China and Taiwan ink currency MoU
07 Sep 2012
Taiwan's central bank has signed an MoU on currency clearance with the People's Bank of China, marking an important development in cross-straits financial ties and paving the way for the island to become a new outlet for the offshore yuan trade.
Set to come into effect at the end of October, the agreement lays the groundwork for China's currency to become deliverable offshore in Taiwan, trading in a new interbank market under the currency code CNT and supported by a new clearing bank - the first outside Hong Kong and Macau. Details such as the choice of clearing bank have yet to be finalised.
While the MoU has symbolic importance as a step forward for cross straits financial ties and the internationalisation of the RMB, its real impact on the offshore yuan trade is likely to be restricted by the small size of the Taiwan market compared to Hong Kong, and Taipei's limitations as a financial centre.
Taiwan trumped other candidates that were vying to become the next stepping stone for offshore RMB expansion despite seeming to be the least likely choice: London would have offered greater access to the EU along with different time zone coverage, while Singapore could have expanded the reach of the programme in Southeast Asia.
"As an initial take, we think that this is a significant announcement symbolically, but will have limited initial impact on how the offshore RMB market functions and behaves. The bigger near-term impact instead may be on TWD and TWD assets. We have recently identified TWD as being a preferred long in Asian FX relative value trades," says a note from J.P. Morgan Asia Pacific emerging markets research.
As offshore yuan funds are already fungible outside Hong Kong, CNH and CNT will theoretically have the same exchange rate - with marginal variance possible due to market inefficiencies. This means trading opportunities in CNH-CNT spreads are likely to be limited compared to the possibilities previously opened up by the CNY-CNH differential.
"We expect little impact on CNY, CNY NDF or CNH spot or forwards. There is initial talk of Taiwan siphoning off Hong Kong's RMB liquidity, but Taiwan is yet to turn into a credible alternative centre for offshore RMB activity, so CNT activity will likely be limited to serving Taiwan specific offshore RMB participants and transactions," said the bank, adding that any marginal reduction of CNH deposits would nonetheless contribute to a tightening of CNH liquidity at a time when the deposit base is already declining.
The timing of the move is of note meanwhile, coming almost two years exactly after the offshore yuan scheme was first rolled-out in Hong Kong, providing a hint of the likely pace of future development. The MoU also confirms the programme's expansion will involve setting up more clearing banks and making the currency deliverable in a wider range of jurisdictions, rather than channelling activity through Hong Kong.
The importance of the development for Taiwan moreover is clear. Besides strengthening its standing in the global financial system and the symbolic significance for its relationship with China, the MoU will reduce cross-straits trade costs, as well as allowing the island to better leverage its trade surplus with the mainland and RMB amassed from growing business ties.
The Taiwan dollar is set to benefit from being made deliverable on the mainland, and the scheme could reinvigorate investment flows from China to Taiwan. "In the past, such cooperations have led to sizable rallies in Taiwan assets and moves in USD-TWD lower, on the anticipation of greater growth in China related activities," says J.P. Morgan.
Yuan-denominated business will bring an additional source of revenue for Taiwan's financial sector, and the agreement importantly opens this market to domestic banking units (DBU), which can deal with onshore entities. Under Taiwan's current regulations, only overseas banking units (OBU) are allowed to conduct RMB business through clearing banks in Hong Kong, and the change will allow the two types of entity to engage in RMB lending and borrowing among themselves.
Additionally, the agreement will create a new domestic market in RMB-denominated bonds as Taiwanese corporates seek to raise funds for their mainland investments. Following the MoU, the island's financial regulator on Tuesday gave the green light for local listed companies to float Yuan-denominated bonds, or "sweet potato bonds", domestically, starting later this year.
This will offer investors a more attractive choice than the offshore options that were made available in July when the watchdog in July raised the barrier on RMB bond issuances by OBUs.
Author: Orlando Bowie