The internationalisation of renminbi and its recent moves - CWG

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Qingshan Zhang
Dentons, Beijing
qingshan.zhang@dentons.cn

The internationalisation of the Chinese renminbi (RMB) is a massive programme that may take decades. Its ultimate objective is to promote global use and full convertibility of RMB. To achieve that objective, China’s legal regime needs to go through a number of substantial reforms in the two respects. Global use of RMB largely refers to RMB’s share in the global portfolio of reserve currencies and in the global payments. RMB convertibility includes the ability to convert RMB into a foreign currency and the ability to do the opposite. Noticeably, as China is facing some pressure of capital outflows due to its slowing economy, RMB convertibility is more concerned with the ability to convert RMB into a foreign currency.

The history

The renminbi played a negligible role in global payments before 2007.

To illustrate this, RMB ranked only sixth in global payments by value this May despite years of efforts, accounting for 1.79 per cent of the total value, behind the United States dollar’s 40.88 per cent, the euro’s 32.91 per cent, the British pound’s 6.75 per cent, the Japanese yen’s 3.53 per cent and the Swiss franc at 1.88 per cent.^[1] Hence, there is still a long way to go before RMB is widely accepted by the international community. As a matter of fact, RMB has become fully convertible on current accounts since 1997, so RMB convertibility is primarily concerned with capital accounts.

RMB internationalisation took a big leap forward in June 2007 when a Chinese bank issued the first RMB-denominated bonds in Hong Kong. Since then, although the progress remains slow, RMB internationalisation has made a number of breakthroughs that have drawn international attention. These breakthroughs include:

• In June 2009, an offshore RMB clearing centre was set up in Hong Kong. The Hong Kong clearing centre was authorised to settle trades with Hong Kong, Macau and the Association of Southeast Asian Nations in RMB. This authorisation has been expanded to the rest of the world since July 2010.
• In September 2013, the China (Shanghai) Pilot Free Trade Zone was established. It is essentially an alternative to relying on offshore RMB clearing centres as a testing ground for liberalised financial markets and capital flows.
• In September and October 2013, the Belt and Road Initiative was unveiled with the aim to develop infrastructures in and expand China’s trades with, countries across Asia and Europe. The increase in bilateral investments and trades between China and these countries should have expedited the internationalisation of RMB.
• In June 2014, an offshore RMB clearing centre was set up in London. The London clearing centre was authorised to settle global trades in RMB.
• In November 2014, the Shanghai-Hong Kong Stock Connect was launched, enabling mainland Chinese investors to trade designated stocks quoted in Hong Kong and Hong Kong investors to invest in the Shanghai stock market.
• In December 2015, RMB was added to the basket of Special Drawing Rights by the International Monetary Fund. The inclusion has effectively laid a foundation for the wider use of RMB as a reserve currency around the globe.
• By 14 May 2019, China had struck currency swap deals totalling RMB 3.67tn with 38 countries and regions.^[2]

China’s efforts in reforming its legal regime

Accompanied by these breakthroughs is China’s great efforts to reform its legal regime. The reforms are largely aimed at expanding the use of RMB and facilitating RMB convertibility on capital accounts. Owing to space constraint, this essay only highlights the   reforms that the author believes are crucial to the RMB internationalisation process.

Use of foreign capital

Since last October, a non-investment foreign-funded company incorporated in China may further invest the foreign currency-denominated capital paid by its foreign shareholders in another China-based company. Meanwhile, such ‘reinvested’ capital may, at its owner’s request, either be converted into RMB and then transferred to the investee’s account or be directly transferred to the investee’s account. Generally, in both scenarios, the reinvested capital may only be paid to a third party for the purpose of the investee’s daily operations.^[3] This deregulation provides more flexibility to a foreign investor’s business planning and may help increase its willingness to convert foreign currency into RMB.

