Talking points:
– Chinese currency is referred to by many names: Yuan, CNY, CNH, RMB, reference rate
– The Chinese Yuan is traded in two separate markets: onshore (CNY) and offshore (CNH)
– Yuan exchange ratesare managed with a floating-rate regime by the PBOC
– Relevant regulators in China for the Yuan are: PBOC, SAFE, CFETS
– Top Chinese media
Yuan’s Multiple Names
The Chinese currency, widely called as the Yuan, has multiple names referring to different purposes or functions.
Yuanis simply the name of a basic unit of account in China, similar to the ‘Dollar’ in the United States. The Chinese currency used in mainland China is called the Chinese Yuan, or ‘CNY’ to denote the ‘onshore Yuan.’ And just like the US currency, the Yuan can be broken down into smaller units, just like the dollar can be broken down into quarters and dimes, the Chinese Yuan can be broken down into Jiao (.1 of 1 Yuan), Fen (.01 of 1 Yuan), etc.
Reminbi can be loosely translated as “people’s currency” in Chinese. This is likely why the term has become known as the name of the Chinese currency. RMB is the abbreviation for Reminbi.
Yuan’s Onshore/Offshore Markets
China’s unique capital markets, which are not yet fully open, makes the Yuan’s role different in domestic and international markets.
On the onshore market (CNY), Yuan is mainly used for two purposes: A) interbank settlement, and B) corporates selling and purchasing foreign exchange for business purposes. However, this is not meant to imply that mainland China does not have retail traders. Each Chinese citizen has an annual quota of US$50,000 or equivalent that they’re allowed to transact. They are allowed to use this quota to purchase foreign currencies freely without specifying any specific reasons. The difference lies in the leverage when trading the currency. Unlike many international markets, the leverage is 1:1when the Yuan is traded at onshore markets, at least for now.
Yuan’s offshore markets are outside of mainland China, and this includes traditional centers in Hong Kong, Singapore and London as well as the newly developed center in Luxembourg. In order to distinguish from the onshore market, Yuan trading at offshore markets are given a separate ticker, CNH, such as USD/CNH.
At the offshore market, Yuan trading is more active and market-driven. In general, Hong Kong is often considered to be the most important offshore center for the Yuan. According to the research study, RMB Regionalization (Mu, 2011), the Yuan’s role in Hong Kong has exceeded US Dollar’s since 2005. As a global leading trading company, FXCM Inc. offers USD/CNH trading via its FXCM Asia and FXCM UK subsidiaries.
The Third Rate
For each yuan pair, in addition to the onshore rate and offshore rate, there is one more important rate that traders need to keep an eye on. It is called the reference rate, also known as the mid-point rate, the central parity rate or the daily fixing. All of these refer to the benchmark rate set by China’s central bank on a daily basis.
More specifically, the central bank of China refers to three things to determine the central parity rate: A) The closing rate at China’s interbank foreign exchange market on the previous trading day; B) Demand and supply conditions in the foreign exchange market and C) Exchange rate movements of major currencies.
Yuan’s Formation Regime
The Onshore Yuan is under a managed floating-rate regime, which implies neither free floating nor fully controlled. If we say free-floating is the white color and fully-controlled is black, the Yuan’s color is grayish-white.
At current onshore market, the Yuan rate is allowed to float within 2% above or below the reference rate. The trading band is set to be stable over a period of time, and it will not usually change on a daily basis. It was originally set to be 0.3% in 1994. And then it was revised to 0.5% in 2007 and to then to 1% in 2012. The current 2% range was set in 2014.
Yuan’s onshore rate (CNY) and offshore rates (CNH) affect each other under the current managed-floating system.
1) Market forces will affect all three rates but with different degrees of impacts. As China’s financial markets aren’t yet fully opened, market forces and external factors could have a lessened impact than they might in other international markets. However, as China continues to open up its financial markets and promote the Yuan’s globalization process, market forces will likely play a larger role.
2) China’s central bank directly guides the onshore exchange rates through the daily reference rate and the trading band. The regulator indirectly influences the Yuan’s offshore rates despite the fact that the impact is not as strong as that towards onshore rates.
3) When the market is extremely volatile, the central bank can use open market operation to directly impact offshore rates. An example is that
they hit HIBOR with a 66.82% rate less than a month ago to shake short-sellers out of the market.
Because market forces and degrees of government influence differ between the onshore and offshore rates are different, we may see discrepancies in USD/CNH and USD/CNY moves from time to time.
Yuan regulators
Most traders may have heard of People’s Bank of China (PBOC), which is China’s central bank. However, this isn’t the only regulator with a say on Yuan rates. There is one other regulator and one subsidiary of the PBOC that can have a considerable impact on the Yuan’s exchange rate.
State Administration of Foreign Exchange (SAFE) is an administrative agency that designs foreign exchange policies and regulates the foreign exchange market. It isa deputy-ministerial-level agency and a half-level below the PBOC, which is a ministerial-level state agency. PBOC and SAFE combined function similarly to the Federal Reserve in the US.
We have mentioned above that the central bank determines the reference rate on a daily basis. The rate is not released directly by the headquarters in Beijing. Instead, it is announced by China Foreign Exchange Trade System (CFETS) Center, a subsidiary of PBOC in Shanghai. Besides the daily reference rate, the CFETS reports other important rates, such as the Yuan’s swap and bond rates.
This mechanism is not randomly set. It highlights the fact that Beijing is the political center and Shanghai is the financial center. Policies are designed at the political center and usually first applied in the active markets such as in Shanghai and Shenzhen. This is why China has stock exchanges in Shanghai and Shenzhen but none in Beijing.
These cities also are the pilot regions in China for new policies and reforms: For example, Shanghai established the first free trade zone in China and now is building up the first offshore Yuan center in mainland China. The Shanghai-Hong Kong Stock Connect has been used as the first channel for foreign retail investors to participate in China’s domestic equity markets. As a result, foreign capital and international traders and investors may be able to look deeper into Shanghai and Shenzhen to explore potential investment opportunities.
Top Chinese Media
DailyFX provides a daily digest to keep readers up-to-date on news typically covered only in Chinese-language sources. This daily digest focuses on market sentiment, new developments in China’s foreign exchange policy, changes in financial market regulations and economic coverage. The sources include but not limited to:
PBOC & SAFE: the central bank and foreign exchange regulator.
China Securities Regulatory Commission (CSRC): equity market regulator.
Sina News: China’s most important online media source, similar to CNN in the US. They also own a Chinese version of Twitter, called Weibo, with around 200 million active usersmonthly.
Hexun News: Chinese leading online media of financial news.
China Stock News: Chinese leading online media of financial news.
Written by Renee Mu, DailyFX Research Team
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Source: Daily fx