Finance Committee on Feb. 17th, 2015

[The Chair, Conservative, James Rajotte]

I call this meeting to order. This is meeting number 66 of the Standing Committee on Finance. I want to welcome all of our guests here this morning.

Pursuant to Standing Order 108(2) we are beginning our study on the Canadian renminbi trading centre.

We want to welcome some very distinguished guests here this morning. First of all, from the Department of Finance, we have the assistant deputy minister of financial sector policy branch, Mr. Rob Stewart. From the Bank of Canada, we have the chief of financial markets department, Mr. Paul Chilcott. From BMO Capital Markets, we have the managing director, Mr. C.J. Gavsie. From Export Development Canada, we have the vice-president and chief economist, Mr. Peter Hall. From the Industrial and Commercial Bank of China, we have Mr. William Zhu.

Thank you so much for being with us here this morning. Each of you will have up to five minutes for an opening statement and then we'll have questions from all the members.

We'll begin with Mr. Stewart, please.

[Rob Stewart, Assistant Deputy Minister, Financial Sector Policy Branch, Department of Finance]

Thank you very much. I welcome the opportunity to be here today.

Thank you for the opportunity to speak to your committee.

I would like to make some remarks about the offshore renminbi centre.

Canada is the first country in the Americas to have agreements in place with the Chinese government to facilitate the use of its currency, the renminbi, in trade, commerce, and investment between the two countries. This development is a tremendous opportunity for Canada, and I'm pleased to be able to provide some background today.

To start, I'd like to discuss the renminbi itself, often also referred to as the Chinese yuan, which is the primary unit of the currency, and what's behind its growing use. While the renminbi is subject to controls imposed by the Chinese government, some of these controls have been relaxed in an effort to gradually internationalize the currency. The extent to which the internationalization occurs will largely depend on the continued opening of China's capital account, the degree to which there is flexibility in China's exchange rate regime, and most importantly, how the private sector chooses to engage in renminbi activity.

The process of internationalization has essentially been a phased market-based approach with Hong Kong serving as a policy testing ground since 2003. It was then that the Bank of China (Hong Kong) was designated as the first renminbi clearing bank outside of mainland China, allowing foreigners to open renminbi denominated accounts for the first time.

This was followed with a launch of a series of pilot programs aimed at increasing the use of the currency in trade settlement, and then further measures aimed at increasing the use of the renminbi as an investment currency. There are now essentially no limitations on the use of renminbi for the purposes of trade settlement, while certain restrictions do still remain on inflows into China for investment purposes.

Over time, two distinct pools of renminbi have developed: an onshore pool that trades only in mainland China, and an offshore pool that trades in Hong Kong and other foreign financial centres. In spot foreign exchange markets, the onshore pool is larger, with an estimated average daily turnover of U.S. $17 billion compared to $8 billion in the offshore pool. However, in currency swap and option markets, offshore trading is larger, with an estimated average daily turnover of U.S. $24 billion compared to U.S. $19 billion onshore.

This difference can be attributed to the absence of Chinese restrictions on the use of offshore renminbi, including the freedom for financial institutions to launch and trade derivative products in the currency. Because the onshore version of the currency is subject to restrictions, including a maximum trading band for the currency on any given day as well as limits on conversions for offshore investments, onshore and offshore renminbi are not completely fungible and trade at slightly different exchange rates.

The relaxation of controls has seen a buildup in the pools of offshore currency around the world. There are now a number of offshore renminbi centres where a variety of products and services denominated in the currency are offered. These centres typically require the designation of a clearing bank by China to transit payments in renminbi to and from mainland China. Hong Kong is the most established of these centres, and other important offshore renminbi centres include London, Luxembourg, Singapore, and Frankfurt.

With the agreement between China and Canada last November, Canada has joined these centres. This agreement has three elements.

First, the Bank of Canada and China's central bank, the People's Bank of China, PBoC, signed a memorandum of understanding related to the clearing of renminbi transactions in Canada. The Industrial and Commercial Bank of China, ICBC, was subsequently designated by China as the renminbi clearing bank for Canada, allowing access to the onshore renminbi market in addition to the offshore market. As a designated clearing bank, ICBC will be able to directly access the People's Bank of China payment systems to clear renminbi denominated transactions to and from Canada. In the absence of a designated clearing bank, domestic banks would have to use one or more correspondent banks with renminbi access to China, potentially reducing efficiencies and increasing risk when compared to the direct link that ICBC will now provide.

Second, the two central banks agreed to establish a reciprocal currency swap line. My Bank of Canada colleague, Mr. Chilcott, will have more to say about this.

Finally, Chinese authorities agreed to grant Canada a quota on investment of 50 billion renminbi under the renminbi qualified foreign institutional investor program, known as RQFII, which will allow Canadian qualifying financial institutions to offer renminbi denominated investment services in China's domestic capital markets to Canadian and other investors. Individual Canadian asset managers will be able to apply to the Chinese securities regulator for a portion of this quota. These elements should support the increased use of renminbi in Canada-China trade and facilitate investment by Canadian financial institutions and their customers. For Canadian firms doing business in China, using renminbi could be more efficient than using a currency of an unrelated country, typically the U.S. dollar, thereby lowering transaction costs.

