UPDATE ON THE ASIAN ECONOMY 12/2014. N o 4. Exploring new opportunities as China liberalises its economy.

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1 UPDATE ON THE ASIAN ECONOMY 12/2014 N o 4 Exploring new opportunities as China liberalises its economy.

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3 Issue 04 December Bala Swaminathan, General Manager, Westpac International Welcome The Year of the Horse saw the Asian Business accelerating its growth momentum. China has been a key focus for us this year, where we have significantly deepened our presence as we continue to support all of our customers doing business in the Australasia-China corridor. We remain at the forefront of the RMB internationalisation story with our leading financial markets capability as one of only two Australian banks to have a market makers licence for both AUD/CNY and NZD/CNY, as well as a Foreign Exchange Derivatives licence for G7 and RMB currencies. Over the year, we have been quick to take on new opportunities as China liberalises its economy and takes steps to build Shanghai as an international financial centre. We are very excited to open our sub-branch in the Shanghai Free Trade Zone, and to provide deeper support for our customers, in what we expect will be a more dynamic business environment, facilitating even greater trade and investment flows between China and Australasia. Our sub-branch will offer an extension of Westpac s service offering across trade finance, foreign exchange and debt capital markets. On a final note, we are excited about Westpac being one of the first banks in Australia to connect with the RMB hub in Sydney. Being able to directly trade with RMB will make it much easier for our customers to do business between China and Australia, saving them both time and cost, and we are ready with our market-leading capability to support them. I wish you a safe and happy holiday season and a prosperous start to the New Year.

4 2 December 2014 Issue 04 The future of RMB

5 FEATURE BEYOND THE SYDNEY RMB HUB Issue 04 December Beijing s long, patient campaign to establish the Chinese yuan as a fully convertible international currency got underway a decade ago in 2004, when Hong Kong residents were allowed to convert their Hong Kong dollars into renminbi (RMB), subject to a daily limit. But it really kicked into gear in 2009, when the Chinese government got serious about promoting the wider international use of the Chinese currency, the renminbi (RMB) when it launched its cross-border RMB trade settlement program. China wants to move away from the US dollar as a reserve currency (a currency in which other countries hold reserves) and is aiming to have 30% of foreign trade settled in RMB by Ultimately China wants to see the RMB become a reserve currency itself, with the nation s capital account widely expected to be effectively open by On a scale of nought to ten, Beijing is at about seven on its path to internationalise the RMB, says David Olsson, specialist in Sino-foreign crossborder investments at law firm King & Wood Mallesons. The last steps will involve reducing capital controls and making its currency fully convertible. It s a step-by-step process but currency convertibility is the ultimate goal is the time they have been talking about for that, but I think the time will probably come sooner than we think: the reform program has been speeding up and China s policy makers are talking with more confidence about the process, says Olsson. China s global trade activity, on the current account, has seen large sums of foreign currency accumulate within China, and pools of RMB outside the country. China is removing some of the restrictions that limit the free flow of money in and out of the country, says Olsson. In effect, a Chinese citizen or company cannot move money out of China without getting the necessary approvals from the relevant authorities, and similarly, anyone wanting to bring cash into China or invest in the country has to gain approval or fall within an approved payment or investment channel. Managing the flow of capital That is the capital account barrier, says Olsson. China is trying to manage the process of removing the barrier, because it realises that it can t have capital flowing out too quickly, nor can it have capital flowing in too quickly. It is trying to manage that process in a gradual and controlled manner, he says. It is one thing for the currency to be used internationally, but there are other pre-conditions to full convertibility. China will also have to liberalise its interest rates and move to a more flexible exchange rate, while at the same time focusing on building deeper and more liquid domestic financial markets says Olsson. there is no doubting China s commitment to making its currency a fully convertible, deliverable and internationalised currency over the coming years. Full convertibility does not necessarily equate to completely free flows of capital. Olsson says China s regulators will continue to monitor transactions to restrict speculative money flows and safe guard financial stability, but there is no doubting China s commitment to making its currency a fully convertible, deliverable and internationalised currency over the coming years. For the RMB to be treated as a reserve currency, Olsson says it needs to be held in the reserve accounts of China s major foreign trading partners. Many countries, including Australia, are starting to do that. We also need to see the RMB accepted into the basket of reserve currencies at the global level, which requires full convertibility, and a fully open capital account, he says. David Olsson works with King & Wood Mallesons as a China specialist. He has recently returned to Melbourne after 5 years in Beijing and is working with clients on cross-border investment and business strategies. He chairs the Australian RMB Working Group and was recently appointed by Premier Mike Baird to lead an initiative to drive Sydney s ambitions as an offshore RMB trading hub.

