London ups the ante in the offshore yuan market

The launch of an oversubscribed yuan-denominated bond issue in the UK by HSBC Holdings last month intensifies the rivalry in the offshore yuan business between Hong Kong and London.

Europe's biggest bank sold 2 billion yuan (US$317 million) in 3 percent, three-year bonds. It was a major shot across the bow in London's ambition to become the occidental hub in the lucrative, emerging offshore yuan market.

The bond "builds on the progress London has already made toward becoming the Western hub for renminbi," said UK Chancellor of the Exchequer George Osborne on April 18. He also said he welcomes Chinese companies issuing bonds in London.

Already the world's biggest currency-trading center, London will be competing with other global financial centers for a share of the burgeoning yuan trade.

Hong Kong, which introduced its offshore yuan bond market less than two years ago, has become the leading offshore market for the Chinese currency since the central government allowed the city to use the yuan in trade settlements, beginning in 2009. Settlements there rose to 1.9 trillion yuan last year.

The report by City of London Corp released last month showed deposits of 109 billion yuan in London, accounting for 26 percent of the offshore spot yuan market. It said an estimated US$680 million worth of yuan on average is traded in London every day. That compares with about US$2.7 billion daily on the spot yuan market in Hong Kong.

"It is anticipated that, as corporate and institutional deposits grow, so will the liquidity of the London market," said the City of London Corp, which governs an area of central London.

Prominence of Hong Kong

Although the offshore yuan market in London is off and running, it will be some time before it can hope to match the prominence of Hong Kong. For one thing, Hong Kong has a much larger yuan hoard than London. Yuan deposits in London are only about a fifth of Hong Kong's 589 billion yuan. For another, Hong Kong enjoys a level of mainland policy support - one might say political coziness - that London lacks.

The National Development and Reform Commission, the mainland's top economic planner, has just approved 25 billion yuan of yuan-denominated bond to be issued by Chinese companies in Hong Kong.

Prior to that, the economic planner had approved 18.5 billion yuan of new issues in Hong Kong by Huaneng Power International, China Datang Corp, China Minmetals Corp and China Guangdong Nuclear Power Group.

For the past two years, the Chinese government has been gradually relaxing capital controls aimed at slowly converting the yuan into a global currency. Hong Kong has been the incubator for policy changes.

On April 16, China widened the yuan's trading band from 0.5 percent to 1 percent.

Earlier last month the government also increased the quota for the Renminbi Qualified Foreign Institutional Investor scheme - which allows foreign investors to buy yuan-denominated funds using yuan accumulated offshore - from 20 billion yuan to 70 billion yuan.

Tse Kwok-leung, head of economic research at the Bank of China Hong Kong, said at an April forum in Hong Kong that London has the right conditions to develop into an offshore yuan center but it will be hard to replace Hong Kong as league leader. "Hong Kong has a good foundation in the offshore yuan market, with advantages in the yuan settlement network," he said, adding that it will remain a major yuan bond center.

Hong Kong certainly feels the competition. The Hong Kong Monetary Authority said it plans to extend the trading of yuan payments by five hours a day at end of June to allow London companies to settle transactions through Hong Kong.

Ample room

Although both cities may harbor grand ambitions, the potential market in yuan is huge, providing ample room for cooperation.

Britain and Hong Kong agreed in January to launch a forum for banks to use Hong Kong's yuan clearing and settlement system and develop new yuan products. The first meeting of the forum will be held in Hong Kong on May 22.

While Hong Kong can help with the flow of yuan, both onshore and offshore, London can be a conduit for European companies in yuan trading.

How quickly London - or, for that matter, Hong Kong - can develop a thriving offshore yuan business sector depends on the pace of progress allowed by the Chinese mainland authorities.