RMB Internationalization and the Shanghai FTZ
By Matthew Zito
SHANGHAI – In 2013, British Chancellor of the Exchequer George Osbourne predicted that the renminbi (RMB)—also known as the yuan—would “become almost as familiar as the dollar” within his lifetime. Today, the RMB is variously reported to be the eighth or ninth most traded currency worldwide and was used in US$120 billion worth of transactions in 2013. And yet recent news of the slowing Chinese economy, its prevalence of shadow banking and the huge debt held by local governments have shaken investor confidence in the viability of the RMB. In this article, we provide an overview of the global RMB investment environment, including the most up to date regulations pertaining to the Shanghai Free Trade Zone.
The campaign to promote the yuan as an international currency began in earnest in 2007, with China’s introduction of dim sum bonds — RMB-denominated bonds issued outside of mainland China. This led to the creation of a system of “one currency, two markets” with onshore RMB designated CNY and offshore RMB designated CNH. This was followed in 2010 by a trade settlement scheme allowing for RMB transactions between Chinese and foreign businesses, and in 2011 measures were implemented permitting RMB-denominated direct investment, both into and out of China.
Today, offshore RMB centers have been established in Hong Kong, Singapore, Taiwan, London, Paris, Frankfurt and Luxembourg, and at least 40 central banks from around the globe have allocated partial reserves to the currency. Recently, the People’s Bank of China signed a high-profile currency swap agreement with its European counterpart, the European Central Bank, adding to the list of 23 territories with such agreements in place with China.
Launched in September 2013, the Shanghai Free Trade Zone (FTZ) is poised to fundamentally transform the status quo of the offshore RMB market. Details of the preferential policies offered to investment enterprises in the FTZ have gradually come into focus through a series of circulars issued by the People’s Bank of China (PBoC) and State Administration of Foreign Exchange (SAFE). Owing to their importance, they are listed here in detail:
- Foreign exchange registered capital can be freely converted into RMB by a foreign-invested enterprise established in the Zone, without having to obtain bank approval as previously. The converted capital must be kept in a designated RMB account and used within the business scope of the enterprise.
- The FTZ allows for a broader cash-pooling scheme — a transaction in which banks facilitate multi-national companies in repatriating their profits to an offshore headquarters via intra-company loans. Doing so requires that the onshore enterprise is registered in the FTZ and affiliated with the overseas loan recipient. Companies established in the Zone can loan up to 50 percent of their total shareholder equity to their offshore entities. Outside of the FTZ this is limited to 30 percent.
- Companies established in the FTZ can borrow offshore RMB of an amount equal to their paid-in registered capital multiplied by a “policy index” published by the PBoC. The borrowed funds must be used inside the FTZ or overseas and cannot be invested in securities or derivatives, or as part of entrusted loans.
- FIEs specifically licensed for equity investment can convert their registered capital into RMB and send this to their portfolio companies, rather than using forex as previously. All foreign-invested enterprises in the Zone are permitted to use their converted registered capital to make onshore equity investments, e.g. in the Shanghai futures or securities market.
- Financial leasing companies in the Zone, including foreign-invested financial leasing companies, are freed from quota restrictions on foreign lending and can open special foreign-lending accounts at local banks. This type of account can be used to retain leasing revenue from overseas and is subject to a simplified settlement procedure.
- Multinational corporations may open international accounts to directly transfer foreign capital between the FTZ and offshore accounts. The amount of transferable capital is subject to a quota based on the total foreign debt held by the company and its related entities. Companies may also set up domestic accounts in the Zone for sending and receiving forex payments between their domestic affiliates. Funds may be transferred between the two types of account within a stipulated quota.
- Banks established in the zone do not need approval from the local banking authorities before setting up branches or appointing executives in the Zone. The 75 percent loan-to-deposit ratio required of banks elsewhere in China is being gradually phased out for banks in the Zone to be replaced by independent risk management systems.
With the launch of the FTZ, the RMB has certainly turned a corner in terms of internationalization, yet significant obstacles remain before it can truly outgrow its reputation as a vehicle for speculation. Offshore deposits held in RMB, for example, account for less than 1 percent of global RMB deposits. The proposed establishment of an offshore RMB clearing house in North America would do a great deal for deepening the market for RMB investment products.
Meanwhile, the PBoC continues to influence deposit and lending rates for offshore RMB via their onshore counterparts. Just last week, the U.S. Treasury Secretary issued a call for China to let market forces play a greater role in the RMB’s exchange rate. To this end, the RMB-USD daily trading band was recently expanded from 1 percent to 2 percent above or below the daily reference rate set by the bank. Alongside these changes, PBoC Governor Zhou Xiaochuan has announced that deposit rates will be fully liberalized within one to two years.
Industry surveys report positive investor expectations for the future role of the RMB in cross-border trade and its stability. HSBC predicts that by 2015, RMB trade settlements will account for one-third of China’s total trade and the RMB will be the third most traded currency worldwide. The government’s stated goal of transforming Shanghai into an international financial center by 2020 will continue to exert pressure on further reforms.
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Guide to the Shanghai Free Trade Zone
In this issue of China Briefing, we introduce the simplified company establishment procedure unique to the zone and the loosening of capital requirements to be applied nation wide this March. Further, we cover the requirements for setting up a business in the medical, e-commerce, value-added telecommunications, shipping, and banking & finance industries in the zone. We hope this will help you better gauge opportunities in the zone for your particular business.