China's Yuan Dreams Pit Germans Against Rest of Exchange World

  • The nation is `holy grail of opportunity,' says Tabb's Nybo
  • Reserve-currency status may drive $1 trillion in foreign flows

For years, if not decades, just about every financial center in the world has tried to set up a yuan trading hub outside China. Countless memorandums of understanding and letters of cooperation have been signed, numerous official state visits made.

QuickTake The People’s Currency

Yet in spite of it all, there’s been scant progress in harnessing China’s economic might -- and the trillions of dollars that could flow with it.

Deutsche Boerse AG is undaunted. Today, the German exchange flips the switch on the first dedicated renminbi-denominated trading venue outside mainland China. The platform will give overseas investors access to about 200 securities consisting of bonds and exchange-traded funds.

“China has, and always will be, this holy grail of opportunity,” said Andy Nybo, a partner at capital markets research and consulting firm Tabb Group LLC.

Onshore Versus Offshore CNY
Onshore Versus Offshore CNY

While other markets, such as London Stock Exchange Group Plc, have seen their own attempts to spur trading in a handful of listed yuan securities fall flat, Deutsche Boerse is trumpeting a key advantage that will help it succeed. Unlike its rivals, the German venture is co-owned by two big Chinese firms, the Shanghai Stock Exchange and China Financial Futures Exchange, which may lend it the credibility it needs to win over investors.

Regardless of the outcome, the stakes are high. With the International Monetary Fund on the cusp of granting China reserve-currency status, the yuan’s emergence as a major force in world markets may attract $1 trillion of foreign money to Chinese debt in the coming years, according to Goldman Sachs Group Inc. Approval probably also will make more countries comfortable including the yuan in their foreign-exchange holdings and boost President Xi Jinping’s drive to open up China’s economy.

Crucial Step

And even if it takes years, getting even a small piece of the action could help strengthen Deutsche Boerse’s derivatives business, which enjoys an effective monopoly on futures tied to German government debt and some of Europe’s most popular stock indexes.

For China, having yuan-denominated securities traded widely is a crucial step in the country’s integration into global financial markets. Many overseas money managers have been kept from owning Chinese securities because capital controls prevent them from directly investing or using the currency. China didn’t allow its currency outside its own borders before 2004, but may now seek to fully dismantle restrictions by 2020.

In trillions of yuan
In trillions of yuan

The Deutsche Boerse joint venture, called the China Europe International Exchange, or CEINEX, is 40 percent owned by the Shanghai stock market. The China Financial Futures Exchange has a 20 percent stake.

Two flagship funds sit at the heart of CEINEX’s product range: a money market ETF similar to those already offered by LSE and Euronext NV, and a fund tracking the Shanghai Stock Exchange 50 A Share Index. The stocks ETF is the first yuan-denominated investment in Europe to follow a gauge of mainland Chinese equities. As yet, there’s no timetable for when futures and other derivatives will join the exchange.

Few Options

Before CEINEX opened its doors, overseas investors had few yuan-denominated options. LSE and Euronext each had an ETF tracking short-dated debt. LSE was first, starting in March, and Paris-based Euronext followed at the end of June. Both firms plan to offer more yuan securities in 2016.

“We would envisage significant issuance to come in the future,” said Nikhil Rathi, chief executive officer of LSE’s stock-market business. “I would expect quite a lot of developments in the next year.”

The two exchanges also list debt securities priced in renminbi (the official name for the Chinese currency) for banks and large companies. LSE has 38 such bonds valued at about 24 billion yuan ($3.8 billion), with half that number joining this year. Euronext has 13 bonds totaling 13.5 billion yuan.

While CEINEX’s launch has focused more attention on overseas yuan products, as well as Deutsche Boerse’s potential advantage, it’s far from clear whether anyone will trade them.

Liquidity Problem

The Commerzbank CCBI RQFII Money Market ETF -- LSE’s only yuan fund -- had just 4,000 pounds ($6,088) of trades in the week ended Nov. 13. That’s far less than the 226 million pounds of the iShares Core FTSE 100 ETF that changed hands in the same span.

“The provision of products and services to capture business resulting from the internationalization of the renminbi is a longer-term play and it will take time for liquidity to build,” said Lee Hodgkinson, the head of markets and global sales at Euronext.

He added that it may take two to three years for volume to pick up.

CME Group Inc. understands just how slow going things can be with China, even as an early mover. Way back in 1985, the Chicago-based derivatives exchange welcomed then-Chinese President Li Xiannian, causing the trading pits to grind to a halt as thousands of traders cheered and tossed paper like confetti.

Ever since, it has been trying to link itself with China’s markets, but progress is still mostly limited to agreements to “explore opportunities.”

“All of this takes time and we are all in the West impatient,” said Leo Melamed, the former longtime leader of CME and now its chairman emeritus. But ultimately, “it’s going to happen.”

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