wells fargo foreign exchange the evolution of the...

Wells Fargo Foreign Exchange

The Evolution of the Chinese Renminbi

Danielle McPherson, Managing Director

April 14, 2015

International Group 1

Onshore vs. Offshore RMB Markets - Overview

Can convert foreign currencies for onshore trade-related payments

Fewer investment options because capital account transactions are restricted

Hedging alternatives are usually non-deliverable instruments

Onshore entities have quotas for how much foreign currency may be converted into RMB

Freely-convertible for use outside of China as a trade or investment currency

However, there are restrictions for CNH entering China such as for capital account purposes

Hedging strategies may include deliverable contracts

Fewer restrictions and greater financial product availability

RMB funds movement is permitted if

trade-related#*

# Subject to prevailing laws and regulations* Certain capital account transactions (i.e. RMB bonds) may also be permitted

Off-Shore (CNH)On-Shore (CNY)

What does the RMB mean?

The full name is Renminbi, literally translated as the People’s Currency

It is often shortened to RMB or referred to as the Chinese Yuan


Foreign Exchange – RMB OverviewUnderstanding the RMB Framework: The Onshore and Offshore Market

Due to China regulations, the RMB is traded both offshore and onshore in China. Rates differ.

Offshore RMB currency code: CNH | Onshore RMB currency code: CNY (ISO Code) The Offshore CNH rate is freely convertible & driven by commercial and speculative flows The Onshore CNY rate is determined by supply and demand forces within the trading band (2% above

or below) set daily by the Peoples Bank of China (Central Bank)

The rates are converging as onshore capital controls are loosened in parallel to efforts such as

Creation of the Asian Infrastructure Investment Bank (AIIB) – Likely to include RMB loans Development of a Global RMB Clearing System - China International Payment System (CIPS) in 2015 Expected eventual IMF acceptance of the RMB for inclusion as a global reserve currency

Over the long-term, customers are expected to

Increase use of the CNH to diversify balances, invest, invoice, settle and hedge Shift use from CNY non-deliverable forwards (NDFs) to CNH deliverable forwards or swaps. The CNH

forward market is very liquid, 24-hours, and avoids NDF-type fixing risk Redenominate more USD invoices into RMB for trade

Onshore vs. Offshore RMB Markets – Closer Look


CNY vs. CNH

CNY and CNH are closely correlated.

Once the currency is freely tradable, there will be one currency.

Source: IHS Global Insight and Wells Fargo Securities, LLC

6.00

6.05

6.10

6.15

6.20

6.25

6.30

6.35

6.40

Jan-1

3

Apr-

13

Jul-

13

Oct-

13

Jan-1

4

Apr-

14

Jul-

14

Oct-

14

Jan-1

5

USD/CNY Spot

USD/CNH Spot

Source: Bloomberg


RMB Internationalization

Source: SWIFT RMB Tracker, Mar. 2015

• China is internationalizing its currency (RMB) to be accepted as a (1) Trade Currency; (2)

Investment Currency; (3) Reserve Currency

• Key development: free-convertibility (Predicted to happen by the end of the year)

• Process is happening in phases but fairly quickly:

• The China off-shore RMB (CNH) is now in the top 7 of global transaction currencies

• China is accelerating the establishment of Offshore RMB Centers (i.e. HK, London,

Singapore, Taiwan, etc.

RMB as world payments currency in value

Customer initiated and institutional payments. Inbound + Outbound traffic. Based on value.


RMB Trade Settlement and Investment

RMB, An Increasingly Important Trade & Investment Currency

Overseas parties can buy/sell RMB in the offshore market through their own banks outside China.

The percentage of China’s total trade settled in RMB is growing rapidly.

Data source: Hong Kong Monetary Authority


Value of Chinese Renminbi

When will the Chinese renminbi become a

completely convertible currency?

Rumor has it that the onshore capital account may be opened within a

year

Without a doubt, the CNY will be come volatile

Source: IHS Global Insight and Wells Fargo Securities, LLC

6.00

6.50

7.00

7.50

8.00

8.50

6.00

6.50

7.00

7.50

8.00

8.50

2005 2006 2007 2008 2009 2010 2010 2011 2013 2014 2015

Chinese Exchange RateCNY per USD (Inverted Axis)

CNY per USD: Mar @ 6.26


7

Wells Fargo FX Forecasts

Source: Wells Fargo Securities, LLC

6M 12M 18M

EUR/USD 1.1000 1.0600 1.0200

USD/JPY 121.00 123.00 125.00

GBP/USD 1.5200 1.5000 1.5100

USD/CAD 1.2700 1.2900 1.3100

AUD/USD 0.7500 0.7300 0.7200

USD/CNY 6.2200 6.2000 6.1600

USD/MXN 15.1000 15.1000 14.9000

USD/BRL 2.9000 2.9600 3.0000

USD/CLP 625.00 630.00 635.00

USD/COP 2420.00 2440.00 2460.00


Risk Identification

Companies with RMB risk fit into three broad categories:

1) Companies that own manufacturing plants / subsidiaries in China have direct currency exposure as they pay for labor and overhead in Renminbi (RMB).

