DBS to debut CNH structured notes in Singapore; close-out settlement backstop in place to deal with China policy u-turn

DBS is set to become the first financial institution to offer renminbi structured notes and unit trust to private banking clients in Singapore on February 28. The bank has also drawn up contingency plans to address the policy risk of Beijing changing its mind on the internationalisation of the renminbi by discussing the establishment of a settlement mechanism under the Singapore Foreign Exchange Market Committee similar to the one that handled offshore ringgit in 1998.

DBS will start offering offshore renminbi (CNH) structured notes and unit trusts to its private banking customers in Singapore from February 28, making it the first regional bank to extend retail structured deposits and notes tied to renminbi bonds outside Hong Kong.

Until now most banks have offered renminbi structured deposits and a limited range of investment solutions - such as retail renminbi bond funds - to retail clients who open a bank account in Hong Kong, where the free trading of renminbi is endorsed by Beijing as part of China's policy blueprint to internationalise its currency. Total bank renminbi deposits in Hong Kong stand at 315 billion yuan ($47.9 billion); with 65 billion yuan of total outstanding renminbi bonds issued.

DBS started offering renminbi currency-linked investments to customers in Singapore on February 7, and extended this to include renminbi bonds on February 21.

The renminbi is still a highly restricted currency. While it is deliverable in Hong Kong, activity remains largely two-tiered, with different sets of market dynamics governing the respective interest rates, exchange rates and forward curves in the onshore and offshore market.

Under Beijing's blueprint to develop Hong Kong as its offshore renminbi centre, the development of renminbi financial products gained momentum in the city after the signing of a memorandum of co-operation by central banks of the two sides in July 2010. This enabled banks in Hong Kong to offer renminbi banking services to any financial institutions and corporates (http://www.risk.net/asia-risk/feature/1732266/china-fast-tracks-hong-kong-offshore-renminbi-centre). The ability of Hong Kong banks to deliver and freely trade the currency has significantly expanded the prospect of their renminbi wealth banking services, outside of just simple deposit taking, remittance and credit/ debit card service as allowed since 2003.

However, for investors, yields aside, the attraction of investing capital in a currency whose offshore availability remains controlled hinges on the confidence they have in how quickly they can cash their positions out at maturity - or how easily the bank could convert the renminbi into other freely tradable currencies should the pace of the renminbi internationalisation hit a policy brick wall.

DBS has moved to address these concerns about offshore renminbi liquidity and convertibility risks, according to Thio Tse Chong, DBS managing director of treasury and markets in Singapore. "If China should one day decide to close up the offshore RMB market, DBS would look at settling in the best and most rational way," he says.

In the case of Singapore, Thio says market participants anticipate an orderly settlement of the offshore pool of renminbi would take place under the auspices of the Singapore Foreign Exchange Market Committee (SFEMC). "They would likely set a close-out settlement exchange rate similar to the [one set during the] capital controls imposed by the Malaysian government in 1998, which effectively ceased the trading of offshore ringgit," Thio says, referring to a set of exchange control measures imposed by Kuala Lumpur to stem speculative flows during the Asian financial crisis.

Such a mechanism would provide an official back-stop should offshore liquidity of the renminbi suffer a similar fate as the offshore ringgit in 1998.

While China is viewed as typically being consistent in its policy initiatives, concern about renminbi-related policy risk is not unfounded. In October 2010, the market was caught by surprise when Hong Kong-designated renminbi clearing bank, Bank of China (Hong Kong), exhausted its annual trade settlement quota of 8 billion yuan. Until that point, many market participants were not even aware a quota existed, resulting in some banks no longer being able to square their renminbi trade settlement positions. The Hong Kong Monetary Authority (HKMA) eventually announced a new trade settlement arrangement in late December, and a renewed settlement quota of 4 billion yuan for the first quarter this year. The HKMA will reassess subsequent conversion quota after the first quarter, pending actual demand observed.

If a policy u-turn was to occur, industry participants in Singapore say it is likely SFEMC would draw heavily on its ringgit experience. On September 3, 1998, the SFEMC, which has the Monetary Authority of Singapore, local and international banks and hedge funds as committee members, announced that due to Kuala Lumpur's imposition of capital controls on its currency, a representative rate based on the last traded price of US$/MYR 4.00 was set for counterparties in Singapore to close out outstanding ringgit-related transactions.

The SFEMC also published a benchmark yield curve for valuing future payments on outstanding ringgit interest rate swaps, and cross-currency swaps between the US dollar and ringgit trading in Singapore, an industry participant says, adding that while the close-out settlement took about three months to complete, it was orderly. Unofficial estimates put 1998 offshore ringgit trading at $5-6.5 billion.

DBS launched short-dated, dual-currency linked investment on foreign exchange-renminbi pairs that are said to give investors returns ranging from 3-12%, depending on which currency is chosen, and on which currency an investor sells the optionality to the bank. Marketing material for renminbi foreign currency fixed deposits and foreign current accounts states that investors "may only withdraw cash in a non-RMB currency from a DBS RMB account". DBS's Thio says: "Like any other foreign currency, renminbi cash withdrawal by clients is subject to DBS's availability of cash notes. However, it is unusual for investors to make such requests on foreign currencies in an offshore market," he adds.

As a next step DBS bank will offer principal-protected products over a wide range of investment options, including RMB bonds and structured notes linked with various asset classes such as forex, interest rates, commodity, equities and credit.

Due to the additional liquidity and conversion risks of the renminbi compared with freely traded currencies, DBS will only offer renminbi investment products to sophisticated investors who maintain a private banking account with DBS Singapore and invest a minimum amount of S$50,000 or US$40,000.

Meanwhile, Standard Chartered is also making preparations to extend renminbi deposit services outside Hong Kong. Andrew Chia, regional head of wealth management for Singapore and South-east Asia in Singapore, says such renminbi products will be offered first to private banking clients and then to retail clients in Singapore this year.