POTENTIAL BENEFITS OF A CANADIAN-BASED RMB SETTLEMENT CENTRE Prepared for: Advantage BC Mr. Colin Hansen, President Suite 3093, Three Bentall Centre 595 Burrard Street PO Box 49067 Vancouver, BC V7X 1C4 Prepared by: MMK Consulting Inc. Stuart MacKay Treena Cook Suite 1202, 1130 West Pender Street Vancouver, BC V6E 4A4 Final Report September 26, 2014
Contents 1. Introduction... 1 1.1. Study objectives... 1 1.2. Study conduct... 1 1.3. Features of a prospective Canadian-based RMB settlement centre... 2 2. Potential transactions cost savings and trade impacts... 3 2.1. International trade between China and BC/Canada... 3 2.2. Potential cost savings through direct CAD-RMB currency exchanges... 3 2.3. Potential impact on trade volumes... 5 3. Other potential benefits and barriers... 6 3.1. Other potential benefits... 6 3.2. Potential Barriers... 7 4. Conclusions... 9 Appendix A Canada and B.C. Trade Volumes with China...10 Appendix B Cost premium of using US dollars for China-Canada trade...15 Page i
1. Introduction China is encouraging the establishment of authorized Renminbi (RMB) settlement centres in countries around the world, to increase the usage of the RMB in international financial transactions. China has long had a direct currency trading agreement with the United States, and in recent years has established mechanisms to directly exchange the RMB for the Japanese yen, British pound, New Zealand dollar, and several other international currencies. While authorized RMB settlement centres have been established in Asian and European financial centres, there is at present no officiallysanctioned RMB settlement centre operating in the Americas. According to Bloomberg, the establishment of an RMB settlement centre typically involves (1) a currency swap agreement between the two country s central banks and (2) the appointment of a clearing bank by China. 1 In addition, these steps may be accompanied by a bilateral agreement between the two countries to allow their currencies to be traded directly, rather than through a third currency such as the US dollar. The Canadian Government has had some initial discussions with the Chinese Government about establishing an RMB settlement centre in Canada, and there is considerable interest within the Canadian financial services industry in this possibility. 1.1. Study objectives The purpose of this report is to perform an initial assessment of the potential benefits of establishing a Canadian-based RMB settlement centre -- with particular focus on the potential for currency exchange savings from denoting Canada-China trade directly in Chinese Renminbi (RMB), or alternately Canadian Dollars (CAD), rather than the current practice of denoting the trade in US Dollars (USD) and incurring the need for currency transactions involving US dollars. The target benefits of having a Canadian-based RMB settlement centre include: Lower transaction costs on the currency exchanges associated with Canada-China trade. Increased convenience and timeliness of CAD-RMB currency exchanges, being fulfilled from one or more offices located in Canada, and operating during North American business hours. Potential for a wider range of RMB-related financial services -- including for example a greater range of credit terms and service options. Increased ability of Canadian-based exporters to China to be able to compete for Chinese business opportunities, by pricing contracts in RMB. 1.2. Study conduct This study has been performed by MMK Consulting on behalf of Advantage BC, and has included: Review of the existing information regarding the concept of establishing a Canadian-based RMB settlement centre. 1 Bloomberg news article, Canada s Oliver Says Early Yuan Hub Talks Under Way With China, June 18, 2014. Page 1
Meeting (jointly with Advantage BC) with current and former Vancouver-based financial services industry representatives, including China-based banks. Meeting (jointly with Advantage BC) with BC-based exporters to China both North American and Chinese-owned. Analysis of the potential impact of direct CAD-RMB currency exchange, in terms of potential exchange rate savings and the expected impacts on trade volumes. Assessment of other potential benefits, along with other potential barriers. Reporting the study findings. 1.3. Features of a prospective Canadian-based RMB settlement centre While the specific nature of a potential Canadian-based RMB settlement centre has not yet been defined in detail, the key features are expected to include: A currency swap line agreement between the central banks of Canada and China, to ensure liquidity with respect to direct RMB-CAD currency trading. The currency swap line agreement would not be an active account, but would be available if required to provide backup liquidity to assure the exchangeability of the RMB (as a managed currency) against the Canadian dollar (as a freely traded currency). Designation of one of the major Chinese banks such as Bank of China, Agricultural Bank of China, Industrial and Commercial Bank of China, etc. as the designated settlement (clearing) bank for direct CAD-RMB currency exchange transactions. A possible bilateral agreement (undertaken in some cases e.g. US, UK, Japan, New Zealand, Korea) to allow the Canadian dollar and Chinese RMB to be traded directly, without the intervention of a third currency such as the US dollar. Establishment by the designated settlement bank of a Canadian RMB settlement centre, including office operations in Vancouver and/or Toronto. The RMB settlement centre would provide a wide range of RMB-related banking services, serving Canadian-based firms as well as the Canadian operations of Chinese-based firms. The settlement centre might also provide RMB settlement services to other countries in the Americas, since they are located in similar time zones. (This concept requires further investigation.) Upgrading of the Canadian-based computer operations of the Chinese bank designated as the settlement centre. It is anticipated that the Canadian-based computer operations would be an extension of the Chinese bank s existing international systems, rather than involving the establishment of a new North American based currency settlement system. Specific details of how the direct RMB settlement centre would work in Canada, including the geographic office location(s) and the basis for participation of existing Canadian financial institutions, remain to be determined. Page 2