6 4 December 2014 Issue 04 Sydney: a new RMB settlement centre

7 FEATURE SYDNEY: A NEW RMB SETTLEMENT CENTRE Issue 04 December As the Chinese government has opened up RMB, Australia has generally been ahead of the pack internationally in grasping the opportunities. As a result, Sydney cemented itself as a RMB trading hub, says Hugh Killen, Managing Director and Global Head of Foreign Exchange at Westpac Institutional Bank. Killen says the Australian government and institutions have got the policy settings right to position Australia favourably in RMB trading. He cites the agreement in November 2011 to allow convertibility between Australian dollars and yuan in the inter-bank market in China; the signing of a bilateral local currency swap agreement between the Reserve Bank of Australia (RBA) and the People s Bank of China (PBOC) in March 2012; the achievement of direct trade between the currencies in April 2013; the RBA beginning to hold yuan reserves and Chinese government debt; and the Australian Securities Exchange (ASX)- Bank of China RMB settlement service, which was instituted in February this year as a result the Chinese Government s announcement of Sydney as an official RMB Hub. The ASX-Bank of China service gives us the capability to clear and settle RMB trades in real time in Sydney catering for Australian companies conducting business in RMB as a working capital currency, allowing for payments. This places Sydney s RMB hub on par with Hong Kong, Singapore or any other offshore hub. The settlement service sits naturally on the back of Australia-China trade flows, he says. It is trade-related FX, which is all about being able to make payments and conduct settlement in real time, in Australia, without having to settle via Hong Kong to affect that trade and settlement. It could be both onshore and offshore yuan, if you ve got proof of underlying, it will go straight into China for payment. Direct settlements This means that Australia is not aspiring to be a currency trading hub for the RMB, says Killen. Anything that happens here will flow off trade. We ve looked at three things. Firstly, the benefit of having a hub down here is increased accessibility: it allows Australian companies to use RMB as a settlement currency in their cross-border transactions, so effectively, taking the US$ leg out of transactions. Secondly, companies doing payables and receivables in RMB will get lower costs and lower exchange-rate risk. Thirdly, it gives our customers the ability to connect further into Asia and more importantly China, and I think we can grow in new markets as well. It s around us having ultimate flexibility to enable our customers activities. The FX flows being trade-related has positioned Sydney up towards the larger end of the centres vying to be RMB trading hubs, says Killen. The biggest offshore RMB trading centre is Hong Kong, followed by Singapore, Taipei then London, and there have been recent announcements appointing Frankfurt, Paris, Kuala Lumpur, Seoul, Luxembourg, Qatar and Toronto as trading hubs as well. Real-time transactions But because of the China-Australia trade relationship, which is so significant, the reason for having real-time settlements in Sydney is very well-articulated. If you look at the settlements hub for London, it is a financing hub, it is all around financial flows; whereas having real-time RMB settlements in Sydney is all about trade. It has real underlyings, says Killen. Time zone is also an attribute in Sydney s favour, he says, although to make that an effective factor, it has to match perfectly. At the moment a company can settle its RMB business via Hong Kong, or self-settle into China, so to make the hub here in Sydney really work, it has to have the same time window as Hong Kong not have a time impediment placed upon it. The ASX-Bank of China service has been working towards actually having extended hours of operation here in Sydney, closer to match the Chinese trading day, says Killen. From an Australian bank perspective, offering the capability is a no-brainer, he says. We re here to follow and enable our customers. If our customers are interested in settling in RMB in real time here in Sydney for trade flows and working capital deals we can do that; if our customers are arranging commodities trades and financing deals out of Singapore, we can do that for them as well. It s around us having ultimate flexibility. Our largest trading partner But Killen argues that this ultimately cements the Sydney hub s viability. The key reason for the banks to develop and offer these capabilities is that our customers want to be able to actually do things with the country s largest trading partner, more efficiently and seamlessly. So from an Australian perspective, that trade side is really important, says Killen. In terms of the FX that flows off the back of that, it will grow over time but I don t think that s a key reason for doing it, he adds.

8 6 December 2014 Issue 04 Opportunities in the Euro Aussie market

9 TRADE FOCUS Issue 04 December When Hong Kong-listed leasing and financing company Far East Horizon looked to raise capital in August this year, it was also looking to broaden its funding base. The company looked across the global debt capital markets for funding, but a recommendation by Westpac to consider the A$ European Medium-Term Note market the Euro Aussie market swayed its Treasury. The result was Far East Horizon s A$200 million five-year senior unsecured note, which was not only its first foray into the Euro Aussie market, but the first public issue in that market from a Chinese name. But if Far East Horizon had any qualms about its debut A$ issue which added a fourth funding currency behind US$, HK$ and SG$ they were assuaged by the transaction s reception. Opening a minimum A$100 deal at 10:15 am Hong Kong time, Westpac had covered that minimum by lunchtime, and closed the books at 3:30 pm that day with more than A$425 million of orders. The deal was ultimately priced later that day and sized at $A200 million, at a coupon of 6.125%. We spoke to Far East Horizon at the right time, says Russell Baines, Director of Debt Securities, Asia, at Westpac. Chinese companies increasingly have to think more internationally about their approach to the capital markets. It was a great trade the pricing provided the issuer with a very attractive option versus alternative markets but it also helped to show the company that they have diverse options in terms of markets they can tap. For Far East Horizon, as their business grows, they re going to have to tap more markets. Baines says the fact that the Euro Aussie market likes repeat issuers, likes differences in maturities, and currencies, was also attractive to Far East Horizon. They like the idea that it is a platform for future growth for them, he says. The internationalisation of the RMB will drive more such issues, he says. That s pushing companies that maybe have been funded onshore by stateowned banks to look more creatively at the different markets, he says. while they liked the A$ yield, they also wanted a name that they knew and understood. As for investors, Baines says Westpac identified significant market demand for the paper. The search for yield was a key part of the trades success, but what was really interesting was that these off-shore buyers have a core allocation of their investment for Australian dollars financial institutions that have A$ deposits, and private banks servicing high net worth individuals and while they liked the A$ yield, they also wanted a name that they knew and understood, he says. About 91% of the paper was bought in Asia, with 5% snapped up in Europe.

