Free trade in Taiwan needed to prevent emergence of multiple offshore RMB curves

The creation of an offshore RMB market in Taiwan could result in a fracturing of liquidity and prevent the currency's further internationalisation

Taiwan regulators need to allow for free transfer of capital between Taiwan and other offshore renminbi centres in order to ensure the consistency in the offshore rates of the RMB, according to market participants.

China and Taiwan signed a memorandum of understanding (MoU) in August this year creating a clearing mechanism for the RMB and Taiwanese dollar, making Taiwan the third offshore clearing centre for renminbi after Hong Kong and Macau. The clearing mechanism will create an offshore renminbi market with the exchange rate quoted under CNT. With 2.6% of all renminbi-settled trade arising between China and Taiwan, the country has a large corporate base that would benefit from local clearing of the RMB.

Taiwanese authorities may choose to treat the CNT as another foreign currency allowing it move cross-border without restrictions. However, according to a senior banking figure in Hong Kong, "national ego" may cause the regulators to ring-fence the local RMB market to purely cater to the Taiwanese players.

However, this scenario would undermine the internationalisation of the RMB by fragmenting liquidity, according to Justin Chan, deputy head of global markets, Asia Pacific and head of Hong Kong trading at HSBC, who instead says that regulators must allow for fungibility between the CNT and the CNH in order for the two currencies to trade at the same rates.

"[Capital restrictions won't be] conducive to the development of the whole market. If you have separate liquidity pools, then it will become a fractional market and there won't be the critical mass to move money around. I think the classical example is Macau because that is not connected with the Hong Kong market. As a result, there are a lot of developments in Hong Kong but not much happening in Macau," he says.

This view is supported by Kim Man Ngan, head of RMB business strategy and planning at Hang Seng Bank, who is concerned that concurrent developments in Singapore and London could create a whole series of different offshore RMB curves.

"Developing a purely local offshore RMB market would not be practical. It would become chaotic when other financial centres, for instance Singapore and London, come to join the market, creating their own offshore RMB, potentially leading to CNS or CNL rates. This might not be the situation that the People's Bank of China would like to see during the course of RMB internationalisation," he says.

A different exchange rate would create arbitrage opportunities as well for banks which have both offshore and domestic businesses for Taiwan. Before the MoU, most RMB business in Taiwan could only be conducted by firms' offshore banks that had access to the clearing bank in Hong Kong.

"If the CNT is determined purely by local demand and supply, there is a possibility that banks and companies can take advantage of the exchange rate differential between the CNH at their offshore arms and the CNT at their onshore banks," Kim says.

According to Alicia Garcia-Herrero, Hong Kong-based chief emerging markets economist for BBVA Research, given Taiwan's strong base of companies doing business in China, it has an advantage over Hong Kong in terms of domestic demand. This may lead to the CNT remaining a domestic play, at least in the short term.

"Taiwan is a much more tightly controlled economy compared to Hong Kong and the central bank may impose controls over the flow of capital if it considers it too high. It is important, however, not to underestimate Taipei's position as a very large domestic financial centre. Where Hong Kong needs to look to foreign companies to fuel the CNH market, Taipei may already have the domestic company muscle to drive it forward," she says.

Taiwan's Financial Supervisory Commission did not respond to requests for comment by press time.