Profit & Loss, by Galen Stops
As the RMB gains in prominence, China faces decisions around settlement mechanisms, which will be crucial to its acceptance as a truly international currency.
China faces a decision – one that weighs operational risks against political risks: does it join the global market and put its currency onto CLS, the primary settlement system for world currencies, or does it build its own utility?
Trading in CNH continued to surge in 2015, and the currency overtook the Japanese yen to become the fourth largest payments currency and is now to be included in the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) basket. All of this points to China’s currency moving further towards the financial mainstream.
However, there’s one key issue preventing CNH trading from really taking off, and it’s a big one. As discussed on a panel at Profit & Loss Shanghai in November, the currency needs a central settlement mechanism if it is going to be able to live up to its potential.
Out of the top 10 most actively traded currencies in the Bank for International Settlements’ (BIS) 2013 survey, RMB is the only one that is not in the continuous linked settlement system, CLS. Likewise, RMB will be the only currency in the SDR basket not in CLS.
This begs the question of whether 2016 will be the year in which China pushes for some form of its currency to be made CLS eligible.
The Obvious Choice?
CLS is a well-established piece of market infrastructure – deemed in the US as a systemically important utility – and as such, the global FX market relies on it. Moreover, as China seeks to internationalise its currency, there appears to be a strong push from the authorities there towards the financial mainstream.
The importance attached to the SDR basket entry by the Chinese authorities is a clear indication of this. As part of the SDR entry, China will be connected to the IMF in a much more pronounced way, not least in part due to the agreements that it has to abide by in order to have its currency in the SDR basket.
All of this seems to point towards a greater degree of RMB integration into the global financial system, something that would help the eventual internationalisation of the currency. It would seem strange, therefore, for China not to use the established settlement infrastructure that is already connected to, and used by, so many firms across the world.
Another potential benefit of CLS inclusion is that being accepted for its settlement service confers a certain status upon that currency as one that is safer for market participants to trade, given the criteria that a currency has to meet to become eligible for its settlement service.
However, despite the benefits of having its currency made CLS eligible, some market participants suggest that China may be considering another path. Although CLS has an oversight committee that includes all of the central banks whose currencies are settled by CLS, the US Federal Reserve is the regulator of the legal entity and acts as the lead overseer of the settlement utility. This, according to some, could prove to be a sticking point for the Chinese authorities in adopting CLS for settlement services.
Jon Vollemaere, CEO and founder of R5FX, adds: “I don’t see China tying themselves to a system where the US Federal Reserve is the lead regulator, and why should they? “I know other central banks are on