The Chinese yuan, also known as the renminbi, is already convertible under the current account - the broadest measure of trade in goods and services. However, the capital account, which covers portfolio investment and borrowing, is still closely managed by Beijing because of worries about abrupt capital flows.
Pressure on Hong Kong to remain top yuan hub
The first part of a series marking the 10th anniversary of yuan business in Hong Kong examines the rise of rivals for the role
After a decade as the only city in the world allowed to conduct offshore yuan business, Hong Kong is now facing fierce competition to its role as the leading offshore yuan centre.
A long list of cities are joining the game, with Beijing no longer offering Hong Kong exclusive rights to the business.
In November, Hong Kong will mark the 10th anniversary of the State Council's approval of yuan business for local lenders. In 2003, an agreement was signed between the Hong Kong Monetary Authority and the People's Bank of China which allowed banks in Hong Kong to offer yuan deposit, remittance, exchange and credit card services from early 2004.
The agreement had nothing to do with the internationalisation of the yuan but was a show of support from Beijing as the city's economy battled back from the blow to confidence caused by the severe acute respiratory syndrome outbreak earlier that year.
When Beijing did kick off its plan to turn the yuan into an international currency, in mid-2009, it used Hong Kong as a testing ground, allowing the city to be the first to conduct cross-border trades in yuan. A year later, Beijing allowed yuan transfers from individual and financial firms' accounts, enabling Hong Kong firms to issue bonds, funds, shares or insurance policies in yuan.
"Many of our clients prefer to do yuan investment due to its continuous appreciation," said Joseph Tong Tang, an executive director of Sun Hung Kai Financial, highlighting the yuan's almost 30 per cent rise against the US and HK dollars since 2004.
"The prospects for the yuan are excellent as China is a huge market for investment. It is only a matter of time as to when the yuan will become an investment currency. But for the yuan to become a truly global currency, free convertibility is very important."
Last year, the mainland started to offer incentives to other cities to conduct yuan business. It included letting the yen and Australian dollar be traded directly with the yuan. Beijing also appointed separate yuan clearing banks in Singapore and Taiwan and next year will introduce a clearing system to allow overseas banks to directly clear yuan business with the PBOC.
Beijing has also earmarked Qianhai, in Shenzhen, and Shanghai as testing grounds for freer convertibility of the yuan, which is another blow to Hong Kong as investors can go directly through the two mainland cities.
Tan Shiming, a global yuan product manager at Citi, said Beijing wanted to see more offshore yuan hubs as part of its "go global" strategy.
"In comparison with Hong Kong, other offshore hubs will offer advantages that are crucial to establishing the yuan's presence in the rest of the world," Tan said. "The yuan offshore market is currently organised around Hong Kong but we expect the yuan offshore hubs could develop in a more independent way and that more hubs will be established to facilitate the path of yuan internationalisation."
He said the new offshore centres would not pose an immediate threat to Hong Kong due to its first mover advantage and closer relationship with mainland, but, in the long term, the city would need to develop new yuan products and services to compete.
Those thoughts were echoed by Mark Konyn, the chief executive of Cathay Conning Asset Management.
"Early mover advantage is clearly not going to be sufficient. This is because China is reforming its financial and banking sectors," Konyn said. "The endgame here is a fully open capital account and convertibility of the currency. Hong Kong will need to stay relevant as other centres develop, and this will include product and services development that support trade settlement and investment in the Chinese currency.
"From a diversification perspective, some investors have already begun to build positions in yuan and this will likely increase as the pace of reform accelerates. China continues to offer access to unique investment opportunities and many are priced in yuan. The expectation is that the domestic China bond market will grow substantially and become attractive for international investors."
Andrew Fung, an executive director of Hang Seng Bank, said Hong Kong was the definite leader in yuan business, with a much bigger deposit base than other centres. At end-July, the city had 695 billion yuan deposited, compared with 109 billion yuan in London in April last year.
"Taiwan's growing fast but it is a local market of its own," Fung said. "It is good to have more centres to market yuan and provide service. Most of the yuan flows eventually end up in Hong Kong as we are the most liquid market in all products."
As of March, 19 per cent of Sino-foreign trade was settled in yuan, compared with 0.4 per cent in 2010. The yuan is expected to become the fourth most used currency in global trade by 2020, according to Standard Chartered senior economist Kevin Lau.
With more usage of the yuan, some are concerned that the Hong Kong dollar could be marginalised.
According to the Bank for International Settlements, trading between the yuan and other currencies grew to 17.8 per cent of total average daily turnover in Hong Kong, close to the Hong Kong dollar's 18.2 per cent share.
Hong Kong Monetary Authority chief executive Norman Chan Tak-lam, however, played down worries and said it was inappropriate to conclude that the Hong Kong dollar was being marginalised just by looking at changes in foreign exchange turnover.
"As Hong Kong consolidates its position as a global hub for offshore yuan business, it is only natural that more financial transactions will involve the [yuan] and other foreign currencies. But we do not need to be overly concerned about this trend," Chan wrote in an article published by the HKMA this month.
Hong Kong's de facto central bank would continue to promote yuan business by enhancing yuan financial infrastructure and platforms and by promoting more fund flows between the onshore and the offshore yuan markets.