Availability of foreign loans

Since May 2016, a Chinese-funded company is allowed to obtain foreign loans in RMB or foreign currency. The aggregate of outstanding loans available to a Chinese-funded company is capped by an amount determined by its net asset and outstanding debts.^[4] Before this deregulation, only a foreign-funded company could obtain foreign loans on its own initiative. This deregulation helps to promote capital inflows and the use of RMB.

Offshore investors’ access to China’s stock market

Since 1 December 2002, eligible offshore investors meeting prescribed standards for a ‘qualified foreign institutional investor’ (QFII) may apply for a licence to invest in China’s stock market with foreign currency, which needs to be converted into RMB for trading.

Offshore investors meeting QFII standards are limited to financial institutions, pension funds, charity foundations, etc. with extensive industry experience.[5] It was the first time that China’s stock market was open to offshore investors. Meanwhile, restrictions on foreign investments in China’s stock market are long in place to contain financial risks. Such restrictions, inter alia, include:

• a quota for a single QFII’s cumulative investments (repealed last September);
• a cap that a single QFII’s shareholding in a listed company cannot exceed 10 per cent; and
• another cap stating that QFIIs’ shareholdings in a listed company in aggregate cannot exceed 20 per cent.

In March 2013, a modified version of a QFII called ‘RQFII’ (RMB-qualified foreign institutional investor) was introduced to China’s stock market. Unlike a QFII, the fund in which a RQFII invests should be offshore RMB without the need of conversion, and proceeds from selling stocks may be moved out of China in RMB or foreign currency upon conversion at such RQFII’s sole discretion.^[6] Since most trading in China’s stock market is processed in RMB, QFII and RQFII programmes help to increase the use of RMB and provide extra liquidity to the market.

Offshore investors’ access to China’s interbank bond market

Since March 2013, an RQFII can invest in China’s interbank bond market, in which Chinese government bonds, financial bonds and corporate bonds are traded.^[7] Since February 2016, other eligible offshore financial institutions that are not necessarily RQFIIs are given access to China’s interbank bond market as well.

An RQFII’s investments must be processed with offshore RMB, while other offshore participants must make investment in foreign currency needing to be converted into RMB for trading. It is noticeable that an eligible offshore investor may trade interbank bonds in its own name and no quota is required.^[8] However, in the early phase, a QFII’s or RQFII’s investments in the interbank bond market was limited to a prescribed quota, which was later repealed in September 2019.

Chinese investors’ access to offshore securities markets

Since April 2006, eligible Chinese investors meeting prescribed standards for a ‘qualified domestic institutional investor’ (QDII) may apply for a licence to invest in offshore securities markets with RMB which needs to be converted into applicable foreign currency for trading.

Chinese investors meeting QDII standards are limited to financial institutions with industry experience.^[9] It was the first time that Chinese investors entered offshore securities markets. An RMB fund that a QDII invests abroad may include its own fund and/or the fund it raises from other Chinese investors. A QDII’s investments are limited to:

• a quota for a single QDII’s cumulative investments prescribed by applicable financial regulator, and
• designated types of securities meeting certain indicators.

In November 2014, a modified version of a QDII called a RQDII (RMB-qualified domestic institutional investor) was launched. Unlike QDII, the fund in which a RQDII invests abroad cannot be converted into foreign currency and thus such fund can only purchase RMB-denominated securities in offshore markets, except in the case where the RQDII is a bank and such bank-type RQDII invests its own fund in offshore securities markets.^[10] RQDII programmes are aimed at expanding the use of RMB and propping up the offshore market of RMB-denominated securities.

Recent moves

On 7 April 2020, the local counterpart of the People’s Bank of China, the Chinese central bank, in the eastern coastal province of Jiangsu which neighbours Shanghai, announced a new regulation titled The Circular on the Furthering of Work related to Cross-Border RMB in the China (Jiangsu) Pilot Free Trade Zone (the 'Jiangsu Circular').

