connect Updates

Ricky Li

Strategic Planner

Economics and Strategic Planning Department

Bank of China (Hong Kong) Limited

Oct 2015

2

A. Latest Updates of the Offshore RMB Market

B. Shanghai-Hong Kong Stock Connect

Content

3

RMB is getting more popular around the globe

BOC Offshore RMB index (ORI)

Source: BOC

China continues to accelerate regulatory reforms towards RMB internationalization

World Payments Currency Ranking & Market Share

Source: SWIFT

• As China’s fast-growing economy continues its integration with the outside world, it is a natural development

for RMB to become more widely used in trade and investment activities.

0.32%

0.33%

0.38%

0.42%

0.50%

0.59%

0.65%

0.75% 0.91%

1.07%

1.13%

1.19%

1.20%

1.27%

1.37%

2012Q2 2013Q2 2014Q2 2015Q2

4

Extension of RQFII quota to multiple key financial markets

A licensed RQFII may raise

RMB funds offshore and

invest directly into securities

markets in China through an

approved investment quota

As of Sep 2015, a total of

RMB411.5bn RQFII quota

has been granted to 141

institutions in 8 countries

A widening channel for offshore RMB funds to access China’s domestic bond and

stock markets

RQFII Quota Distribution

(RMB billion)

RQFII Quota Distribution

(RMB billion)

Source: People’s Bank of China, BOCHK

80

80

80

80

50

80

50

270 270 270

20

2011 2012 2013 2014

30 50 50

Jul 2015

80

80

80

80

50

270

Canada 50 50

Switzerland 50

30

Luxembourg Chile

50

50 Hungary 50

Qatar

Hong Kong

UK

Singapore

France

Korea

Germany

Australia

5

More RMB clearing banks were designated by PBoC Countries

/Regions

RMB Clearing Banks

appointed by PBoC Key Competencies

Hong Kong BOC Hong Kong (Dec 2003) First-mover advantage / largest liquidity pool

Efficient financial infrastructure

Macau BOC Macau (Sep 2004) Proximity to China

Taiwan BOC Taipei (Feb 2013) Trade surplus; Easy acceptance

Singapore ICBC Singapore (May 2013) An established commodity & FX trading center

UK CCB London (Jun 2014) Traditional FX trading center & Europe financial center

Germany BOC Frankfurt (Jun 2014) Strong trade relationship

France BOC Paris (Jun 2014) Breakthrough to Africa

South Korea BOCOM Seoul (Jul 2014) Close economic and political tie

Luxembourg ICBC Luxembourg (Sep 2014) Largest fund centre in Europe

Qatar ICBC Doha (Nov 2014) First RMB clearing bank in Middle East

Canada ICBC Canada (Nov 2014) First RMB clearing bank in North America

Australia BOC Sydney (Nov 2014) Growing trade and financial linkages with China

Malaysia BOC Malaysia (Jan 2015) Strong trade relationship

Thailand ICBC Thailand (Jan 2015) 3rd largest ASEAN trading partner of China

Chile CCB Chile (May 2015) First RMB clearing bank in South America

Hungary BOC Hungary (Jun 2015) One of the largest trading partner of China in central/

eastern Europe

South Africa BOC Johannesburg (Jun 2015) First RMB clearing bank in Africa

Argentina ICBC Argentina (Sep 2015) China is the 2nd largest trading partner of Argentina

6

6

6.1

6.2

6.3

6.4

6.5

6.6

Central parity rate

CNH

CNY

Enhancement of RMB central parity rate fixing mechanism

An important step in forming the market-oriented mechanism of RMB exchange rate

• On August 11, 2015, the PBOC

revamped the central parity rate

fixing mechanism: “Before opening

of the interbank foreign exchange

market, the market makers provide

quotation to China Foreign Exchange

Trading System with reference to the

closing exchange rate on the previous

day, including considerations of

demand-supply conditions and

changes in exchange rates of major

currencies.”

Source: Bloomberg, BOCHK Research

The Trend of CNH, CNY and Central

Parity Rate Against USD

7

The spread between CNY and the central parity rate narrowed

After the change in the reference rate fixing mechanism, the spread between CNY and the central

parity rate nearly eliminated.

However, the spread between CNY and CNH increased significantly.