10 8 December 2014 Issue 04 SOLUTIONS FOCUS Solutions focus The yuan derivatives market Having the full suite of capability in the yuan derivatives markets is critical for a foreign bank operating in China. But building that capability is a step by step process, says Mike Bass, Head of Financial Markets, Asia, at Westpac, as banks have to follow the steps as they are put in place. Bass says you have to start off offering foreign-currency services, so it s still a US$-denominated balance sheet. Then, after a period of profitable operation, you are allowed to apply for a RMB licence, which means that you can transact in the spot FX market onshore, and additionally, take deposits and offer loans denominated in onshore RMB (CNY). The next stage is to apply for a derivatives licence, which allows you to transact in forward foreign exchange and interest rate derivatives. We ve got that, which means we can transact foreign-currency (G7) interest-rate derivatives with corporate and institutional clients, says Bass. Another recent step in China s currency liberalisation is the official approval of an onshore FX options market: previously, that market had been offshore, whether in the form of options on non-deliverable forwards or more recently, options on offshore RMB (CNH.) We re also preparing to offer FX options on CNY, says Bass. That s the next capability we anticipate rolling out. In July, China introduced a mandatory clearing model for the interest-rate derivatives business, the Shanghai Clearing House, which will take over as transaction counter-party, as opposed to inter-bank deals. A toe in the reform waters: The Shanghai Free Trade Zone Created in September 2013, the Shanghai Free Trade Zone, or China Pilot Free Trade Zone, is the first free trade zone in mainland China. It was established as a testing ground for a number of economic reforms. Transactions which are either banned or subject to extensive controls within the domestic economy are permitted. Within the zone, funds can be transferred to and from accounts offshore with minimal restrictions. Other differences between the Zone and mainland China include a dispute resolution mechanism more favourable to foreign investment, fewer financial requirements for setting up a company, a simplified procedure for foreign investors to establish a company and lower minimum investment thresholds. In addition, the zone is piloting a new approach in government functioning the negative list. This approach deems all areas are open for business unless explicitly prohibited, which is the opposite of the government s current approach complete exclusion unless otherwise approved. Westpac opened its sub-branch in the Shanghai Free Trade Zone on December 3.

11 COMMODITIES UPDATE Issue 04 December Commodities update Meaningful correction in commodity prices In 2014 there has been seen a meaningful correction in commodity prices with crude oil down 17% so far this year, iron ore is down 41% and even agricultural prices have fallen with wheat down 19% and skim milk powder down 40%. However, this correction is not consistent amongst commodities, some have even risen. In 2014 further pronounced weakness in non-asian emerging markets that has weighed on global growth. Geopolitics and the feedback from weak commodity prices are aggravating matters in many cases. Westpac s world growth forecast for 2014 is now just 2.9%, a step down from 2013, which was not itself a good year. A significant change was the IMF altering its estimate of relative price levels of advanced/developing shares of world growth from 49:51 previously to 43:57 today. The new weights have raised historical estimates of world growth, given that the developing world has been growing faster, but have lowered 2014 given the EM centric weakness detailed above. You can see why commodity prices have diverged when you look at the various markets in detail. Iron ore prices collapsed as a surge in Australian ore was not offset by a decline in production from the highest cost producers, Chinese miners. We estimate that at current prices, a large proportion of Chinese miners are selling ore at a significant loss. And as crude oil prices have corrected the Saudis appear to be comfortable with lower prices suggesting they may be taking the opportunity to drive the more marginal suppliers out of the market. But not all commodities have fallen in price. Copper prices may be down 7% in the year, but aluminium is up 9%, Zinc 16% and nickel has risen 18%. The last two have been hit by supply shocks while there has been a meaningful correction in aluminium exchange inventories. As such, these commodities have firmed even as growth slowed. To find out more about Westpac Institutional Bank s focus on Asia, speak to your Relationship Manager today.

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