This article provides insights into how corporates can benefit from offshore financing in renminbi (RMB), the market development of the RMB loan market, the impediments to growth, and recent developments in the offshore RMB loan market.
Cross-Border Trade Settlement
Since the Cross-Border Trade Settlement program was launched in June 2009, the RMB has matured and internationalized significantly from being a trade settlement currency to an investment currency of choice.
The program has gradually expanded to include more eligible Chinese companies and locations where trading partners are domiciled. All remaining restrictions on exporters were lifted in August of 2011, opening the floodgates for any Chinese exporter or importer to transact globally in RMB.
The relaxation of regulatory requirements and depreciative expectations on offshore RMB – known as CNH, as opposed to CNY to refer to onshore RMB – in the first half of 2012 also helped the CNH loan market record successive years of growth from 2010 to 2012.
By 2013, CNH-denominated loans have become established as an alternative source of funding for Chinese corporates and for multinational corporations with operations in Mainland China. Demand from the aforementioned segments is expected to remain active.
A pivotal location facilitating the rapid growth in RMB cross-border trade settlements is Hong Kong. RMB trade settlements handled by banks in Hong Kong amounted to about US$428 billion, around 90% of the total cross-border RMB trade settlement in 2012.
The CNH Loan Market
Fueled by the vibrant cross-border trading activities and the ensuing trading surplus, excess CNH liquidity accumulated rapidly, leading to the birth of the CNH deposit market in Hong Kong (US$52 billion in equivalent by fiscal year 2010).
When the scheme was liberalized in 2011 to include all offshore trading partners, the CNH deposit pool in Hong Kong doubled to US$108 billion. This provided the critical mass and foundation to further develop the offshore RMB financing market and the CNH loan market.
In August 2011, the Ministry of Commerce (MOFCOM) in China approved foreign direct investment in RMB, whereby foreign investors are allowed to remit RMB funds raised offshore into China via equity injections or shareholders’ loan to local entities.
MOFCOM’s liberalization threw the gates open to an influx of demand for CNH loans from companies looking to invest into China. Consequently, the amount of outstanding CNH loans grew exponentially from a paltry US$300 million (in equivalent) in 2010, to US$5 billion by the end of 2011.
Although CNH loan volumes went on to hit highs of US$12.8 billion equivalent and US$14.5 billion equivalent for the periods ending 2012 and 1Q 2013 respectively, the CNH loan market remains small compared to the bond market, which achieved volumes of US$38.5 billion and US$42.4 billion during the same periods.
Why CNH Loans?
The key factor which draws Chinese corporates and MNC subsidiaries to CNH loans is undeniably its relatively lower cost as compared to onshore funding costs. In comparison to the CNH offshore rate, the onshore RMB benchmark lending rate (PBOC rate) has historically been higher.
For example, a 1-year working capital facility which would have cost at least 4.2% from the onshore market (based on the previous lowest floating range of 70% applied on 1-year PBOC rate of 6%), could be obtained at a cost of about 3.9% from the offshore market (assuming 100bps spread on top of the base rate of 2.9% during Q1 2013), translating to a minimum savings of 30 bps.
Further analysis into the funding rate gap between onshore and offshore for the period of January 2012 to May 2013 reveals an average differentia of about 100bps, with the narrowest gap of 50 bps in August 2012 and the widest of 270bps in March 2012.
Besides lower costs, CNH loans are also favored by corporates for the comparatively simpler regulatory requirements to be complied with by the borrower, and a shorter speed-to-market cycle.
While a CNH-denominated capital injection will typically require just MOFCOM approval, capital injections in foreign currencies will require additional approvals from the State Administration of Foreign Exchange (SAFE), and a series of post-injection monitoring and reporting centered on the use of the proceeds.
Impediments to Growth
Loan demand is driven primarily by borrowers who are incentivized by lower costs. The contrary is true for issuers in the bond market, who are focused on RMB appreciation as a potential source of yields from their investments.
Given the recent confluence of a resurgent yuan against the greenback and less competitive CNH lending rates, CFOs and corporate treasurers will be hard-pressed to decide between offshore loans or bonds to fund their capital injections/loans.
Also casting a shadow on CNH loans is the absence of an official benchmark CNH interbank rate in Hong Kong, leading to opaque funding cost.
The majority of CNH loans are bilateral in nature and syndicated or club deals make up less than 15% of the total loan volume. This translates to a non-transparent market, which encumbers potential loan market investors with a greater degree of uncertainty.
Furthermore, CNH deposits are held almost exclusively by a small club of banks such as Bank of China, HSBC and Standard Chartered Bank, leading to minimal interbank liquidity as the banks have little incentive to lend CNH to other banks.
Recognizing the aforementioned obstacles in developing the offshore RMB financing market, the Hong Kong Monetary Authority enacted the following measures to improve the liquidity of the CNH loan market.
An official CNH reference rate determined by 13 major CNH participating banks launched in June 2013, set up the standardized interbank rate to boost the syndicated or club loan activities for greater transparency in the market.
In view of the improving market liquidity of the offshore RMB foreign exchange and money markets, as well as the sound and sustained development of the RMB business in Hong Kong, the Hong Kong Monetary Authority removed RMB net open position
and uplifted liquidity ratio restrictions
in April 2013 to release more RMB into the inter-bank market to improve the CNH liquidity.
Effective from July 20, 2013, PBOC has taken a major step forward in interest rate liberalization by removing lending rate controls. Key highlights of the deregulation are as follows:
- Removal of lending rates floor. Prior to the announcement, commercial banks could offer a maximum of 30% discount to the benchmark lending rates. This restriction is now removed and commercial banks can adopt differentiated pricing in lending rates.
- Removal of control on pricing mechanism of discounted bills. In the new regime, discounted bills are priced at a premium above PBOC re-discount rates (which has stayed flat at 2.25% since March 2011).
- Removal of lending rate caps (2.3x PBOC benchmark lending rates) on rural credit unions.
- No change to mortgage loans pricing scheme.
Although the deregulation is seen as a major step forward in interest rate liberalization, it seems to be more symbolic at this point and has exerted limited impact on bank behavior. No bank currently offers discounts close to 30% from the benchmark lending rate.
While the CNH loan market already offers opportunities for corporates to lower their costs and increase efficiency, increasing liquidity and the development of reference rates as well as other ongoing enhancements will make the market even more attractive for an increasing number of corporates to fund their growing business around the world.
About the Author
RMB net open position is the difference between on-balance sheet RMB assets and liabilities, but excluding any RMB structural position (e.g. investment in Mainland subsidiary banks). As per the HKMA Circular dated 23 December 2010, all Authorized Institutions should restrict their RMB net open positions (whether net long or net short) to 10% of their RMB assets or liabilities, whichever is larger.
In reference to the relevant liquidity ratio restrictions in the HKMA Circular dated 9 February 2012.