China's Global Currency Expansion Bringing More Yuan Denominated Products to Market

Chinese regulators plan on developing more yuan-denominated products and allowing more offshore yuan investment opportunities in the continued push for the global expansion of China's currency.

More yuan-denominated bonds, foreign direct investment (FDI) opportunities and eventually initial public offerings (IPOs) will hit the markets in coming years as China gradually allows its currency, also called the renminbi, to be more accessible in international trade and investment. Chinese regulators also want to support international development of Chinese entities.

The People's Bank of China (PBOC) earlier this month announced that it has started looking into permitting Chinese companies with overseas yuan accounts to engage in FDI in the mainland. The central bank also recently said it would allow mainland companies to conduct overseas direct investments (ODI) with the yuan.

"China needs both ODI and FDI of renminbi and we are expecting the regulations of FDI to be announced," Zhang Jianjun, president of PBOC's Shenzhen central sub-branch, said at a conference last week.

The PBOC would monitor differences in offshore and onshore renminbi exchange rates to prevent arbitrage.

The move is the latest in a series of actions to push the yuan into a greater global role.

Earlier this month the PBOC allowed mainland companies to use the yuan for overseas business ventures and acquisitions, provided the companies gain approval from Chinese regulators first.

"It will be interesting to see if the foreign sellers of companies that the Chinese want to buy will be willing to accept renminbi," Dariusz Kowalczyk, a strategist at Credit Agricole, told The Financial Times.

State-owned Bank of China Ltd. this month announced that it would allow U.S. customers to open yuan accounts to buy and sell China's currency.

"We're preparing for the day when renminbi becomes fully convertible," Li Xiaojing, general manager of BOC's New York branch, told The Wall Street Journal. The bank wants to be "the renminbi clearing center in America."

Money Morning Chief Investment Strategist Keith Fitz-Gerald said that was another move by China to start promoting the role of its currency in global trade.

"Prior to July 2010 such trading had been confined within China," said Fitz-Gerald. "Then, the government allowed limited yuan trading in Hong Kong, which has surpassed all expectations by blossoming literally from zero to more than $400 million a day. Against that baseline, here they come and here the Yuan comes."

There is a fast-growing market for yuan-denominated products since China allowed yuan trading off the mainland for the first time last year. Yuan deposits have now reached $46 billion in Hong Kong, but there are few yuan-denominated products to offer investors.

KC Chan, Hong Kong's secretary for financial services and treasury, said there are three stages in product development.

First to come to market are yuan-denominated bonds. These products have already started increasing offerings and according to Chan have already reached 30 billion renminbi in assets. McDonald's Corp. (NYSE: MCD) and Caterpillar Inc. (NYSE: CAT) recently became the first U.S. non-financial companies to sell yuan-based bonds in Hong Kong.

The next stage involves yuan-denominated funds. So far there are four such funds available in Hong Kong.

Lastly are yuan-denominated IPOs, which will happen in coming years but are still not desirable to many investors because of the illiquid yuan market.

"[A] renminbi-denominated IPO has to compete with a Hong Kong dollar-denominated IPO," said Chan. The Hong Kong dollar market offers investors much more liquidity.

Hong Kong has been China's trial market for yuan-denominated products. Besides allowing yuan trading in the territory in July 2010, Beijing has offered two Chinese government debt issues starting in 2009.

Now Monex, Japan's largest online brokerage, is offering yuan-denominated government bonds in Japan, hoping that speculation on yuan appreciation will attract Japanese investors.

Monex also plans on distributing a yuan-denominated bond fund in Japan in February. It is being launched by Diam, one of the country's largest asset managers, and will include government, government agency, international agency and corporate debt.

But the country's global currency expansion has some significant hurdles to clear.

First is the yuan market's lack of liquidity. While many investors want to profit from yuan appreciation, they still like to trade in U.S. dollars. This has driven a rise in synthetic yuan bond issues.

A synthetic yuan bond is a yuan-denominated debt instrument traded in dollars. It differs from the "dim sum bonds," issued by McDonald's, because they trade in yuan.

Since Dec. 15, new issuers of synthetic yuan bonds have sold almost $2.7 billion worth, according to The Journal. The bonds are attractive to investors because they usually offer higher yields than yuan-traded bonds. The lack of investment options for yuan holders keeps yuan-traded-bond yields lower, with the highest coupon so far being 4.625%.

But a three-year synthetic yuan bond from Evergrande Real Estate Group priced earlier this month offered a coupon of 7.5%. The $1.4 billion issue was Asia's biggest high-yield corporate debt deal ever.

China's property developers like synthetic yuan bonds because of the tight regulatory control over bringing yuan into the country - another large roadblock in the currency's global expansion. Companies have to apply to bring yuan into China, and share the intended use and source of the money. Property companies especially could get rejected by the Chinese government, which doesn't want developers buying up land cheaply and pushing up property prices.

Analysts still expect the yuan to continue to appreciate against the dollar. While progression may be slow, investors will see more opportunities to increase their stake in the yuan.

"If you haven't already bought yuan as part of your Chinese investing program, now's the time to do so," said Fitz-Gerald. "Having the yuan on the world's stage will unleash a wave of purchasing power the likes of which the world has never seen and it is a game changer in the truest sense of the world."

News and Related Story Links: