Luxembourg sets its sights on being the European hub for renminbi investment
Though the renminbi has attracted a host of suitors from across the world, it is banking on a small European nation to boost its global standing as an investment currency.
Move over London, Frankfurt and Paris. The Grand Duchy of Luxembourg, a tiny land-locked Western European nation, seems to be far ahead of others when it comes to attracting renminbi business in Europe, sources say.
"Luxembourg has played a key role in increasing the liquidity of the Chinese currency globally," says Nicolas Mackel, chief executive of Luxembourg for Finance, an agency that works for the development of the financial sector in Luxembourg.
The grand duchy, which hosts the European headquarters of three major Chinese lenders, has 44 renminbi bonds listed on its stock exchange till date and is home to a growing number of renminbi-focused funds. Unlike London, Frankfurt and Paris, which boast natural advantages such as bigger trade flows with China and familiarity with investors, Luxembourg is banking on its position as an important investment hub in Europe.
According to sources, cities like London have not been that popular with Chinese lenders due to the unfavorable environment and strict regulations. They add that London has issued only four renminbi bonds to date.
On the other hand, the big concentration of Chinese banks in Luxembourg has ensured that it has become an important part of China's outbound trade, finance, investment, and mergers and acquisition deals in Europe. This has also helped boost the scale and liquidity of the offshore renminbi pool in Luxembourg, sources say.
"Luxembourg's trade with China is tiny. But any currency on its way to being a global reserve currency has to be a trade currency and also an investment currency, which is where we come in," Mackel says.
According to official figures as of December 2013, Luxembourg has the largest pool of renminbi in the eurozone with 64 billion yuan ($10.4 billion; 7.5 billion euros)in deposits, 53.8 billion yuan in loans, 24.7 billion yuan in renminbi bond listings and 256.4 billion yuan in renminbi-denominated assets held in investment funds.
Luxembourg Finance Minister Pierre Gramegna recently indicated that he would press for the setting-up of an official renminbi-clearing bank and for an RQFII quota during his upcoming trip to China.
RQFII, which stands for Renminbi Qualified Foreign Institutional Investors, is a program launched by the Chinese government in 2011 that allows qualified overseas financial institutional investors from overseas to invest in China's onshore financial markets directly using the renminbi.
An official clearing bank facilitates the efficient clearing of offshore renminbi transactions, achieved through the appointed bank's direct cooperation with the People's Bank of China, China's central bank.
One of the key drivers behind the growth of renminbi transactions in Luxembourg is the city's growing number of funds that invest in renminbi opportunities.
These funds collectively called UCITS, which stand for Undertakings for Collective Investment in Transferable Securities Directives, are recognized by institutional investors globally, especially in Asia and Latin America.
For this reason, more fund managers are creating UCITS in Luxembourg for global distribution, and a growing number of these UCITS focus on investing in offshore renminbi products, including dim sum bonds, sources say.
"There are many Luxembourg-based UCITS funds that invest in the offshore renminbi market," says Stefano Chao, an investment manager at AZ Investment Management, which is a subsidiary of Italy's largest independent asset manager, Azimut Holding.
"When we talk to institutional investors in Latin America and Asia, they feel comfortable about investing in UCITS. Luxembourg in this sense is a good jumping point for the internationalization of the renminbi, because Luxembourg funds that invest in renminbi can be bought by international investors," Chao says.
Liberalization journey
China's push to internationalize its currency started in 2008, when the global financial crisis demonstrated the danger of over-reliance on the US dollar.
During the 2008 G20 summit in Washington, former Chinese president Hu Jintao called for "a new international financial order that is fair, just, inclusive and orderly".
Beijing soon began to encourage the use of its currency in international trade, swap arrangements among central banks, and bank deposits and bond issuances in Hong Kong.
Trade in offshore renminbi has since boomed. Increasing Chinese exports also led to a surge in demand for renminbi outside China as Chinese exporters increasingly expected to be paid in their own currency to eliminate exchange risks.
"For a country that's predicted to become the largest economy in the world, it's only logical that the currency also goes global. Renminbi internationalization is a big theme, but it is really about China opening up," says Rongrong Huo, head of renminbi business development at HSBC Europe.
"Many Western countries have increasingly realized they want to engage with China, and offshore renminbi activities are a good way to start that engagement," she says.
Following Hong Kong's success in growing offshore renminbi products and services, other international centers including London, Paris, Frankfurt, Luxembourg and New York entered the race to become a Western center for offshore renminbi.
One area of significant development seen over the last few years is the trend by European companies of switching to renminbi invoicing when trading with their Chinese partners, to avoid exchange risks and receive better margins.
London, for example launched an initiative in April 2012 to make renminbi trade processing easier for European businesses, and offer companies and investors the opportunity to trade, invest and bank in renminbi in London.
Led by the City of London Corporation, and involving efforts from 13 Chinese and Western banks, the initiative achieved considerable progress. Trade finance transactions using the Chinese currency totaled 27.94 billion yuan ($4.61 billion) in the first half of 2013, up from 13.8 billion yuan a year earlier.
"The confidence among clients in utilizing and trading in renminbi has increased probably 200 percent since we started this initiative. So we've seen clients actually wanting to trade in renminbi and invoice in renminbi," says Sonia Rossetti, managing director of Europe head product management at Standard Chartered Plc.
Other European centers like Paris and Frankfurt have also been increasing their renminbi trade settlement and trade finance capabilities.
Currently about 10 percent of Sino-French trade and Sino-German trade is settled in France and Germany, according to statistics from the French central bank, Banque de France, and Frankfurt Main Finance, a financial association that represents major German banks.
Bernard Poignant, China adviser of Paris Europlace, an organization responsible for coordinating and developing the Paris financial marketplace, says the growing use of renminbi for trade transactions demonstrates "a concrete effort to promote the use of renminbi with French customers dealing with China" by French banks.
"Our goal is to increase the percentage of commercial trade in renminbi. Many small and medium-sized businesses will not know about this option and its benefits if we don't explain it to them," Poignant says.
Poignant's views are echoed by Lutz Raettig, chairman of the supervisory board of Morgan Stanley in Frankfurt, who adds that German banks are working hard to ensure sufficient renminbi liquidity to facilitate the growing renminbi trade flow.
Globally, renminbi usage in international trade finance grew to 8.66 percent in October 2013, from just 1.89 percent in January 2012, according to Society for Worldwide Interbank Financial Telecommunication figures.
This milestone made renminbi the second most used currency for trade finance internationally, just behind the US dollar, which has a share of 81.08 percent. About 18 percent of China's global trade is now denominated in renminbi, compared with less than 1 percent nearly four years ago.
Next step
But becoming an international trade currency is only the first step in the renminbi's progress to become a global reserve currency. The next key step is to turn it into an investment currency, as global investment flows are far larger than trade flows.
To achieve this, many offshore renminbi products have been developed in recent years, and one notable example is the offshore renminbi bond, which helps companies to raise funds in offshore renminbi.
Currently Luxembourg Stock Exchange lists the third-largest number of offshore renminbi bonds globally after Hong Kong and Singapore.
That doesn't appear surprising considering that the Luxembourg bourse always had a global focus, especially after listing the first Eurobond in 1963.
"We were interested in international business early on, and have become good at listing bonds. We have developed additional after-sale services for issuers, so it's not just a one-off service," says Robert Scharfe, CEO of the Luxembourg Stock Exchange.
Scharfe says listing a large number of renminbi bonds on the Luxembourg Stock Exchange brings numerous benefits to the local economy, despite the fact many issuers and investors of the bonds are not based in Luxembourg.
In addition to the listing fees received by the stock exchange, Luxembourg's local law firms and banks also gain from such moves as they can provide services to the bond issuers. Their proximity to and understanding of the Luxembourg investment environment is of great help to the bond issuers, Scharfe says.
Since most of the bond listings are structured using a special purpose vehicle for legal and tax reasons, many of these SPVs are based in Luxembourg. Most of the bond transactions are cleared by Clearstream, a clearing house headquartered in Luxembourg.
Elsewhere in the world, Asian financial centers like Singapore, Taiwan and Macao are following Hong Kong's footsteps to grow offshore renminbi activities, fully utilizing their advantage of geographical proximity to the onshore Chinese mainland market.
Industrial and Commercial Bank of China in Singapore and Bank of China in Taiwan and Macao have been appointed as official clearing banks over the past few years, giving a boost to the liquidity of offshore renminbi flow to the three centers.
Last March, Singapore and China also doubled the value of its swap line to $48 billion, three years after the swap line was initially established.
Under a swap agreement, central banks agree to exchange each other's currency and can then lend the money out to domestic banks in cases of emergency. It is considered an effective tool to boost market confidence in the renminbi.
Key advantages
Another key driver behind Luxembourg's progress in developing offshore renminbi activities is the growth of Chinese banks in the city.
In October 2013, China Construction Bank became the third Chinese lender to set up its European headquarters in Luxembourg, following BOC and ICBC.
This concentration of Chinese banks in Luxembourg has resulted in much of the financing for Chinese companies in Europe moving through the duchy, and also helped the country grow its offshore renminbi pool and liquidity.
The history of Chinese banks setting up shop in Luxembourg started in 1979 when the Bank of China established a branch in the country.
BOC then opened a subsidiary in 1991, to prepare for the bank's expansion into other European countries using the European Union's single passport policy. Five branches managed by BOC Luxembourg were established subsequently in Rotterdam, Brussels, Warsaw, Stockholm and Lisbon.
Different from branches, which are offshore arms of foreign banks, subsidiaries are separate legal entities, regulated in the same way as local banks.
"Opening a subsidiary in Luxembourg allowed us to access certain EU markets quickly," says Zhou Lihong, general manager of Bank of China Luxembourg.
ICBC's expansion in Luxembourg was quite similar. It established a representative office in 1998, which quickly upgraded to a branch in 1999. In 2006, ICBC established a subsidiary in Luxembourg, to prepare for the bank's expansion to other European countries.
The fast expansion of Chinese banks in Luxembourg, however, comes amidst controversial talk of Chinese banks in London shifting their investment focus from London to Luxembourg in response to tightening regulatory pressures.
The issue first emerged in 2012 when a group of Chinese banks expressed frustration over regulatory matters in a letter sent by the Association of Foreign Banks to Britain's Treasury.
Their main complaint concerned the British regulator's refusal to let them open branches, which would have had lending and financing capacity proportional to the parent company's balance sheet.
Subsidiaries, in contrast, are subject to the strict capital requirements that apply to Britain's local banks, hence lending and financing capacity is proportional to the balance sheet of the subsidiary itself.
Zhou from BOC believes much of the discussion about Chinese banks shifting from London to Luxembourg is centered on an incorrect understanding of Luxembourg's financial regulation as relaxed.
"On the contrary, Luxembourg's regulators have extremely strict standards. Since Luxembourg follows EU laws, there is no way that Luxembourg regulators can be less strict than other EU countries," Zhou says.
"Where Luxembourg regulators have an advantage is their flexibility, efficiency and pragmatism. They are accessible and listen to our questions. I think it is a very open relationship. We are working toward the same goal."
The future
Despite foreign governments' eager efforts to become involved, there is still a lot to be done for China to completely liberalize its capital account and for the renminbi to become a true global currency.
Historically China has implemented many capital account controls to prevent hot-money inflow from abroad in speculation on renminbi appreciation, which could destabilize China's domestic economy.
But since lifting the renminbi-dollar peg in 2005, the Chinese currency has appreciated to a state many economists now consider to be an equilibrium exchange rate, allowing the Chinese government to gradually lift these capital controls and welcome more foreign investment.
China also launched a free trade zone in Shanghai last year, which includes a pilot program that allows greater liberalization of capital account controls. If proven successful, these policy changes will be adopted across the country.
Ding Yifan, deputy director of the institute of world development, under the Development Research Center of the State Council, says China's capital account liberalization will take time.
Ding says that China's capital account liberalization and currency appreciation in recent years have been recognized by encouraging statements issued by the World Bank and International Monetary Fund. But at the same time, he believes capital account controls will not be completely lifted in the foreseeable future.
Alongside the Chinese government's efforts to liberalize the renminbi, European regulators also need to develop appropriate methods to regulate growing yuan-denominated transactions in the eurozone, says Yves Mersch, a member of the European Central Bank's executive board.
The increasing presence of Chinese banks in the euro area also brings its own challenges regarding banking supervision, including the need for greater international cooperation and exchange of information, Mersch says.
Challenges aside, Mersch also says the renminbi is on a promising path to becoming established as a global reserve currency.
"Clearly, having become an important trading and payment currency, the renminbi is now taking the first steps toward establishing itself as an international investment currency. If it can do so successfully, it might one day become a leading reserve currency," he says.
cecily.liu@chinadaily.com.cn