2) Companies that pay Chinese vendors in RMB have direct exposure to the currency.

3) Companies that pay Chinese vendors in USD have indirect exposure to the currency.

In all cases, an appreciating RMB has the potential to increase costs for a US based company, and therefore hurt margins.

Many types of companies have RMB

risk.

Manifestation of Currency Risk


Hong Kong was the first market to support an RMB clearing system outside mainland China.

Chinese and foreign companies with a legal entity in China can open a standard bank account

Foreign companies can open CNH accounts at Chinese and foreign banks in HK.

Foreign corporate entities not established in China can settle import or export trade with China in CNH.

All payments are for the settlement of trade in goods and services imported or exported to China

9

Key aspects of the offshore RMB market


Meets industry and customer demand

Create a natural currency hedge

Mitigate foreign exchange exposure

Repatriate funds on your own schedule

Negotiate favorable trade terms/invoicing in renminbi

No need to open a CNH account in order to make or receive CNH payments

10

Key aspects of the offshore RMB market


Payment Currency

In which currency should I make my payments?

Currency Key Considerations

CNY(Onshore)

• Eliminates supplier’s currency risk as a factor during purchase negotiations (may facilitate better pricing terms)

• Currency risk exposure can be addressed via hedging strategies

CNH(Offshore)

• Eliminates supplier’s currency risk as a factor during purchase negotiations• Currency risk exposure can be addressed via hedging strategies• Requires that counterparty accepts payment to CNH account

USD • Completed via international wire transfer• Currently most common method of payment into China• Places currency risk on supplier and may result in higher pricing• Difficult to forecast costs if price changes with each order

Trade-related payments can be made in the currency (USD or CNY) designated on the invoice. This becomes important in the negotiation process

To prevent payment rejection, the originating bank (WFB) will ask exporter to verify:

Transaction is trade-related

All enterprises with export rights are eligible to settle their cross-border trading transactions in RMB unless such enterprises are subject to key supervision


Payment Execution

Situation: Supplier

requires payment in

RMB (onshore)

Payment in CNY:

Wells Fargo verifies

payment is trade related

Wells Fargo converts USD

to CNY at spot rate

Wells Fargo remits CNY

payment to onshore

beneficiary bank

(supplier’s bank)

Beneficiary bank matches

customs number and

credits supplier’s account

How can Wells Fargo help execute each payment option?

Situation: Supplier

requires payment in

RMB (offshore)

Payment in CNH:

Wells Fargo converts USD

to CNH at spot rate

Wells Fargo remits CNH

payment to offshore

beneficiary bank

(supplier’s bank

domiciled in Hong Kong)

Beneficiary bank

immediately credits

supplier’s account

Situation: Supplier

requires payment in

USD (onshore)

Payment in USD:

Wells Fargo remits USD

payment via

international wire to

onshore beneficiary bank

Wells Fargo is the world’s

largest provider of USD

wires into China

Onshore payments must be trade-related

Onshore OnshoreOffshore


Summary

China Financial Liberalization

Impact over the Next 2-3 Years Corporate Implication

Capital Control Liberalization

• Fewer restrictions on the FX conversion between USD & RMB, and the movement of cash in and out of China

• Potentially more funding options for China on-shore operations (i.e. Raising cheaper capital in Hong Kong to inject equity into the China Subsidiary)

• Increased USD-RMB Volatility

• Cash-Rich Subsidiaries: More ways to repatriate cash provided that tax obligations are fulfilled

• Cash-Poor: Less restrictions on borrowing from the Head Office (i.e. Borrowing Gap)

• Greater need for FX hedging

RMB Internationalization

• Easier access to offshore RMB (aka CNH)

• Increased cross-border transaction volume in RMB

• Emergence of commodities redenominated into RMB (i.e. Gold)

• Greater demand by Chinese exporters to transact in RMB (i.e. LCs)

• Asia to Asia trade corridor will see the largest RMB transaction increases

Interest Rate Liberalization

• Peoples Bank of China (PBOC is allowing the market to dictate lending rates and eventually deposit rates, particularly after the introduction of Deposit insurance

• Lending Rates to go down (for quality corporates)

• Deposit Rates to go up


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