CNH Tracker-Trade settlement to shrink offshore RMB discount

By Saikat Chatterjee

HONG KONG, Oct 6 (Reuters) - The yuan traded in Hong Kong
has been unusually weaker than its mainland counterpart but will
probably narrow the gap next week when China reopens for
business after a long holiday and companies take advantage of
this market dislocation.

The yuan traded in Hong Kong , or "CNH", usually
trades at a premium to the onshore rate because of
the limited supply of CNH outside of China. CNH is freely
convertible outside the mainland.

A steep, late summer selloff in riskier assets such as Asian
bonds and currencies, along with the illiquid trading conditions
in Hong Kong that hampered cross-border trade settlement, caused
a discount to open up between the two markets two weeks ago for
the first time since its birth in June 2010.

As markets recovered somewhat this week, the discount has
narrowed to less than 0.7 percent from a record 2.6 percent on
Sept. 25, but still at elevated levels.

Further narrowing in the CNH/CNY spread would ensure more
orderly growth of the offshore market and would smooth out
cross-border trade flows.

With Chinese stocks listed in Hong Kong and dollar
bonds of mainland companies benefiting from a short squeeze on
Thursday, this gap may narrow more and eventually converge,
barring an ugly turn in the euro zone debt crisis.

Since the offshore market's launch, whenever CNH has widened
1 percent from CNY in the spot market offshore subsidiaries of
Chinese companies have stepped in to arbitrage the gap.

In October 2010, when demand for offshore yuan skyrocketed
because of a temporary shortage, offshore subsdiaries of
mainland importers settled their trade in Hong Kong, causing the
gap basically to disappear in around two weeks.

Indeed, at the depths of the CNH selloff late last month,
currency traders said there were also some heavy dollar selling
against the offshore yuan near its lows.

Yuan-denominated trade settlement has grown at a healthy
pace. Trade settled in yuan as a percentage of total China trade
grew to 10 percent in the second quarter compared to less than
one percent in the first quarter of 2010.

WEEK IN REVIEW:

* Feeling the heat. Expectations that the Chinese currency
will strengthen in the medium-term could put pressure on Hong
Kong banks' ability to increase loans as more depositors choose
to keep money in yuan, KPMG's head for financial services in the
territory Martin Wardle said this week. Such a development would
likely push up interest rates in the city as demand for loans
grows more quickly than do new Hong Kong dollar deposits.

* More quotas. After a severe pounding last week,
authorities got into the act. Beijing doubled the quota for
settling cross-border yuan trade to eight billion yuan for the
last quarter. While the quota will help in reducing market
volatility for now, market players said more structural reforms
are needed such as a central bank clearing authority.

* Navigating the waters. Amid the market turmoil in the CNH
markets, mainland shipping company Sinotrans Shipping
sold a 2.6 billion yuan ($406 million) three year bond at 3.3
percent. Bank of China Hong Kong, BOC International,
Agricultural Bank of China and Wing Lung Bank were joint
bookrunners of the deal.

* While the gap between the yuan traded in Hong Kong and
mainland has narrowed sharply, the weakness in CNH has sent
investors scurrying to high grade credits. Morgan Stanley says
it prefers high quality dim sum credits over high yield names
since the CNH credit quality curve is too flat and doesn't
compensate investors for going down the quality curve.

CHART OF THE WEEK:

CNH deposits in HK grow: link.reuters.com/mus24s

Even as concerns about the euro zone debt crisis and the
global economy kept investors preoccupied, offshore yuan
deposits in Hong Kong banks have grown at an impressive pace.
One out of every ten dollars of deposits in Hong Kong banks are
now denominated in yuan.

LEAGUE TABLES

YTD dim sum bond issuance:

Book runner: Proceeds (RMB mln): # of issues:

1. HSBC 29,355.0 57

2. Standard 16,281.3 36

Chartered Bank

3. Bank of China 8,281.7 13

4. Deutsche Bank 8,117.6 14

5. RBS 7,338.5 18

YTD synthetic RMB bond issuance:

Book runner: Proceeds (RMB mln): # of issues:

1. Deutsche Bank 4,679.2 4

2. Citi 2,912.5 2

3. Bank of America 2,312.5 1

Merrill Lynch

4. Bank of China 2,312.5 1

5. HSBC 1,248.5 2

* Thomson Reuters data as of October 6

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(Additional reporting by Nethelie Wong with IFR; Editing by Kim
Coghill)