The term 'internationalisation of the yuan' has been much heard of late and brings delight to Hong Kong ears, promising as it does the prospect of a steady flow of opportunity to benefit the city's economy.
The pace of change has not only been fast, but is escalating at an unprecedented level since the first yuan bond was launched in Hong Kong just two years ago. And investors should take heart that the market is becoming more liquid. While the individual investor may not get excited about trade settlement in yuan, it is a crucial component in its development as an international currency.
The market has more "depth" to it says Vishal Goenka, head of local currency and global credit trading for Asia at Deutsche Bank. "This is positive," he says, adding that what we see in Hong Kong in terms of yuan products is a fully functioning credit market if not a foreign exchange market - yet. For the present, he foresees an increase in bond issuance as investors seek greater exposure to the yuan.
In a report released last October, Deutsche noted that China's importance to the global economy stands in marked contrast to the importance of its currency in global trade - just 0.3 per cent of global foreign exchange turnover in 2011 despite having a significant portion of foreign direct investment.
So there is an imbalance. Deutsche Bank expects 30 per cent of China's trade to be conducted in yuan by 2015. It also expects yuan bond market capitalisation to account for more than half of the Hong Kong debt market by 2015.
"What you have is a high quality, diversified, decently yielding credit market," says Geoffrey Lunt, senior product specialist in Asian fixed income at HSBC Global Asset Management in Hong Kong. Lunt says this is an interesting option for investors as there is a misperception that it is a low-yield market.
And despite the recent slowing in the pace of yuan appreciation, Lunt still favours it long term versus the US dollar. The yuan, he says, is an Asian currency which tends to be less volatile and not as susceptible to high interest rates. It offers a way of diversifying a portfolio while lessening risk.
"The Chinese government is continuing to pave the way for the internationalisation of the yuan," says Arthur Lau, head of fixed income for Asia ex-Japan at PineBridge Investments. He cites policy changes, such as agreements for swaps with other central banks and trade settlements with Japan in yuan, as an example.
Certainly, there's been a surge in liquidity in Hong Kong. According to the Hong Kong Monetary Authority, deposits hit a peak of 627.3 billion yuan in November 2011, though had fallen to 553.9 billion by May's end. Nevertheless, HKMA figures show the momentum is still on the ascendancy. Trade settlement figures have also risen. HKMA figures for the first quarter show 580.4 billion yuan in trade was settled in the same currency, and Hong Kong banks handled 98 per cent of it.
What does this mean for retail investors? Other than yuan-denominated bonds - available mostly to institutional investors - there isn't a plethora of options other than depositing it in the bank, but the range of products is expected to grow with the addition of exchange-traded funds and equity products.
Despite recent reports suggesting the yuan has approached "fair value" against the US dollar, and is therefore no longer seen as undervalued, investors shouldn't be deterred from yuan-denominated products just because the currency has - at least, for the short term - ceased appreciating.
US-based investment bank JP Morgan says the gradual increase of yuan-denominated loans and other products are factors to take into account when deciding to invest. It added that as more investment opportunities for companies holding the yuan appear, so too will they be able to increasingly hedge their currency risks.
Elaine Wong, head of advisory for product and sales at Credit Suisse Private Banking in Hong Kong, thinks there are reasons to expect mild yuan appreciation against the US dollar (perhaps 2 or 3 per cent annually in a pro-risk environment) over the next year. Wong says this is because demand for the yuan and related financial products from central banks and investors should grow.
Raymond Gui, executive director and senior portfolio manager at Income Partners in Hong Kong, who specialises in Chinese fixed-income funds, says the focus on yuan products has switched to yield rather than appreciation. Partners runs two yuan yield funds, one offering 3 to 4 per cent yield, while another offers returns of 10 per cent. He says his firm takes an active investment approach by sourcing offshore bonds in the market.
Meanwhile, Deutsche Bank offers an offshore yuan bond index tracker for investors, an alternative way to gain exposure to the currency. It tracks offshore bonds and certificates of deposit with a minimum issuance size of one billion yuan (HK$1.2 billion) and no less than 12 months maturity.
So what does the future hold? Alex Kobler, head of investment products and services Asia-Pacific for UBS, notes the increasing ease with which investors can move offshore yuan funds onshore and invest in onshore capital markets. This should result in more yuan investments. "Yuan futures and derivatives is another area we expect to see growth," says Kobler, citing the fact that Hong Kong Exchanges & Clearing will launch yuan futures trading this quarter.
Josephine Lee, head of wealth management for Citibank in Hong Kong, says there has been an expansion in the number of ways retail investors can gain exposure to the yuan. She notes the launch of the yuan-denominated qualified foreign institutional investor scheme known RQFII in January, followed by a decision in April to allow institutions under the scheme to launch exchange-traded funds. "These funds allow investors to gain direct exposure to both the A-share market, as well as the bond market," says Lee.
Helen Lam, senior portfolio manager at Allianz Global Investors, says demand for yuan products remains high and a reflection of the fact that investors are not just looking for currency appreciation.
With the offshore bond market experiencing sustained growth, as well as Chinese and multinational companies approaching the offshore market for funding - particularly Hong Kong, and to a lesser extent Singapore and London - this should help improve liquidity and broaden the investor base.
HSBC's Lunt says no matter which way the yuan pie slices, Hong Kong is the winner. "We gain by being at the heart of the project," he says.