Offshore Trading in Yuan Takes Off

Offshore Trading in Yuan Takes Off

By SHAI OSTER in Hong Kong, DINNY MCMAHON in Beijing and TOM LAURICELLA in New York

China's currency, pent up inside the country's borders for decades, is emerging as a hot property in global foreign-exchange markets, just months after Beijing allowed the yuan to be bought and sold outside the mainland for the first time.

Daily trading in the yuan has grown from zero to $400 million in the past few months, as the currency of the world's second-biggest economy begins to flow around the globe. Global trading in yuan allows businesses to buy and sell the currency to finance trade, investment and borrowing. It's an important step for the yuan to play a role in global financial markets.

The yuan makes up a sliver of the $4 trillion daily trading in currency markets and is dwarfed by trading in the dollar, yen and euro. But traders are surprised at how quickly it is gaining critical mass.

.The value of the yuan remains tightly controlled by China, so its value won't rise and fall to the same extent as the dollar or euro, in spite of the new trading. Even so, foreign-exchange traders who are embracing the currency see demand for yuan rising sharply. Bankers in New York, London and Tokyo are rushing to set up new trading systems and back offices to trade in yuan.

"This is the beginning of a new era," said Norman Chan, head of Hong Kong's central bank. "This is a step moving to full convertibility of the yuan, and is a major change of the international financial landscape."

The yuan makes up a sliver of the $4 trillion daily trading in currency markets and is dwarfed by trading in the dollar, yen and euro. But traders are surprised at how quickly it is gaining critical mass. Chinese companies are placing yuan into accounts in Hong Kong, where the offshore trading is allowed, and could have as much as 300 billion yuan ($45 billion) there by the end of the year.

China Winning Currency War Access thousands of business sources not available on the free web. Learn More The yuan, which closed official trading Monday at 6.6670 per dollar, down slightly on the day, has risen 2.4% against the greenback since mid-June, when China loosened the currency's peg against the dollar and allowed the yuan greater flexibility to rise or fall in value.

The continued growth in yuan trading isn't a foregone conclusion. China could reverse itself and slow the growth of the market. China's leaders fear that if too much currency builds up too quickly overseas, they could lose control of inflation and interest rates, said Xiang Songzuo, deputy director of the Center for International Monetary Research at Remin University of China.

.Nevertheless, the establishment of offshore trading in yuan is "game changing," said David Mann, head of research in the Americas for Standard Chartered Bank. "It's arrived much faster than anyone expected."

In July, Chinese regulators opened the door by letting banks and individuals freely trade yuan outside of mainland China for the first time. Creating that infrastructure is a necessary step in allowing the yuan to float freely, and have markets set its value. For now, China will keep its tight rein on the value of the yuan even with the parallel market in Hong Kong.

On Dec. 6, Chinese regulators broadened the scope of the program, increasing the number of exporters that can use yuan to trade their goods from a few hundred to nearly 70,000.

Some predict it will only be a few years before 20% to 30% of China's $2.3 trillion of imports could be conducted in yuan rather than U.S. dollars. Today less than 1% is done in yuan, according to Standard Chartered.

Mr. Mann says trading in yuan could match that of the Japanese yen before long as the third most-actively traded currency behind the dollar and the euro.

Until now, investors who wanted to speculate on the yuan, or companies that needed to hedge against its fluctuations, could only do so indirectly, through contracts that tracked the currency's moves. Those contracts were useless for businesses that needed actual yuan to buy or sell goods.

To buy and sell yuan offshore, traders need an account in Hong Kong. Chinese companies can move money to offshore yuan accounts only for business purposes, such as exports or imports. And restrictions remain on repatriating that money.

But as long as that money is in an offshore yuan account, the holder is free to trade with it in any way.

Already, banks such as Citigroup Inc. and HSBC are offering investors yuan-priced options and interest-rate derivatives. Mutual funds dedicated to yuan-priced investments have already been created.

The move has opened the doors to wider issuance of yuan-denominated bonds and other investments. McDonald's Corp. and Caterpillar Inc. recently became the first U.S. non-financial corporations to sell debt priced in yuan, in what is being nicknamed the "Dim Sum" bond market.

A big driver of the increase in yuan holdings offshore is emerging economies, major trading destinations for China. HSBC forecasts that at least half, or nearly $2 trillion worth, of China's cross-border trade with emerging markets could be settled in yuan annually within three to five years.

For example, countries rich in natural resources that export commodities to China could get paid in yuan and then use the yuan to buy finished goods and services from China—cutting out the cost and hassle of converting to dollars.

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.The moves come against a broader background of growing Chinese concern over the country's reliance on the dollar.

Long term, the offshore yuan market could decrease demand for the dollar and lower its value. That's in part because Chinese companies doing business with counterparts in other countries wouldn't need U.S. dollars to conduct that business as they do today.

In Hong Kong, where speculation is an obsession, individual investors quickly piled in to yuan, even though they are limited to converting only 20,000 yuan a day. On display by bank teller windows are interest rates for Hong Kong, U.S and now Chinese deposits.

For the yuan to become fully convertible, China would have to allow it to be exchangeable for other currencies at any time, something that's not possible under the new regulations.

The keen level of interest in the offshore yuan trading was evident last week in midtown Manhattan at the headquarters of HSBC. Some 80 traders from 20 banks came to hear a presentation organized by ICAP PLC on offshore yuan trading featuring Esmond Lee, an official from the Hong Kong Monetary Authority. Previous sessions in Hong Kong and London had been similarly packed.

"What makes it exciting is that this is a move by China in a direction that many have been waiting for," said Edward Brown, an executive vice president at ICAP, the world's largest broker of currency trades among banks.