2. Potential transactions cost savings and trade impacts 2.1. International trade between China and BC/Canada Trade between China and Canada totalled $73.2 billion in 2013, including $16.9 billion between China and BC. Import volumes outweigh export volumes, although both have increased significantly over the past four years. At present, the vast majority of this trade is denominated in US dollars. International trade between China and BC/Canada ($ billions) B.C. Canada 2009 2013 2009 2013 Exports $2.5 $6.7 $11.2 $20.5 Imports 8.8 10.2 39.7 52.7 Total Trade $11.3 $16.9 $50.9 $73.2 Four-year increase +50% +44% Source: Statistics Canada In 2013, BC accounted for 23% of total Canadian trade with China, including 32% of total Canadian exports. Together, the four western provinces accounted for 37% of Canada s total trade with China, including 67% of total Canadian exports. 2.2. Potential cost savings through direct CAD-RMB currency exchanges Based on the Bank of China s posted currency exchange rates on a typical day, there is an apparent currency exchange advantage of approximately 1.03% in converting directly between CAD and RMB, rather than using the US dollar as an intermediate currency (see following table for detailed calculation). At the same time, based on discussions with banking industry representatives, we understand that posted exchange rates are frequently discounted, on a negotiated basis, with commercial customers. The amount of the actual discount will vary depending on the size and nature of the transaction, as well as the approach taken by the customer in negotiating rates. Thus the following analysis is based on the assumption that approximately half of the currency exchange savings based on posted rates would still be actually realized by customers, after allowing for negotiated discounts, resulting in a net transaction cost saving through direct CAD-RMB currency exchanges averaging approximately 0.5%. In addition, in interviews performed for this assignment, several industry representatives have indicated they believe that the pricing of contracts in RMB, rather than in US dollars, should lead to significant changes in pricing of Canada-China trade. They see RMB-denominated contracts resulting in significant tightening of prices, resulting in representative net contract price reductions in the range of 3% or more. Page 3
The following analysis is focused on the impact of currency exchange cost savings, and does not consider the potential impact of changes in pricing behaviours. As noted, the comments of industry representatives suggest that the impact of RMB-denominated contracts on pricing behaviours may be even greater than the impact of the currency exchange cost savings. Calculation of potential currency exchange cost savings through direct RMB-CAD trading 1. Converting C$ to CNY Direct To buy CNY 1,000,000 direct from C$ = Indirect To buy CNY 1,000,000 from US$ = To buy US$161,804 from C$ = C$177,101 US$161,804 C$179,166 Premium to use US$ C$1,065 (1.17%) 2. Converting CNY to C$ Direct To buy C$1,000,000 direct from CNY = Indirect To buy C$1,000,000 from US$ = To buy US$928,247 from CNY = CNY 5,825,500 US$928,247 CNY 5,877,564 Premium to use US$ CNY 52,064 (0.89%) 3. Average cost premium based on posted rates Cost premium of intermediate US transactions relative to direct Canadian Dollar/RMB exchange 1 : Converting C$ to CNY 1.17% Converting CNY to C$ 0.89% Average cost premiums based on posted rates 1.03% Estimated potential transactions cost savings, based on negotiated rates 2 0.5% 1 2 Source: Bank of China posted rates see Appendix B for details. Preliminary estimate based on discussion with banking community representatives. Actual savings would vary by size and nature of transaction. Page 4
2.3. Potential impact on trade volumes The BC Ministry of International Trade has developed a sophisticated model that analyzes the relationship between tariff reductions and trading volumes, on a country-specific basis. Assuming that currency exchange cost reductions have a similar magnitude of impact as tariff reductions, the potential impact of a 0.5% currency exchange cost saving, if all Canada/China trade was denoted in RMB rather than USD, is illustrated in the following table. If 100% of China-Canada trade was denoted in RMB, the estimated impact would be a $480 million increase in total China-Canada trade -- including $215 million in increased Canadian exports to China. For BC (also included in the Canadian numbers), the estimated impact would be a $120 million increase in China-BC trade -- including $70 million in increased BC exports to China. The actual use of RMB (rather than the US dollar) for China-Canada trade is unlikely to reach 100% in the foreseeable future, given the current dominant convention