CNH Tracker-Cash squeeze may stifle initial stock connect demand

By Saikat Chatterjee

HONG KONG, Sept 4 (Reuters) - An increase in offshore yuan

deposit rates may become more pronounced in the days ahead as a

landmark stock market connect plan between the mainland and the

former British colony enters the final stages of completion.

That extra cost could, at least temporarily, stifle demand

for mainland China stocks from offshore retail investors, which

the connect scheme is ultimately meant to encourage.

The tightening in offshore liquidity is evident in the

behaviour of offshore yuan deposit rates.

For example, three-month interbank rate for offshore

deposits hit a 2014 high of more than 3 percent in late August

compared to 1.5 percent in June before receding slightly. That

compares with similar deposits onshore at around 4.4 percent.

Authorities expect the landmark stock-connect programme

between Shanghai and Hong Kong - another step in China's efforts

to open up its markets - will launch in October. Regulators and

market participants are racing to test mechanisms to ensure

readiness.

The anticipated initial wave of demand for mainland stocks

once the scheme opens could put further upward pressure on

offshore deposit rates as investors wanting to buy onshore

stocks can only do so using offshore yuan.

More prolonged pressure on offshore yuan liquidity could

prompt some regulatory response.

"We will have to see a sustained demand for mainland shares

for at least a month to trigger some kind of policy response to

boost CNH liquidity," said the head of currency trading at a

U.S. bank in Hong Kong.

Among the likely policy responses expected by banks is a

potential upgrade to Hong Kong's yuan liquidity support facility

to coordinate with the new settlement mechanisms.

Another potential fix could be use of an emergency currency

swap line previously set up with China's central bank to

smoothen any temporary liquidity mismatches.

Meantime, divergence in the trends between the offshore and

the onshore markets will present arbitrage opportunities for

banks and corporates.

An extended squeeze in the offshore market would push the

yuan in Hong Kong to start trading at a premium to the mainland

as opposed to near identical rates for most of this year.

It would also force banks to offer higher interest rates

encouraging retail investors to convert their Hong Kong dollar

holdings into Chinese currency deposits, which would eventually

help correct some of the liquidity squeeze.

WEEK IN REVIEW:

New fixings. Thomson Reuters Corp , the news

and information company has been appointed by the Taipei Foreign

Exchange Market Development Foundation as the official

calculating agent for its offshore renminbi benchmark otherwise

known as the CNT TAIBOR. This industry rate will provide a

formal benchmark for market participants to reference when

pricing renminbi loans, interest rate contracts and derivatives

products.

Fresh quotas. Blackrock (NYSE: BLK - news) , the world's biggest money

manager said this week its Hong Kong subsidiary has been awarded

a $500 million QFII investment quota by the State Administration

of Foreign Exchange. The allocation relates to the QFII licence

received by Blackrock in October 2012.

More RMB, please. Hong Kong and Taiwan investors have strong

interest in yuan assets, but they appear to have distinct

preferences and attitudes towards the asset class, according to

a latest Manulife survey. Nearly four out of every five

investors in Hong Kong own yuan investment products compared to

one in two in Taiwan, the survey said.

CHART OF THE WEEK: Yuan deposits in Hong Kong: http://link.reuters.com/nez26t

Yuan deposits with Hong Kong banks have peaked out after

nearly hitting a high water mark of one trillion yuan earlier

this year. A rapid growth of renminbi-denominated yuan

investment quotas and an unusual episode of currency weakness

earlier this year have been blamed as factors behind the fall.

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THOMSON REUTERS SPEED GUIDES

(1 US dollar = 6.1408 Chinese yuan)