How China’s Onshore and Offshore Renminbi Markets Work

Original Article by GlobalMacroForex

Before reading this article, I recommend you first read my previous article on How interbank SWIFT and Clearing works.

China currently has capital control restrictions in place that prevent and regulate transfers of renminbi in and out of the country.  So when mainland exporters or importers need forex transactions for trade purposes, they have to get the Chinese government to act as the market maker.  This has created a market for offshore renminbi for trade as well as speculative purposes. 

Offshore renminbi is the same currency as onshore but it’s done through America’s interbank system CHIPS instead of the mainland Chinese CIPS system.  The offshore renminbi has significantly less regulatory/legal restrictions.  The mainland currency is labeled “CNY” while the onshore currency is labeled “CNH” by the forex market.

Arbitrage?

Sometimes price differences emerge between these two,

Some market participants have access to both onshore CNY and offshore CNH, but these are mostly state-run enterprises or private companies that have to justify and clear their onshore forex transactions with the government.

If the onshore CNY is higher,

The market is usually a bear on China and rejects Beijing’s arbitrarily dictated onshore rate by selling offshore.  This forces the Chinese government to use up US Dollar reserves to buy up offshore CNH.  If the government is unwilling or unable to do this, then the price difference continues.

If the offshore CNY is higher,

The market is a bull on China but can’t get their hands on onshore renminbi due to the capital account restrictions.  In this case, companies with preexisting business in China will try to arbitrage the difference by paying liabilities with offshore CNH and getting new onshore CNY from the government labeled as FDI. 

The government can more easily control this type of arbitrage when companies are trying to get rid of onshore CNY.  Beijing restricts corporate dividends to parent companies, so market participants often have to overbill their own Chinese foreign entities to get the outgoing forex (conversion into USD).

In addition, the Hong Kong Monetary Authority has a swap line with the Chinese Central Bank to get renminbi (trading Hong Kong Dollars with renminbi).  Then the Hong Kong authorities sell the newly converted CNH to depress the offshore rate into convergence.  This allows to the government(s) to profit from the bull market but doesn’t stop a bear market.  If the offshore rate is lower, this Hong Kong swap line does not help.  [Source: Chi Lo]

Bond Market?

In the next article, we’ll compare the different bond markets in these two currencies.  As well as analyze what is causing the offshore Dim Sum bond market to shrink while the onshore Panda bond market grows.