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New offshore yuan products to relax currency flow

(Shanghai Daily)

08:28, May 20, 2013

According to the media, the Qianhai Equity Trading Center, which is expected to commence operation this month, will provide loans to Qianhai enterprises by launching yuan-denominated wealth management products on the Hong Kong capital market.

These wealth management products are pledged by assets of small- and medium-sized enterprises. Given the higher risk profile of these enterprises, the yields are expected to reach as high as 10 percent. Private banking clients as well as private equity firms in Hong Kong will be the target group of investors.

Since November 2012, yuan deposits in Hong Kong have started growing again after stagnating for a year. In further relaxing currency flows between Qianhai and Hong Kong, offshore investors now have an additional avenue into yuan investments. More importantly, the double-digit rate of return is relatively attractive compared with the average 2.5 percent and 4.0 percent yields for yuan time deposits offshore and Dim Sum bonds respectively.

While further details are not available at the time of writing, the structure of such wealth management products is likely to be similar to those that onshore banks issue through trust companies. However, they should be subject to more stringent regulatory control since any failure would undermine investor confidence over the future financial reforms in the city.

The new scheme, alongside the yuan cross-border loan program unveiled in January, will provide channels for Qianhai firms to tap "cheap" offshore funding, which in turn, would enhance their operating margin. Small businesses on the mainland, especially those that have long struggled to raise funds from the large state banks, will also benefit.

The latest initiative also signifies China's determination to push forward capital account liberalization. It allows Beijing to test the regulatory procedures as well as the operational risks of cross-border financial activities.

That echoes with the policy moves and speeches made recently by other Chinese regulatory bodies and senior officials. To encourage foreign direct investment into China, the State Administration of Foreign Exchange has simplified the procedures of forex registration, forex account opening, and forex settlement. In April, Yi Gang, vice governor of the People's Bank of China, said that the authority is planning to widen the dollar-yuan trading band in the near future to better reflect market forces.

Offshore impacts

The impact of the scheme on offshore yuan liquidity should be limited. In particular, the program will likely be monitored under a quota system. If needed, the regulators could divert more yuan flows to the offshore market. One of the policy considerations is to allow Hong Kong banks to access the onshore interbank market for funding.

Meanwhile, the authorities can also encourage more use of yuan in outward direct investment, where growth has lagged yuan-denominated foreign direct investment. Other policies on the cards include relaxing the yuan daily conversion limits for Hong Kong residents and allowing yuan outward remittances for mainland individuals and corporates.

Following the launch of offshore yuan trust products and cross-border loans, the scope of yuan business between two regions will be further enhanced. For instance, the authorities are planning to allow Qianhai companies to directly issue Dim Sum bonds in Hong Kong. Individual investors in the city might be allowed to participate in the yuan-denominated version of Qualified Domestic Institutional Investor program.

Chinese regulators have also reportedly given the green light for offshore companies to set up private equity funds in Qianhai. If such pilot programs succeed in Qianhai, we expect them to be implemented gradually in other Chinese mainland cities. The experimentation in Qianhai will provide valuable references for the nation as a whole.

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