Hong Kong as an offshore RMB clearing hub

The inclusion of the Renminbi (RMB) in the elite International Monetary Fund special drawing rights (SDR) basket of currencies is a largely symbolic recognition of the increased importance of the Chinese economy in the world. China now wants the RMB, which remains relatively unused throughout the world in trade and finance, more widely used.

If Beijing follows through on its promise to fully liberalise the RMB, making it a true international currency by 2020, banks will have the ability to settle RMB trades the world over. Already, the People’s Bank of China has signed a wide range of RMB swap agreements with central banks and is appointing a growing list of clearing and settlement banks at key cities around the world.

Hong Kong is a major financial center and trade facilitator for the mainland. It is one of China’s largest RMB transaction partners, befitting its strategic role as a financial center. Hong Kong has benefited enormously from this privileged position in bridging the gap between the mainland and the rest of the world while also providing financial services unavailable throughout China. Hong Kong currently holds the majority of RMB deposits outside of mainland China and manages the largest amount of financial products from mainland-linked equity to offshore RMB-denominated bonds and everything in between. But with financial transactions requiring RMB set to be handled throughout China and the world, Hong Kong’s present dominance and longer-term role as the primary hub for RMB clearing has become tenuous.

In the long term, Hong Kong’s leading role as the primary RMB clearing and trading hub is far from secure. While it benefited during the early stages of RMB liberalisation owing primarily to its monopoly position, it may not continue to play the dominant role. RMB deposits have started to decline in Hong Kong as Beijing has increased the number of swap agreements with other central banks and appointed new clearing banks in other major centers.

The erosion of Hong Kong’s prominent position in RMB clearing and settlement is due not to any weakness of Hong Kong financial services, but the rise of other centers able to provide RMB financial services. RMB clearing and settlement is now conducted around the world and these centers will only continue to diminish Hong Kong’s dominance in RMB payment services. This even omits the very real expectation that within a few years, Chinese banks will be able to provide these services. Even at a young age, Hong Kong’s best days for RMB clearing and settlement may already be behind it.

The internationalisation and liberalisation of the RMB that erodes the natural monopoly of Hong Kong need not however, spell its demise as the dominant bridge from the mainland to the rest of the world. Hong Kong benefits from numerous natural and competitive advantages that it must continue to exploit. Remaining a leader in innovative products and solutions demands innovation not resting on past success.

Even if more RMB payments are settled elsewhere, trusted financial regulators, respected judiciary, a Chinese- and English-speaking population, and more international banking institutions than anywhere on the mainland will drive Hong Kong’s competitive edge against China and the rest of the world. Furthermore, its proximity to major international ports and shipment areas will maintain its natural geographic monopoly as traders will bank where they trade.

To build upon its natural and competitive advantages, Hong Kong will need to evolve and adapt. First, Hong Kong can remain a major financial hub for China but must maintain its international flavor. It is no surprise that major financial centers from Singapore to New York to London serve their clients by maintaining a diverse, top quality workforce. This soft skill strength of Hong Kong should not be dismissed lightly but will be strength in dealing with global clients.

Second, Hong Kong must build upon its strengths of payment settling, clearing speed, and security. With the variety of payment options and security threats, these new standards will be driven in equal parts by financial ingenuity and technological savvy. With its burgeoning tech start-up culture, and an adjacent one in Shenzhen, Hong Kong is well placed to play a leading global role in fintech to ensure that payments arrive fast and secure.

Third, Hong Kong is well placed to offer mainland firms a wider variety of products and solutions than Chinese banks. Mainland banks do not have the product diversity or sophistication to offer the increasingly complex solutions and hedging products they will need with a liberalised and internationalised RMB. Rather than lamenting the loss of dominance of its RMB settlement position, Hong Kong can use this as an opportunity to sell a wider variety of higher-value products, building upon its established preeminence in clearing and settlement to manage the risk firms face.

Just as growth in China causes relative decline in other countries’ positions but can result in total absolute gains for both sides, the same is true in Hong Kong for RMB payments. A liberalised and international RMB may create additional competitors for Hong Kong, but with it, the opportunity for much larger rewards to open up.

Christopher Balding is an Associate Professor in Peking University HSBC School of Business, Shenzhen, China. He holds a PhD in Political Economics from the University of California at Irvine.