HONG KONG, June 19 Offshore yuan trade is rapidly surpassing the once-dominant non-deliverable currency forwards market in the Chinese currency as traders gravitate to its improved price discovery and liquidity.
Beijing's push to promote the usage of yuan in global trade, and the promise of further market reforms, will likely make deliverable offshore yuan more popular in time to come.
For years, the non-deliverable currency forwards market in yuan traded in the global currency markets from Hong Kong to New York represented the only way to bet on the Chinese economy.
While that changed with the emergence of the deliverable offshore yuan markets in the second half of 2011, not even the most pessimistic of market watchers predicted such a swift decline for the NDF market.
A report this week from London, the world's biggest foreign exchange trading hub, showed for the first time how quickly the offshore yuan currency market has overtaken its NDF counterpart in recent months.
Based on a detailed FX survey, the report by the City of London concluded that trading in deliverable products for the yuan exceeded that of NDFs for the first time in 2013.
That rise in market share is nothing short of meteoric, considering that the offshore yuan market has been in London only for the last three years.
Banks in Hong Kong and Singapore have shared anecdotal evidence of the rise in deliverable yuan volumes on their platforms, but London's report is the first of its kind in its reach.
To understand the reason for that decline, it is necessary to understand the reason for the growth of the NDF markets in the first place.
The NDF market began to emerge in the early nineties focused on the emerging market currencies in Latin America and quickly spread to Asia and Eastern Europe.
Because NDF trading was primarily used as a means to hedge exchange rate risk for non-convertible currencies, market growth has been greatest for currencies of countries with increasing economic importance and strong capital controls such as China.
At the peak of its popularity in 2010, NDF trading in the yuan or renminbi exceeded trading on the mainland by more than a ratio of two to one as institutional investors ranging from hedge funds to sovereign wealth funds dabbled in these markets to gain exposure to Chinese currency risk.
But the advent of the CNH market in July 2010 changed that.
For the first time, investors could now settle their trades in yuan without having to worry about exchange rate risk or depend on the erratic fixings by the People's Bank of China on which these contracts were settled.
As the quality of prices improved along with the underlying liquidity in the CNH markets, more market players gravitated towards the deliverable markets in the currency.
While volumes grew quickly in offshore yuan trade, the NDF market remained attractive for some large funds with evidence from as recently as 2013 confirming the offshore deliverable markets in Hong Kong and Singapore moving in line with NDFs.
But the London data shows how quickly the rise of the CNH markets have come at the cost of NDFs.
The overall yuan market in London expanded by more than half from 2012 to $25 billion, but the rise was led by growth in deliverable yuan currency products, estimated at $18 billion, while NDF trade shrank to $6 billion.
In 2011, the total market size was about $10 billion with the non-deliverable market comprising more than $8 billion.
This year, Beijing has allowed for greater two-way volatility in yuan trade as part of market-opening reforms, but its midpoint fixings have defied global market moves, making it difficult for traders to rely on NDF contracts as a barometer for market-based pricing.
It may be too early to sound the death knell for the NDF market given that China is still far from full capital account convertibility, but one thing seems certain - the decline of NDF trade appears inevitable.
WEEK IN REVIEW:
* China's Bank of Communications Hong Kong branch completed its sale of 2 billion yuan ($322.11 million)three-tranche Formosa bonds in Taiwan, according to a term sheet seen by Reuters. The book reached 3.2 billion yuan with orders from almost 60 accounts.
* Singapore plans to launch a facility to provide overnight yuan liquidity as trade transactions using the currency rise. The city-state has also been allowed to conduct cross-border yuan transactions with eligible corporates and individuals in the Suzhou Industrial Park.
* Yuan deposits in Taiwan rose to 290 billion yuan ($46.71 billion) by the end of May, up 0.88 percent from a month earlier. Yuan deposits in South Korea rose by a net $1.42 billion to a record $11.33 billion mainly on increased investment by local institutions in China.
* China will allow free trade zones to be established only if they can be replicated elsewhere in the country, a senior commerce ministry official told the state news agency Xinhua.
* China specified ownership limits for overseas investors buying shares in companies listed in China via the Hong Kong-Shanghai stock connect scheme. A single foreign investor cannot hold more than 10 percent of a company, while the maximum combined holdings of all foreign investors in a single Chinese listed firm will be 30 percent.
CHART OF THE WEEK:
RMB deposits in Hong Kong: link.reuters.com/vyc25t
Despite the Chinese currency's weakness in recent weeks, yuan deposits in Hong Kong have grown in recent months with total deposits edging towards the 1 trillion yuan mark.
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($1 = 6.2090 Chinese yuan) (Additional reporting by Michelle Chen; Editing by Jacqueline Wong)