With change being a constant in the Renminbi (RMB) clearing market, financial institutions domiciled outside of Greater China will be challenged to determine the best approach for market entry. This article provides insights for financial institutions looking to navigate the RMB environment and developing a clearing strategy.
Ever since RMB internationalization began in the early 2000s for individuals, and as it opened to corporates in 2009, there has been a continuing series of policy changes by the Hong Kong Monetary Authority (HKMA) and the People's Bank of China (PBOC). While the frequent changes to business rules, message formats, liquidity rules and other practices designed to make the use of the RMB easier, constant change has also made it challenging for some financial institutions to finalize their strategy.
Over the past year, changes to practices have stabilized and the continued push by China to internationalize the RMB, coupled with increased confidence amongst the business community to utilize the RMB in settlement, has resulted in a significant increase in the number of financial institution entrants into the offshore market,
The recent announcement of a new China International Payment System (CIPS) brings about another change, however, and it is causing financial institutions looking at entering the market to consider which clearing system to connect to, the potential costs, future barriers to entry, and determine if there are any first mover advantages.
One part of the consideration is whether to use the onshore RMB (CNY), which is useful for suppliers in China but also results in difficulties due to regulatory and documentation requirements; or whether to use the offshore RMB (CNH), which is more freely traded and more easily convertible. Whilst China has just one currency from an International Organization for Standardization (ISO) perspective, two foreign exchange markets have evolved – the CNY and the CNH. The CNY rate can only be accessed for merchandize trade within a three month period. Financial institutions are not able to access the CNY rate in the overseas markets and can only access this via the Mainland Chinese Correspondent Banks (MCBs), on the provision that they are able to abide by the PBOC regulations. In addition, overseas financial institutions will be required to open a nostro account with a MCB and liquidity will be limited to the individual MCB's assigned quota. The CNH rate is more freely traded and more easily convertible.
Along with looking at regulatory or convertibility factors, financial institutions also need to evaluate the products those clients will need, how they service those clients, optimize interest rates, and whether they will need to move funds in and out of Hong Kong. For example, if a financial institution decides that it needs to expand its product offering significantly so that it can provide different products for different clients, it has to consider factors such as the clients' target markets and how much CNY regulations may hinder the clients' businesses.
Three (or More) Clearing Systems
As the number of overseas RMB Clearing systems increase, financial institutions will need to determine which RMB clearing systems to use and connect. Financial institutions have access to the Hong Kong's Clearing House Automated Transfer System (RMB CHATS), or they can develop RMB clearing systems in other locations such as Singapore and Taiwan Overseas clearing systems which can be used for domestic settlement, direct links/settlement into Mainland China or via correspondent banking. Alternatively, if the beneficiary is in Mainland China, they can use a MCB for clearing via China National Advanced Payment System (CNAPS). Financial institutions can also wait for CIPS, which will become available by 2014/2015. CIPS and the MCB/CNAPS models can only be used to support settlement with Mainland China.
Key determining factors when choosing a clearing system would be access to liquidity, counterparty and settlement risks, investment costs of integration and client needs.
The appropriate solution is specific to each financial institution. They need to consider infrastructure requirements including settlement requirements, transaction costs, reciprocity, regulatory reporting, client and market cutoff times, and the knowledge of their staff. Financial institutions should also conduct financial analysis of the fixed and variable cost of entry into the market.
For a branch-based financial institution whose home-country business clients have large suppliers in China, it may be preferable to establish a correspondent bank relationship. For another financial institution with a strategy to expand into Asia, on the other hand, setting up a local branch in Hong Kong and connecting into local infrastructure may be more effective.
Regardless of which options financial institutions select, they will need to consider whether to route payments from all their branches into one branch and then into the clearing system, or whether multiple branches will connect directly into the clearing system, as well as how to manage liquidity, NOSTRO accounts, reconciliation and other internal processes.
Financial institutions can consider developing those connections themselves, and use a global bank with extensive experience in clearing as a single point of contact globally to transact in RMB, so that all the financial institution's branches can use the same channel to transact in RMB regardless of whether they are in London, Singapore, Taiwan or another market (pending local regulations).
Financial institutions may find that only large global banks can offer the broader experience, contacts and network that provide better support for the financial institution's own clients, and the assurance that transactions have been completed. With their depth of experience globally in on-boarding clients and offering clearing services, global banks can also provide the international service levels and customized solutions that financial institution clients expect, as well as the thought leadership and knowledge of policy changes that enable the financial institution to better position itself.
Having one country with two currencies and three clearing ways can make it more challenging for financial institutions providing RMB clearing services for their clients. Analyzing the market carefully and leveraging experienced partners can help in determining the optimal and most efficient solution.
Vice President of RMB Product and Clearing
J.P. Morgan Treasury Services