The volatilities of CNH were much larger than that of the CNY after change in the mechanism

After PBOC improved the CNY|USD central parity rate fixing mechanism, there has been

substantial changes in the spreads between CNY, CNH as well as the central parity rate

1106

1264

-200

0

200

400

600

800

1000

1200

1400

2/2/2015 2/3/2015 2/4/2015 2/5/2015 2/6/2015 2/7/2015 2/8/2015 2/9/2015

Spread between CNY & CNH Spread between CNY &Central parity rate

Source: Bloomberg, BOCHK Research

8

RMB may not keep up the pace with USD appreciation

Factors that may exert downward pressure on

the RMB exchange rate against the USD

– The weakening Chinese economy

– The flagging export sector

– In terms of the real effective exchange rate,

RMB appreciated 12% in the past one year

– The Fed’s rate hike may lead to a continued

strong USD

The chance of sharp depreciation is not high

– The PBOC may stabilize the FX market

– Although China’s economy is still weak, the

growth rate of GDP will not largely diverge

from the target of approximately 7%, which is

still higher than most countries.

Slim chance of sharp depreciation within this year, but downward pressure remains

100

105

110

115

120

125

130

135

Source: BIS

RMB real effective exchange rate

9

Relaxed restrictions for interbank bond market access

Widened investment scope for Offshore Institutional Investors in the Interbank

Bond Market, scale and frequency of investments are expected to increase

• Financing quota shall not

exceed the amount of

outstanding bond

• Funds obtained through the

repo transactions can be

transferred for use in offshore

• Greater flexibility in bond

investments onshore, which will

attract more offshore

institutions to invest RMB into

onshore interbank bond market

Jun 2015:

Clearing Banks and

Participating Banks Authorized

to Conduct Repo Transactions

in the Interbank Bond Market

• Pre-approvals are no longer

required to access the

interbank bond market

• Institutional investors can

decide their own amount of

investment

• Broader range of investments

to include bond repo, bond

lending, forward bond

agreements and other

derivative products

Policy Relaxation on Interbank

Bond Market Access for

Offshore Sovereign Institutions

Mainland

China’s Interbank

Bond Market

July 2015:

10

Currently, the RMB liquidity pool in

Hong Kong accounts for more than

40% of the entire offshore pool

In Q2, the RMB deposits increased

for three consecutive months as

RMB exchange rates became stable

The recent RMB exchange rate

fluctuation lead to the slight decline

in the Hong Kong RMB deposit

Substantial RMB liquidity pool supports the financing activities for global institutes

and corporate customers

Hong Kong RMB deposits dropped slightly

Hong Kong RMB Customer Deposits

(RMB billion) Aug 2015

979bn

Source: HKMA

0

200

400

600

800

1000

1200

01/10 01/11 01/12 01/13 01/14 01/15

11

Issuance of offshore RMB bond decelerates

In Q2 2015, the total issuance of

offshore RMB bond was

RMB41bn, jumped more than

200% QoQ.

However, the issuance volume

decelerated in Q3 as investors

worried that the RMB might further

depreciate.

The yield of the offshore RMB

bond in the secondary market

increased. To a certain extent, this

might affect the intention of issuing

RMB bond

127

91

64

37

120

51

81

52

88

113

90

230

4 7 21 15

234

88

271

114

173

126

432.86

175.5

129.25

67.5

234.59

139.5 123

32

55

20.5

57.9 51.92

193.5

161.5

57.2

12.5

0

50

100

150

200

250

300

350

400

450

07/12 01/13 07/13 01/14 07/14 01/15 07/15

The offshore RMB bond market developed rapidly in the past few years. Recently,

the issuance amount dropped due to investors’ concern on exchange rate

Source: BOCHK

12

RMB RTGS continueed to grow very rapidly

In the first half of this year, the

total RMB RTGS volume in Hong

Kong amounted to over

RMB100tn, YoY 30%.

The total RMB RTGS volume

was equivalent to 98% of the

sum of the RTGS volume in

HKD, USD and EUR.

Offshore transactions accounted

for nearly 90% of the RMB RTGS

volume, while about 10% was

cross-border transactions

0

5

10

15

20

25

01/11 07/11 01/12 07/12 01/13 07/13 01/14 07/14 01/15 07/15

The RMB clearing bank in HK provides reliable and efficient RMB clearing services

to financial institutions all over the world.

Aug 2015

21.8tn

Hong Kong RMB RTGS Volume (RMB trillion)

Source: HKICL

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RMB’s growing reputation among central banks

UAE, 35bn

Korea, 360bn

Pakistan, 10bn

Iceland, 3.5bn

Belarus, 20bn

Hong Kong,

400bn

Thailand, 70bn

Malaysia, 180bn

Indonesia, 100bn Singapore, 300bn

Mongolia, 10bn Kazakhstan,

7bn

Uzbekistan, 0.7bn

Turkey,

10bn

Australia, 200bn

Argentina, 70bn

Brazil, 190bn

UK, 200bn

Ukraine, 15bn

New Zealand,

25bn

Hungary, 10bn Albania,

2bn

ECB, 350bn

Source: PBoC, BOCHK

Switzerland, 150bn

Qatar, 35bn

Russia, 150bn

Sri Lanka,

10bn

Canada, 200bn

Armenia, 1bn

Suriname, 1bn

South Africa, 30bn

Chile, 50bn

Many central banks around the world have signed bilateral currency swap

agreements with People’s Bank of China.

