Profit & Loss, by Galen Stops

It was no surprise when the latest Bank for International Settlements (BIS) triennial survey showed that the average daily turnover of RMB has grown from $120 billion in 2013 to $202 billion as of April 2016, an 81.8% increase.

This also means that the RMB has doubled its market share as a percentage of FX market turnover to 4% and is now the world’s eighth most actively traded currency and the most actively traded emerging market currency, overtaking the Mexican peso.

Growth Drivers

There are a number of factors driving this growth, but perhaps the most important one is simply the growth of China’s economy and, subsequently, its trade demands. Data from the World Bank shows that GDP in China has grown from $3.5 trillion in 2007 to $10.7 trillion in 2015.

“I think the growth of the currency is mainly trade-based,” says Jon Vollemaere, CEO of R5FX. “At the moment, the main reason why the currency is growing is because China is a massive economy and they’re huge buyers and sellers of everything on the planet.”

In addition to this, Chinese authorities have been working to promote the currency, to relax currency controls for the first time in 2010 and encourage the growth of offshore RMB trading and clearing centres, of which London, Singapore and Hong Kong are currently the largest.”

The eventual aim appears to be to fully internationalise the currency, and to this end China’s government has worked to develop important pieces of infrastructure around the currency.

“The Chinese authorities are really establishing policies and taking steps to further promote RMB internationalisation and one important part of this is the establishment of clearing centres.

Maintaining Perspective

Despite all these steps to encourage RMB growth and how quickly the currency has climbed up the BIS and Swift rankings, it is important to maintain a certain degree of perspective about the currency’s role in global financial markets.

RMB still represents only 1.86% of global payments by value, according to Swift, and $202 billion of the $5.1 trillion per day overall FX market turnover, according to the BIS figures. In contrast, the US dollar is still on 88% of all FX trades.

There are still pieces of the infrastructure puzzle missing, however. RMB is not a CLS accepted currency and currently there is no similar alternative settlement infrastructure in place in China.

Whether it will choose to push for CLS adoption of the currency or build something separate in China remains the subject of debate, and is a question that Profit & Loss addressed earlier this year, but once it does have that type of settlement infrastructure in place it will undoubtedly change the risk profile of the RMB and increase trading of the currency.

SDR Inclusion

Although the inclusion of the RMB into the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) basket on October 1 was in many respects more important symbolically and politically than financially, it still marks an important milestone for the currency.

This is the first time in history that the number of currencies in the SDR basket has increased, with the IMF arguing that its inclusion makes the basket representative of the currencies being traded in the world, a clear sign of the RMB’s growing importance in the FX market and in world trade.

More Reforms to Come?

Researchers at HSBC also argue that the SDR inclusion is likely to trigger more financial reforms by the Chinese authorities. In a paper published shortly after the SDR inclusion, HSBC researchers pointed out that although USD/CNY has been stable in Q3, there has been a sharp divergence between the onshore and offshore FX forwards and swaps markets.

They note that, with SDR implementation now completed, the IMF and SDR users will begin to demand consistent onshore and offshore FX forward curves.

The Political Factor

Underlying all of these potential growth points for the RMB is the question of whether there is the political will to pursue some of these measures.

Vollemaere comments: “If there is an event with political implications, such as could potentially occur in the South China Sea for example, then it could change the trajectory of RMB growth. We saw this happen with the ruble, which was progressing nicely and the market was beginning to open up, and then there was the dispute over Ukraine and now the currency is right back where it was a number of years ago. Something similar could still happen in a controlled economy, which couldn’t happen in sterling or euro or yen, not withstanding Brexit – who would have thought?”

APAC on the Rise

The growth in RMB trading highlighted by the latest BIS survey was part of a broader trend of increased trading volumes in emerging market currencies in the Asia-Pacific region.

The Indian rupee, the Thai baht and the Singapore dollar all moved up three places in the BIS rankings, while the Korean won rose by two places. In addition to the currencies being traded more, the major APAC financial centres are seeing a larger proportion of the global FX trading activity take place there.

But what is interesting is that Tokyo, Hong Kong and Singapore increased their combined share of FX intermediation from 15% in 2013 to 21% in the most recent BIS survey. This begs the question of whether this is a temporary shift in FX trading activity or whether it is the beginning of a new trend where more activity will shift to the APAC region, potentially at the expense of London.

“The reason why London is the biggest FX centre is largely because of its geography, it’s history, it’s well-established legal and financial systems, etc,” says Vollemaere. “But ultimately it’s where the customers are that really counts. Customers call London because liquidity is good there, they can get their trade done and that’s where the relationship is.

“But it will be interesting to see if that relationship starts to shift,” he continues. “Lots of the Singapore firms used to have a very big London night desk, but they don’t as much any more because they have liquidity and they can get it done in their own day. It really depends where the customer behind them is, and right now there’s a lot more wealth kicking around in Asia than there used to be so there’s lots more potential for local customers,” .