The Jiangsu Circular only applies to the China (Jiangsu) Pilot Free Trade Zone (the Jiangsu FTZ). From our reading of the Jiangsu Circular, regulation on the use of offshore RMB on capital account is further relaxed, and RMB is expected to play a bigger role in maintaining supply chains within the border of China. Free trade zones are often deemed as testing grounds for China’s economic policy. Hence, once a new policy is proven to be feasible, it would be implemented across the country in a short time. As generally observed, the Jiangsu Circular has further loosened regulation on RMB-denominated funds that a Jiangsu FTZ-based company receives from its foreign shareholders through foreign direct investment (FDI) or borrows from offshore lenders. Accordingly, such repatriated offshore RMB is regulated in the same less stringent way as foreign currency-denominated fund on capital account. For example, RMB proceeds in a capital (bank) account or foreign loan (bank) account of a Jiangsu FTZ-based company may be loaned to such company’s China-based affiliates in the form of an entrusted loan.

Alongside deregulation on the use of repatriated offshore RMB, there is another remarkable policy aiming to finance offshore market players. Chinese banks are permitted, directly or through offshore banks, to provide RMB loans to Chinese companies’ offshore suppliers, clients or other business partners to. Such RMB loans must be spent in purchasing products offered by Chinese companies. This policy could help to prevent or at least slow down manufacturing plants moving out of China and buy China more time to upgrade its supply chains. At the same time, as more cross-border trades are settled in RMB, it may increase offshore businesses’ willingness to take and spend RMB.

On 8 May 2020, the Shanghai counterpart of the People’s Bank of China and certain other local financial regulators jointly announced a new regulation titled Several Measures on the Overall Enhancing of the Opening, Innovation and Development of Financial Industries in the Lingang New Area of the China (Shanghai) Pilot Free Trade Zone (the 'Shanghai Circular'). The Shanghai Circular rolls out 50 measures with a view of testing a number of reforms in financial industries in the Lingang New Area. In addition to reducing limitations on foreign investors’ access to financial industries, the following measures stipulated in the Shanghai Circular would help to increase the use of RMB and ease regulation on RMB convertibility.

The cash pooling system

Local regulators will explore a ‘cash pooling’ system for eligible multinationals, in which cash inflows and outflows in RMB or foreign currency of a multinational (including its offshore and onshore members) could be centralised in a pooling account for the sake of managing currency conversion. Cash inflows and outflows would directly offset each other without being subject to the requirements for currency conversion. The multinational only needs to apply to its bank for currency conversion for the excessive amount (if any) after offsetting the opposite cash flows.

Easier RMB settlements

Eligible firms in the Lingang New Area (especially, eg, those in the sectors of semiconductors, artificial intelligence, aerospace and aviation and new energy) could find it easier to settle payments with repatriated offshore RMB. To be specific, where RMB is raised abroad and repatriated to an eligible firm in the Lingang New Area, such firm may make payments for its daily operations with the repatriated RMB by solely presenting its bank with a wire instruction, rather than a full set of contracts, invoices, wire instructions and so forth in relation to the underlying transaction as currently required for RMB settlements outside the area.

Long-term liberation roadmap

In the long term, the Lingang New Area will make an effort to advocate free capital outflows and inflows, full RMB convertibility and the integration of foreign currency accounts and RMB accounts for the same person.

Outbound transfer of certain credit assets

The Lingang New Area is intended to facilitate the irreversible transfer of onshore trade financing credit assets owned by onshore certified financial institutions to offshore banks and other institutions. By and large, the Shanghai regulators encourage participants to make payments in RMB for the outbound transfer of the credit assets. This will undoubtedly expand the global use of RMB.

The outlook

The internationalisation of RMB is facing some challenges, especially as the threat of a Sino-US trade war lingers and Covid-19 depresses the global economy, However, the fact that the pandemic has essentially been brought under control within the Chinese border and proper measures have been taken to reboot its economy demonstrates that effective governance is being exercised in China. On this basis, China can be reasonably expected to get involved in more global trades and investments, and that its financial system will be less regulated over time. Therefore, we believe that RMB internationalisation will progress steadily and irreversibly.