As Hong Kong is working hard to overcome the lack of liquidity and the dearth of investment instruments and hedging tools, institutional investors are getting bullish about the long-term prospects of Hong Kong’s offshore
As of the end of 2010, the total of offshore renminbi (CNH) in deposit accounts with banks in Hong Kong amounted to 314.9 billion renminbi (US$48 billion), according to the Hong Kong Monetary Authority (HKMA). This is rather small, considering that the balance of broad money supply (M2) – covering cash in circulation and all deposits – amounted to 69.98 trillion renminbi as of the end of October 2010, according to data from the People’s Bank of China (PBoC), China’s central bank.
While traders tend to be more concerned about foreign exchange risks and price margins for their goods, institutional investors (IIs), because of their nature, have different requirements: pension funds, endowments, and central banks are more interested in generating steady but substantial returns (inflation plus) for their stakeholders and need to be able to freely convert their cash holdings into other assets (such as bonds or fixed income, equities and alternatives) that will yield the target returns for covering their liabilities.
Asian IIs generally hold their assets denominated in domestic currencies because the bulk of their liabilities is in domestic currencies. Yet, as a means of diversification and for the purpose of hedging risks, they have substantial holdings in foreign currency-denominated assets too, usually in US dollar, and more often than not in the form of US treasuries.
Keen interest from IIs
The possibility, therefore, that the renminbi becomes a major foreign exchange currency in Asia presents regional IIs with fresh opportunities and challenges, that may force them to rethink the way they manage their assets. An internationalized renminbi would be attractive to regional IIs, principally because of its stability and interest rate differential.
The PBOC’s protective monetary policy means that the renminbi is likely to remain one of the most stable currencies in the foreseeable future. Even if the value of the renminbi appreciates by five percent annually for the next few years – a conservative estimate – it will still be a good investment for regional institutions.
The interest rate differential between the offshore and onshore renminbi would make it profitable for holders of offshore renminbi to bring their renminbi holdings onshore. Renminbi bonds issued by onshore institutions pay a coupon of about 6% while CNH bonds (also known as dim sum bonds) pay about 3%.
The number of Qualified Foreign II (QFII) licences granted could serve as a measure of the interest from Asian IIs and corporates: in 2009 alone, six QFII licences were issued, almost as many as in the period between 2003 (when the programme started) and 2008. According to the latest data available from the China Securities Regulatory Commission (CSRC), those that were granted QFII licenses in 2009 were: Korea Investment Trust Management; BEA Union Investment Management; Bank Negara Malaysia; Woori Bank; Korea Development Bank; and Hanhwa Investment Trust Management.
Yet, despite the keen interest in the offshore renminbi, regional IIs show no sense of urgency to switch their foreign exchange holdings to CNH. Their wait-and-see attitude may be given in by the current lack of liquidity in the CNH market and the shortage of renminbidenominated investment instruments and hedging tools.
Building liquidity, instruments
The good news is that Hong Kong authorities, particularly the Hong Kong Exchanges and Clearing (HKEx) and the HKMA, are working feverishly to lay the groundwork for enhancing the liquidity of the CNH market. On March 3, for example, HKEx announced the establishment of the renminbi equity trading support facility (TSF), a mechanism that is designed to provide liquidity support for investors that will be buying renminbi-denominated shares in the secondary market.
When it is in place in the second half of 2011, the TSF will allow investors to buy renminbi-denominated shares in the secondary market even if they do not hold sufficient renminbi – as long as they have Hong Kong dollars to cover the purchase. With the TSF, the HKEx is aiming to enhance the liquidity in the CNH market and to facilitate the trading of renminbi-denominated shares in the secondary market, something which should pave the way for fund managers launching renminbi-denominated equity funds and other renminbi-denominated mutual funds, thus expanding the breadth and depth of CNH investment instruments. HKEx chief executive Charles Li believes renminbi-denominated shares listed in Hong Kong will be attractive to IIs, particularly those that trade Shanghai or Shenzhen-listed A-shares using their Qualified Foreign II (QFII) scheme.
But the TSF applies only to equities, just one asset class in the entire CNH market. Clearly, a lot more has to be done in developing other asset classes so as to enhance overall liquidity.
Dim sum centre
HKEx is pulling all stops to ensure the success of the first renminbi-denominated IPO in Hong Kong, the listing of Cheung Kong’s US$1.5 billion renminbi-denominated Reit, whose assets mainly consist of Oriental Plaza, a Beijing office, shopping and hotel complex with a gross floor area of 800,000 square metres, that is 33.4% owned by Cheung Kong and 18% owned by Hutchison Whampoa. In addition, having renminbi-denominated Reits trading in what is still basically a Hong Kong-dollar market will definitely expand the breadth of renminbi-denominated investment instruments for both institutional and retail investors.
At present the only offshore renminbi-denominated assets available to IIs are CNH bank bonds and corporate bonds (known as dim sum bonds) – of which there are few, far between. However, should the liquidity issue in the CNH market be overcome, Hong Kong would be well placed to be the global financial centre for dim sum bond issuances.
