by Mark Ford

When China announced the pilot Renminbi (RMB) Trade Settlement Scheme (RTSS) in April 2009, it cleared the way for yuan-denominated trade settlements between certain enterprises on the Chinese mainland and counterparties in countries in the Association of South East Asian Nations (ASEAN) as well as Hong Kong and Macau. Last year the scheme was expanded so that trading partners across the world could participate in yuan-denominated letters of credit and other trade transactions.

The impacts of the RTSS will be substantial, challenging the US dollar's domination of world trade and establishing the yuan alongside the dollar, euro and yen as a key currency in foreign exchange markets. Whilst there is huge enthusiasm for RMB settlements, bankers canvassed by DCInsight say the current value of this business remains low because of the limited number of Chinese firms participating in the scheme and bureaucratic procedures in the RTSS mechanisms.

Early days

Demand is clearly strong from exporters and importers of goods to and from China for trade finance transacted in the Chinese currency. "Chinese buyers are increasingly telling our exporters that they want to pay for purchases using yuan-denominated L/Cs to mitigate exchange rate risk," one London-based banker told DCInsight. "This is particularly the case with exports where the parties need to agree a stable price over the medium - or long-term," he added.

Another banker said he expected to see as much as 95 per cent of all of China's exports to be covered by the scheme in five years. During the first year of the scheme, only around 0.4 per cent of China's exports were covered by the pilot scheme.

The scope of the original pilot scheme was not large - covering only trades between 450 specified Chinese enterprises in five cities. Only trades between Shanghai, Shenzhen, Guangzhou, Zhuhai and Dongguan with Hong Kong and Macau, as well as transactions between Yunnan and Guangxi with ASEAN countries were allowed.

Nevertheless, the scheme marked a step in China's long-term strategy towards globalizing its currency and reducing the dominant influence of the dollar in world markets. China's current role in foreign exchange markets is not commensurate with the size of its economy and export capacity - due mainly to limitations on the yuan's use in international trade and restrictions imposed on its supply and convertibility.

China has yet to build a financial services infrastructure to truly represent a globalized Chinese currency, and there has been some speculation over the roles of Hong Kong and Shanghai in this respect.

China's 12th five-year plan announced in March 2011 specified that fast-growing financial hub Shanghai will focus on onshore financing activities, while Hong Kong will develop offshore yuan business with help from Shanghai.

World opening

In June 2010, the RTSS was opened up to the rest of the world when enterprises in 20 Chinese mainland provinces and cities were admitted into the scheme.

Nonetheless, the scheme is limited. Chinese companies receiving payments must still be on the list of Mainland Designated Enterprises (MDEs) and validate with their local bank that the transaction conforms to requirements specified by the People's Bank of China.

Trade services offered by banks typically include L/Cs, including standby L/Cs, documentary collections and open account trading. However, RMB transactions are limited to the amount of an actual trade transaction, and payment to MDEs has to be made directly.

International banks such as HSBC, JPMorgan and Standard Chartered have embraced the scheme, typically by promoting trade services in the Chinese currency and launching RMB-denominated current accounts. It is now possible to find RMB-denominated L/Cs arranged by banks in countries including Turkey, South Africa and Russia, as well as in many European, North American and Australasian countries.

Sometimes it is up to countries to make the first move so that L/Cs can be RMB-denominated. In February 2011, Nigeria said it had included the Chinese yuan on the limited list of currencies it allows for trade settlement in the foreign exchange market, thereby enabling Nigerian banks to denominate L/Cs in the Chinese currency.

The HSBC Group reckons to be at the forefront of banks to introduce RMB capabilities and products, having now rolled these out across much of its worldwide network. It claims several RMB firsts - as the first international bank to complete RMB-denominated trade settlements across six continents, the first foreign bank to issue RMB bonds in Hong Kong and the first international bank to offer RMB current account and cheque services.

Growth anticipated

A banker at HSBC Bank Canada, which completed its first Canadian international RMB trade settlement transaction in January 2011, said he expected rapid growth in trade yuan-denominated settlement transactions.

Executive vice president for commercial banking at HSBC Bank Canada, Mark Watkinson is optimistic about the future too. "China's continued, explosive growth in the world trade market will likely result in a significant increase in Chinese imports and exports being settled in RMB," he says.

A London-based banker told DCInsight that he expects to see RMB trade finance growing steadily over the coming months, after which he anticipates stronger growth over the next five or six years as China's currency liberalization plans unfold and impact on world markets.

Some analysts say RMB cross-border transactions will show their strongest increase in the ASEAN region over the next few years, in line with strong growth anticipated in Sino-ASEAN trade. Estimates vary, but one analyst reckons that in five years, yuan-denominated transactions may account for 50 per cent of China's USD 200 billion annual trade with Hong Kong and 30 per cent of the USD 250 billion of trade between China and ASEAN countries.

Pros and cons

The perceived benefits of RMB financing include reduced dependence on the dollar, on which almost all trade flows in the ASEAN region are currently based. There are widespread concerns in Asia about the potentially negative impacts of rising US fiscal deficits and government indebtedness on the long-term stability of the US dollar.

Supporters of reduced dependence in the region on the dollar include secretary-general of the UN Conference on Trade and Development (UNCTAD), Supachai Panitchpakdi. He says Asian countries should increasingly use local currencies in inter-regional trade settlements to avoid currency disturbances stemming from US monetary policies. As well as encouraging more RMB account settlement, he argues for more use of the Indonesian rupiah or the South Korean won in regional inter-trading.

Other benefits of the RMB scheme include the yuan's lower volatility since the global financial crisis compared with the dollar, euro and yen. Yuan-denominated transactions could also help counterparties save costs, since a stable currency should result in reduced currency conversion and hedging costs when traders will no longer need to hold US dollars

But enthusiasm in these early days of RMB trade financing is tempered by the inevitable teething problems of a new system. One banker told DCInsight that the validation process MDEs need to undertake in the scheme means it can take several days to complete a transaction, although she is hopeful that transactions will be executed more quickly once all the parties grow accustomed to the procedures.

Another point made by several bankers is that for the moment, the scheme is limited to too few Chinese MDEs and the that RMB will only take off in a big way when the possibilities for writing yuan-denominated business are extended across China's increasingly vibrant trading base.

Mark Ford's e-mail is