of using the US dollar. However, even a 50% take-up would be projected to increase the volume of Canada-China trade by $240 million. As noted earlier, these estimated impacts are conservative in that they are before considering the significant potential impact on trade volumes of tighter pricing behaviours, if Canada-China trade contracts are denominated in RMB rather than in US dollars. Exports to China Imports from China Total Sensitivity of trade volumes per 1% tariff +2.1% +1.0% reductions 1 Trade volume impact of a 0.5% average reduction currency exchange costs 1.05% 0.5% 2013 Trade volumes ($m) BC $6,693 $10,234 $16,927 Canada including BC $20,488 $52,727 $73,215 Increase in trade volumes, assuming 100% denomination in RMB ($m) BC Canada including BC $70 $215 $50 $265 $120 $480 1 Source: BC Ministry of International Trade based on the Ministry s gravity-based model of tariff reduction impacts. Page 5
3. Other potential benefits and barriers 3.1. Other potential benefits In addition to the potential currency exchange rate savings, and the potential impact on trade volumes, the research and interview program has identified several areas of other potential benefits: Potential for same-day currency exchange transactions, and for more quickly resolved transaction issues. With a Canadian-based RMB settlement centre operating during North American business hours, Canadian business operations would be able to conduct RMB- CAD currency exchanges in real time, rather than having to wait for the next business day in Asia or Europe and then sometimes experiencing additional delays in resolving issues over a number of business days. This situation is indicated by financial service representatives as occurring fairly frequently on international currency exchange transactions, often costing businesses several days worth of interest. Potential to provide RMB settlement services firms in other North and South American countries. There may also be an opportunity to provide RMB settlement services for companies based in other parts of the Americas. The potential to provide services to other countries from a Canadian RMB settlement centre merits further investigation. Direct and indirect job creation. The establishment of front-office operations in Toronto and/or Vancouver would create direct jobs for the day-to-day operations of the RMB settlement centre -- as would the requirements to establish and maintain the computer interfaces required to operate the settlement centre. These direct employment impacts would be in addition to the employment impacts of increased trade volumes between China and Canada. Potential for a broader range of RMB settlement services. During our interview program, we were advised of a number of current limitations on the ability of exporters/importers to trade using CAD, USD, and RMB financial instruments. Examples included regulatory/policy constraints (e.g. limitations on the use of letters of credit longer than 60 days), as well as specific occasions where currency exchanges involving RMB have had to be executed in other locations (e.g. in San Francisco rather than Vancouver). Establishment of a Canadian-based RMB settlement centre could help to address these issues. Marketing advantages for Canadian exporters pricing in RMB rather than US dollars. While the predominant practice is currently to transact Canada-China trade in US dollars, Canadian firms that are early adopters of selling in RMB may have an advantage in competing in Chinese markets, especially in relation to US firms that continue to price in US Dollars. Conversely, if Canadian exporters are slower to price in RMB than some other jurisdictions (e.g. New Zealand and Australia), this may put Canadian exporters at a competitive disadvantage. Impact on general business cooperation and trade levels between China and Canada. The signing of a Canada/China swap agreement, plus the establishment of a Canadianbased RMB settlement centre, can be expected to create goodwill and act as an encouragement to Canada/China trade that goes beyond the measurable benefits similar to the goodwill generated by the Province of BC s 2012 initiative to offer a dim sum bond, denoted in RMB, to the international marketplace. Page 6
3.2. Potential Barriers Our research and interview program also identified a number of potential barriers to the use of a Canadian-based RMB settlement centre, including: Risks of being an early adopter of RMB-denominated transactions. The US Dollar has been the currency of choice for international trade between Canada and China for many decades, and the current system is well established and relatively stable. Several interviewees noted the risks inherent in being one of the first companies to begin transacting in RMB, if there are operational problems in making and receiving payments, and/or if exchange rate risks are incurred. Uncertainly regarding the Chinese business environment, and the implications of pricing in RMB. Canadian exporters market their products to Chinese buyers using a variety of sales channels, including both direct sales and commissioned agents. For all sales, but particularly for those involving commissioned agents, there is a level of uncertainty regarding the potential risks of a change to RMB-based pricing, in terms of not jeopardizing access to existing and potential future customers. Preference of some Canadian and Chinese firms to purchase or sell in US dollars. In addition, some firms, because of their company-specific international funds flows, may have a preference to receive or pay in US dollars. Despite these concerns, most of