The launch of the Shanghai-Hong Kong Stock Connect pilot programme is another important step in the renminbi's journey to internationalisation. Together with a programme for the mutual recognition of funds between the mainland and Hong Kong, which is hoped to soon follow, these steps will support a wider use of the renminbi globally as an investment currency.
This will quicken the pace of the opening of China's capital account, which will have significant implications for the country's financial market reforms.
Hong Kong enjoys a significant lead over other offshore renminbi centres. It has the largest offshore renminbi liquidity pool (over 1 trillion yuan, or about HK$1.3 trillion), a critical mass of talent and the necessary infrastructure. Currently, it processes 90 per cent of China's renminbi-settled cross-border trade, and has over a quarter of the aggregate worldwide quota for the renminbi qualified foreign institutional investors scheme.
Hong Kong also offers a broad spectrum of renminbi banking and financial services, and the widest choice of offshore renminbi investment products. A growing number of renminbi products offered in other centres are also packaged or managed out of Hong Kong.
Nevertheless, competition is heating up. London recently completed the offering of renminbi-denominated treasuries issued by the UK government. While these bonds were not issued under the renminbi qualified foreign institutional investors scheme, it is the world's first renminbi bond issue by a foreign government, a move that immediately jump-started the creation of offshore renminbi assets in the London market.
At present, markets such as London and Singapore, as the trading hub of the European Union and Southeast Asian blocs respectively, have a relative advantage over Hong Kong in the areas of foreign exchange, fixed income and derivatives trading.
While Hong Kong was previously mainland China's only partner in experiments involving the cross-border use of renminbi, China today has demonstrated a readiness to replicate the Hong Kong experience in other markets.
Moreover, the recently established Shanghai free-trade zone indicates that some of the market liberalisation experiments could be first tested there rather than in Hong Kong. There is no longer any implicit guarantee of exclusivity. Therefore, the question for Hong Kong is, how can it maintain its position as the leading offshore centre in this new paradigm of multiple offshore renminbi markets?
The pace and progress of renminbi internationalisation are, by necessity, dictated by the degree in which difficult domestic reforms are implemented. In the process, the mainland will need to test ideas and find solutions. Hong Kong should continuously assess the progress of these reforms, identify mainland needs, provide expertise, advocate solutions and offer to carry out trial runs.
There are several pressing issues on the mainland's reform agenda. Interest rate and exchange rate liberalisation are no doubt two difficult tasks. Another key policy objective is to develop orderly fund flows between the onshore and offshore markets.
To fully open its capital account and converge with international markets, China will need to put in place transparent systems and regulation. There is also the all-important financial security concern - that massive inflows and outflows of international liquidity under an open capital account could exacerbate volatility and destabilise the onshore market.
Before China's capital account becomes fully convertible, Hong Kong should adopt a two-pronged approach. One prong is to compete by offering a comprehensive range of renminbi products and cost-effective solutions, a robust and efficient infrastructure and a worldwide network of coverage.
One function of an offshore market is to help the onshore market in price discovery and operational risk management. Hong Kong in particular should quickly develop a deeper offshore renminbi bonds market with vibrant secondary trading to assist in price setting, and a vibrant renminbi foreign exchange trading platform with multi-tiered products and derivatives.
It should also participate in the development of the renminbi cross-border inter-bank payment system, which is being led by the People's Bank of China, to solidify Hong Kong's position as the leading offshore renminbi settlement centre. As well, Hong Kong must continue to cement its lead as the offshore centre for renminbi wealth and asset management through renewed efforts in product innovation.
The other prong is to focus on areas where other offshore centres may not enjoy the same degree of access. This includes helping the mainland to set market-oriented policies for orderly cross-border flows between the onshore and offshore markets, and designing and jointly administering appropriate industry-wide systems and regimes to enable and monitor such cross-border flows.
It also includes helping to develop seamless connectivity between the mainland and Hong Kong clearing and settlement systems so that, through Hong Kong, the mainland could seamlessly connect with the global network. The Shanghai-Hong Kong Stock Connect is a case in point.
Monetary cooperation and maintaining financial stability is another area where the trust between the Hong Kong and mainland regulators could help cement a crucial role for the city.
Hong Kong withstood the onslaught of the 1997 Asian financial crisis and the 2008 global financial crisis. Severely tested on both occasions, Hong Kong's financial system and infrastructure weathered both crises well. As the onshore market becomes exposed to the contagion of global market dislocations, Hong Kong could share its experience and establish a cross-border platform with the mainland to jointly monitor and manage volatile cross-border flows of international liquidity. This is a crucial function, one which Hong Kong is best suited to perform.
As the renminbi capital account becomes fully convertible, Hong Kong should quickly seize the opportunity to develop a comprehensive range of multi-currency transactions, services and products to encourage the expanding use of the renminbi in Hong Kong. In a free and open market environment, the offshore market that outperforms others is the one that succeeds in developing a broad, sustainable and genuine demand for renminbi for commercial and investment needs.
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