Fund managers assess impact of RMB SDR inclusion

A decade after China introduced a flexible foreign-exchange rate mechanism, the International Monetary Fund has designated the renminbi as a global reserve currency, foreshadowing a gradual, but major impact on global investment portfolios. 

Fund managers say investors will now need a long-term strategy for including Chinese assets in their portfolios on a permanent basis – as with other reserve currencies – rather than opportunistically. 

Moreover, bond fund managers will have to prove their capabilities and breadth of access in respect of the mainland debt market if they are to benefit from its expected opening and the anticipated inclusion of RMB bonds in global fixed income indices.

However, market observers agreed that liquidity inflow into Chinese assets would be minimal in the short term, while the mainland would need to pursue further financial reforms before the renminbi became a true global reserve currency. 

The IMF yesterday decided to include renminbi as the fifth currency in its special drawing rights (SDR) basket from October 1, 2016, after its five-yearly review. This was widely expected after Christine Lagarde, IMF managing director, voiced her support for the move last month.

The renminbi will be the third largest currency in the SDR basket with a weighting of 10.92%, alongside the dollar (41.73%), euro (30.93%), yen (8.33%) and sterling (8.09%). It is also the single emerging-market currency being included in the basket.

The final weighting is in line with market expectations, although it is at the lower end of 10-15% range of  tipped by asset managers. Global central banks must now hold renminbi in their reserves, but the weighting is an indication rather than an obligation about how much they need to hold.

As of September, a total of 188 IMF members held $280 billion equivalent in the SDR currencies, meaning the basket accounts for 2.5% of the $11.3 trillion of global central bank reserves. The renminbi accounts for 1.1% of global reserves. For every one percentage point increase in allocation to Chinese onshore financial assets, this implies around $110 billion in inflows from global central banks.

Jan Dehn, head of research at UK fund house Ashmore Group, said global institutional investors would now need a material and permanent allocation – as is the case with the other SDR currencies – rather than opportunistic exposure.

“Many institutional investors only participate in emerging-market countries on an opportunistic basis,” he noted. “They often only invest in a small segment of the market – say, external debt or local bonds and equities – and very rarely in the full opportunity set [such as credit, private equity or property].”

Yet while the potential flows are huge, market participants expect the impact on portfolios to be gradual, agreed market participants.

Jeffrey Kleintop, chief global investment strategist at investment services firm Charles Schwab, said: “I don’t think [the inclusion] will have a huge impact in the short term. Declaring it is one thing and getting countries to hold it is another." The move “almost means nothing” for a year or two, he added.

Wang Tao, economist at UBS, said the inclusion was like a “stamp of approval” that would lead global investors to boost their renminbi holdings over the time. The long-term impact on markets is likely to be significant, particularly for the Rmb40 trillion ($6.3 trillion) of onshore bonds in China, the world’s third largest debt market, agreed market participants.

However, Wang does not expect foreign investors to buy Chinese bonds aggressively in the near term for a number of reasons, including the expected imminent hike in US interest rates, the trend for renminbi devaluation, narrowing credit spreads and the rising number of mainland bond defaults.

The growth of renminbi exposure among foreign asset owners and asset managers alike is now much more likely to come in the form of RMB-denominated fixed income than in equities, agreed Shanghai-based consultancy Z-Ben Advisors. Foreign investors only hold some 2% of the mainland’s Rmb40 trillion in onshore bond assets, according to UBS.

Still, Ken Hu, Asia-Pacific chief investment officer for fixed income at Invesco, expects foreign investors’ holdings of onshore RMB bonds to rise to 12% of the total, equivalent to about $680 billion of flows into the mainland debt market. But he did not suggest a time frame in which this might happen.

What would boost interest in Chinese debt among institutional investors on this front is the inclusion of renminbi bonds in global indices, said Jim Veneau, Asia head of fixed income at Axa Investment Managers.

Bond fund managers are excited about the potential of such a move, but they will need to prove their capabilities to foreign asset owners if they want to win a mandate, said Nicholas Britz, Shanghai-based associate at Z-Ben. Both mainland and offshore bond managers would need to show track records that also extend to the newer, higher-yielding instruments being introduced in China, he noted.

Offshore managers, especially those investing in mainland bonds via the qualified foreign institutional investor (QFII) and renminbi QFII schemes, will need the broadest possible access to the onshore bond market, Britz added.

Of course, to facilitate foreign investor participation, China must further liberalise its bond market, noted industry participants. 

This process continued in July this year with the landmark opening of its interbank bond (IBB) market, which accounts for 95% onshore bond trading volume, to foreign official asset owners. Central banks, sovereign wealth funds and international financial institutions can now participate in the onshore IBB market via a registration system, rather than through a pre-approval licence and quota system. 

Overall, 34 QFII investors, 128 RQFII investors, 37 foreign central banks, 82 foreign commercial banks and 16 foreign insurers have become IBB members, according to UBS.

The mainland central bank, the People’s Bank of China, had been lobbying aggressively for the SDR inclusion since March. The surprise renminbi devaluation in August was another important step in helping China to meet the IMF’s conditions for SDR inclusion.

When China will fully open its capital account remains a big question, but currency experts at HSBC and Standard Chartered expect this to happen by 2020.

Bernadette Tio provided additional reporting for this story.