Understanding potential of the CHF-RMB swap line

On 21 July 2014, the Swiss National Bank (SNB) and People’s Bank of China (PBoC) announced a reciprocal three-year, Swiss franc-renminbi (CHF-RMB) currency swap line with a maximum swap value of RMB150 billion (23.3 billion Swiss francs, or US$24.4 billion).

Currency swap lines allow central banks to purchase and repurchase currencies from one another within a fixed term and a capped amount.

The Chinese agenda

Since 2008, in the aftermath of the latest global financial crisis, China started negotiating swap lines with its trading partners.

The global financial crisis of 2007-2008 shook the Chinese export industry. Since the renminbi is not free ly convertible, most payments in and out of China were, and still are, made not in renminbi but mainly in US dollars. It is easy to calculate the loss that Chinese exporters suffered with each cent the US dollar depreciated during the financial crisis in 2007.

Such loss could be avoided if international China-related trades were to be settled in renminbi. That’s why the Chinese go for bilateral swap lines – China’s financial system is not yet ready for the full convertibility of its currency.

With a renminbi swap line in place, the foreign central bank can obtain the Chinese currency, and lend it on to its commercial banks, export credit agencies and credit insurance or guarantee agencies.

They will then be able to provide trade finance in renminbi to their clients that export to China, i.e. provide export credit, credit insurance or export guarantees denominated in renminbi.

So if a foreign commercial bank is short of liquid renminbi funds, it can borrow from its central bank, and its central bank may effectuate the swap line to get renminbi from the PBoC.

Lender of last resort

In this sense, the swap lines are opening channels by which the PBoC may one day be acting as lender of last resort to foreign banks’ renminbi-denominated operations.

Given the prospective growth of such operations, the channels could effectively serve as an important source of stability, and their establishment could be understood as building the infrastructure of a comprehensive global renminbi system.

If high liquidity in capital-account transactions can be reached at the offshore renminbi hubs, the renminbi could one day be internationalised even with China’s capital account remaining closed.

The Swiss agenda

Interestingly, the Swiss government initially was not keen on the idea of currency swap against renminbi. In August 2011, Switzerland’s Federal Council even turned down a motion filed by a member of parliament to negotiate a swap line with China, based on a series of reasons.

The swap line was considered to be unilaterally beneficial to the Chinese private sector because Chinese importers and exporters may now use renminbi for their international transactions, saving transaction costs and reducing foreign exchange risks versus trading in US dollars.

But for Swiss companies, the risks were not reduced, merely shifted from US dollars to renminbi, while the latter currency represented – due to its limited convertibility and political risks – actually higher risks.

The Federal Council also observed that by then China’s swap lines had hardly been utilised, and international payments to and from China were still made chiefly in US dollars.

Another problem that the Swiss government saw was the fact that according to the Swiss constitution, the SNB may only sign swap lines for monetary purposes, not for reasons of export promotion.

Payments take off

Nevertheless, as a result of continued policy liberalisations, renminbi payments started to take off in value from early 2011. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) reported in its renminbi internationalisation white paper a growth of 874% between October 2010 and June 2011. In February 2014, for the third consecutive month, the renminbi overtook the Swiss franc as the world’s seventh-most-used currency for international payments.

HSBC predicts that by 2015, one-third of China’s cross-border payments will be made in renminbi, making it the third-most-frequently traded currency after the US dollar and the euro.

It is against this backdrop that the Swiss government sought the first
Sino-Swiss government-to-government financial dialogue in December 2013, which finally resolved upon the signing of the CHF-RMB swap line.

Hence, the turn of Swiss attitude cannot be attributed so much to trade promotion or financial stability as to the opportunities that the growing renminbi brings along, as a rising currency for international payment, clearing, and one day perhaps, even reserve.

The outlook

The swap line is, however, only one basic condition for Zurich to establish itself as a renminbi hub. To operate as a renminbi hub, Zurich needs the relocation of a Chinese commercial bank to function as the clearing bank, and it needs the commercial banks’ demand for renminbi.

Whether Zurich will become a renminbi hub largely depends on the Swiss financial institutions. The Swiss banks have to be innovative and look beyond currency trading and so-called dim sum bonds – two major current renminbi hub activities.

Two advantages

We see two advantages of Zurich as a future renminbi hub. First, Switzerland is a centre for international commodities trading and China is a prominent commodities trader. A lot of commodities trade is guarantee-driven, but the large majority of this – over 70% by 2011 – is denominated in US dollars. If this were to shift to renminbi, that could make a huge impact. The other advantage lies in the excellent Sino-Swiss political, trade and investment relations, and the trust of China’s central government in its Swiss counterpart. If Switzerland has an innovative idea, it will most probably be heard.