• Total Amount of the Bilateral Currency Swap Line is now more than RMB3.1tn

14

Inclusion of RMB in the SDR basket

According to PBoC, RMB is now the 7th largest reserve currency in

the world. More than 40 worldwide central banks or monetary

authorities have already added RMB into their reserve

The compositions of SDR will be reviewed at the end of 2015 and

the new currency basket will be effective from September 2016. We

believe that RMB is possible to be added in the SDR basket in the

coming review

According to IMF, a currency could be included in the SDR basket

when

1. the volume of merchandise and service export in the country is

one of largest in the world in the past 5 years, AND

2. it is a freely useable currency

USD, 41.9%

EUR, 37.4%

GBP, 11.3%

JPY, 9.4%

Current Composition of the SDR

After decade of monetary and currency reforms, RMB basically fulfills the criterion for

adding into the SDR basket

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A. Latest Updates of the Offshore RMB Market

B. Shanghai-Hong Kong Stock Connect

Content

16

SH-HK Stock Connect Became A Key Investment Channel

Total turnover (As of Aug 2015)

– Northbound trade - 1.3 trillion

– Southbound trade - 0.53 trillion

The Stock Connect operated very smoothly, showing that the operational mechanism and risk

management measures were effective

760 1023 1536 786 1620

12372

5443 4357 4227 2427 1686

58797554 6193

55677817

10768

10463 1420211139

57484549

Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15

Northbound (NB) Southbound (SB)

Although there are some tapering off in recent weeks, the long term impact of SH-HK

Stock Connect in connecting China’s capital market to the world is significant

SB record of

HKD26.1bn

on 9Apr15

NB record of

HKD23.4bn

on 6Jul15

Source: HKEX, BOCHK Research

SH-HK Stock Connect Average Daily Trading Volume (HKD’m)

17

New policies allowed public

offer fund and social security

fund to buy HK stocks

through stock connect,

southbound trade was getting

more popular

After Jun, the volatilities of

the China’s stock market

increased significantly.

This caused impacts to

Northbound trade to have a

large amount in net-buy or

net-sell

Stock Connect Activities after debut last year

17

Daily net-buy amount in Northbound trade and Southbound trade (RMB 100M)

Northbound trade was more popular than

the southbound trade.

Northbound trade

Southbound

trade

Accumulated amount of Northbound

trade minus Southbound trade

18

Northbound trade was more popular

than Southbound trade

As of Aug 2015, the total turnover of

Northbound trade was 1.3 trillion, while

the total turnover of Southbound trade

was 0.53 trillion. Southbound trade was

once more active in Apr this year

Turnover increased gradually

In both markets, the turnover of stock

connect increased gradually. But still

the volume was quite small, compared

to the whole market. (Daily turnover %

of the whole market: Northbound

(about 0.6%) Southbound (about 1-3%)

Correlated with market indices

Highest Southbound Stock Connect

turnover: RMB227 billion (Jun)

Highest Northbound Stock Connect

turnover: HKD234 billion (Apr)

In the above period, both indices in HK

and SH stock market increased to a

very high level

Quota remained sufficient

Major characteristics of the Stock Connect

In general the overall quota in this

scheme remained sufficient, except

that the daily northbound quota was

once used up in Nov 2014 and the

southbound quota used up in Apr

2015.

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Major implications of Stock Connect

Significance Implications

• Promote the development of the

Hong Kong offshore RMB market

• Explore new customer segments

• Introduce new investment

products

• Provide professional services

• Strengthen the collaboration of

the two markets

• Regulators and the market

participants develop closer

cooperation arrangement, which

will increase the demand for

talents in the financial industry

• In medium to long term, the

capabilities of both capital

markets will be greatly enhanced.

Promote the liberalization and reform of the China’s capital market

Consolidate the position of Hong Kong and Shanghai as financial centres

Support the development of RMB internationalization

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Diversified Investment Channels

PBOC is liberalizing the capital account step-by-step to facilitate cross-border

investment flows and ensure sufficient risk controls are in place

2015 2014 2006 2011 2003 Going Forward

QFII Scheme

QDII Scheme

RQFII Scheme

Shanghai - Hong Kong

Stock Connect QDII2 Scheme

Shenzhen-Hong

Kong Stock Connect

Mutual Recognition

of Funds

• Ultimately, relaxing capital controls provide both domestic and overseas investors with new

investment channels to invest their RMB funds, open up new opportunities for financial-

services firms and help China’s transition to an economy driven more by consumption and

services

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