the interviewees are favorably disposed towards the concept of establishing a Canadian RMB settlement centre. Some interviewees believe that, once the initial risks and uncertainties have been addressed by the successful achievement of RMB-denominated transactions, the Canada-China market will quickly gravitate towards this method of doing business. If this expectation is well founded, it raises the question of who the early adopters of RMB-denominated transactions might be whether they will be exporters or importers from China and Canada, and what types of products will be the first to be priced in RMB. While the answer to this question is not yet clear, the following table illustrates some of the major export/import volumes for various product types, as a basis for further consideration of the issue. For British Columbia, approximately 85% of exports to China in 2013 were resource-based wood products or minerals. Thus these sectors are natural ones in which to investigate opportunities to begin trading in RMB denominated contracts, rather than in USD denominated contracts. Page 7
Leading Exports/Imports to and from China (2013) BC CANADA Exports Imports Exports Imports Pulp Mills Sawmills and Wood Preservation Coal Mining Copper, Nickel, Lead and Zinc Ore Mining Logging Other Computer and Electronic Products Apparel Manufacturing Miscellaneous Manufacturing Leather and Allied Product Manufacturing Other Pulp Mills Iron Ore Mining Oilseed (except Soybean) Farming Sawmills and Wood Preservation Coal Mining Other Computer and Electronic Products Apparel Manufacturing Miscellaneous Manufacturing Leather and Allied Product Manufacturing Furniture and Related Products Manufacturing Other $ billions $1.72 1.39 1.27 0.87 0.43 1.01 6.69 $2.25 1.12 0.74 0.36 5.76 10.23 $ billions $2.58 1.97 1.91 1.45 1.45 11.13 20.49 $14.87 2.85 2.64 1.48 1.37 29.52 52.73 Page 8
4. Conclusions Based on the preceding analysis, this study concludes that: There is significant and growing interest in the establishment of a Canadian-based RMB settlement centre and a general consensus that such a centre would be in Canada s and BC s interest. Based on currency exchange costs and efficiency considerations, there appears to be a significant opportunity for such a centre to lead to increased trade between China and Canada, by enabling China-Canada trade to be denominated in Chinese RMB or Canadian dollars, rather than the current practice of using US dollars as the intermediate currency. The potential impact on China-Canada trade from the currency exchange savings associated with of eliminating the need to use US dollars as an intermediate currency is estimated as being up to $480 million in additional Canada-China trade -- including up to $120 million in additional BC-China trade. This estimate is conservative in that it is before considering the possibility of tighter contract pricing resulting from increased use of RMB denominated contracts, leading to additional increases in trade volumes. There are also number of other potential benefits that may be significant in terms of encouraging China-Canada trade. These include: The potential for same-day currency exchange transactions, and for more quickly resolved transaction issues, leading to daily interest cost savings. The potential to extend RMB settlement services to serve US and Latin American based firms from Canada. Direct job creation, through settlement centre operations, plus indirect job creation through increased Canada-China trade levels The potential for the RMB settlement centre to provide a broader range of RMB settlement services than are currently available in Canada and BC. Marketing advantages for Canadian exporters, from being able to quote prices to Chinese customers in RMB rather than in US dollars. Positive impacts on goodwill, general business cooperation, and trade levels between China and Canada. The main barriers to greater use of the RMB as a frequently-used currency in China- Canada trade appears to be the traditional use of the US dollar as the currency of international commercial transactions, and the reluctance of businesses to be the first to take the risk of designating contracts in RMB. In summary, the potential benefits of an RMB settlement/service centre, in terms of increasing Canada-China international trade, are seen as being very significant not only in terms of reducing currency transaction costs, but also in terms of increasing the overall convenience and efficiency of international CAD-RMB payment transactions. Page 9
Appendix A Canada and B.C. Trade Volumes with China Page 10
BC - Exports Page 11
BC - Imports Page 12
Canada Exports Page 13
Canada - Imports Page 14
Appendix B Cost premium of using US dollars for China-Canada trade Page 15
Appendix B Cost premium of using US dollars for China-Canada trade (Based on posted Bank of Canada rates, June 4, 2014.) Wire Transfer/Cheque Rates Buy C$ Sell C$ % spread AUD $ 0.9851 1.0411 5.68 CNY 0.1717 0.1771 3.17 EUR 1.4634 1.5134 3.42 GBP 1.8057 1.8557 2.77 HKG $ 0.1384 0.1434 3.61 JPY 0.0104 0.0109 4.31 USD $ 1.0773 1.1073 2.78 Buy US$ Sell US$ % spread CNY 0.1579 0.1618 2.45 1. Converting C$ to CNY Direct To buy CNY 1,000,000 direct from C$ = Indirect To buy CNY 1,000,000 from US$ = To buy US$161,804 from C$ = C$177,101 US$161,804 C$179,166 Premium to use US$ C$1,065 (+1.17%) 2. Converting CNY to C$ Direct To buy C$1,000,000 direct from CNY = Indirect To buy C$1,000,000 from US$ = To buy US$928,247 from CNY = CNY 5,825,500 US$928,247 CNY 5,877,564 Premium to use US$ CNY 52,064 (+0.89%) 3. Average cost premium based on posted rates 1.03% Page 16