Canada may also benefit from a first mover advantage by being the first country in the Americas to have a designated clearing bank. A quicker buildup of expertise in renminbi liquidity in Canada than in other centres could have lasting beneficial effects for our financial industry.

In addition, with a similar time zone, there is an incentive for firms and financial institutions located in other countries in the Americas to use clearing services here for their transactions in China. The extent to which this materializes, however, will depend in part on individual decisions and the cost and efficiency of using Canadian clearing options compared to that of other centres.

Canada's clearing bank, the Industrial and Commercial Bank of China, is getting ready to begin renminbi clearing and planning to be operational in the coming weeks. Now that Canada and China have come to an agreement on the three supporting elements of the Canadian renminbi centre, it will be up to the private sector to take advantage of the opportunity that has been delivered.

An important consideration when measuring the success of Canada's renminbi centre and renminbi internationalization more generally is that the market is still in its infancy. It does not currently have the deep sophistication that would allow businesses and financial institutions to fully engage in renminbi markets the way they would, for example, in the euro or the yen, but as commercial demand, liquidity, expertise, and trade grow over time, so too will the market evolve and be able to support the use of the renminbi on a much greater scale than is currently available.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll now hear from the Bank of Canada.

Mr. Chilcott, please.

[Paul Chilcott, Chief, Financial Markets Department, Bank of Canada]

Good morning, Mr. Chairman and honourable members.

The Bank of Canada appreciates this opportunity to provide an overview of its recent work to support the development of renminbi activity in Canada.

Last fall, in support of the government initiative led by the Department of Finance to promote increased trade and investment between Canada and China, and to support domestic financial stability should market conditions warrant, the Bank of Canada negotiated two agreements with the People's Bank of China. The first was a reciprocal currency swap agreement. The second was a memorandum of understanding relating to the clearing of renminbi transactions in Canada. Separately, Canada was also granted a renminbi qualified foreign institutional investor quota, initially 50 billion renminbi. The quota enables investors to access renminbi products in domestic Chinese markets.

The swap agreement with the People's Bank of China is similar in structure to ones the Bank of Canada already has in place with the U.S. Federal Reserve and a number of other major central banks. The agreement would allow the Bank of Canada, should we judge circumstances to warrant it, to swap Canadian dollars for up to 200 billion renminbi. The Bank of Canada could then lend the renminbi to Canadian financial institutions that required renminbi to meet their payment obligations. However, as with our activities in other currencies, it should be underlined that Canadian financial institutions are responsible for the management of their renminbi liquidity needs, including in stressed circumstances, and the Bank of Canada envisages that it would only contemplate lending renminbi as a last resort and in support of the stability of the Canadian financial system.

To provide some context, to date the Bank of Canada has never activated any of its central bank swaps to finance foreign currency liquidity provision. The swap should nevertheless help give confidence that increased levels of renminbi activity in Canada are manageable. The swap agreement is reciprocal in nature so the People's Bank of China could activate it to draw up to $30 billion Canadian. The swap is initially for a three-year period, but is renewable.

The MOU between the Bank of Canada and the People's Bank of China is a cooperative agreement to establish a regular dialogue on the conduct of renminbi business and the evolution of renminbi clearing and liquidity conditions in Canada. As with the swap, the People's Bank of China has similar agreements in place with the central banks of other jurisdictions where the use of renminbi is growing.

The cooperation will include sharing aggregate information on the level of activity denominated in renminbi occurring in Canada in particular financial products. The collection of this information from financial institutions in Canada is the responsibility of the Office of the Superintendent of Financial Institutions, and OSFI is working with industry to put in place appropriate reporting arrangements.

Once the MOU is in place, the People's Bank of China designates the Canadian subsidiary of the Industrial and Commercial Bank of China as the Canadian clearing bank. The supervision and regulation of ICBC's activities in Canada fall within the remit of OSFI, as laid out in the Bank Act and OSFI's own supervisory framework. At the same time, the Bank of Canada has an interest in clearing and settlement arrangements in Canada from a broader financial system perspective, and will monitor the evolution of renminbi clearing and renminbi liquidity conditions in Canada, and maintain a regular dialogue with the PBoC on those issues.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Chilcott, for your presentation.

We'll go to Mr. Gavsie from BMO Capital Markets, please.

[C.J. Gavsie, Managing Director, Global Head of Foreign Exchange Products and China Capital Markets, BMO Capital Markets]

Thank you, Mr. Chair and honourable members of the committee.

I'm pleased to be here to participate in this committee's study on the Canadian RMB trading centre.

I'm also honoured to be joined here today by my colleagues from the Department of Finance, Export Development Canada, the Bank of Canada and the Industrial and Commercial Bank of China.

In my role as head of foreign exchange products at BMO Capital Markets and as co-chair of the Toronto Financial Services Alliance working group on the RMB hub, I had the opportunity to work with many stakeholders in both public and private sectors in support of efforts to make the dream of an RMB hub in Canada a reality.

Our efforts were predicated on the idea that Canada can benefit significantly from trade diversification, especially to major growing economies such as China's. Such increased trade creates jobs at home and strengthens Canada's economy.

Historically, Canadian companies have tried to do business in China while having to use U.S. dollars to pay their Chinese suppliers, that being a currency many Chinese suppliers will accept. This arrangement adds foreign exchange transactions to the purchases and the process, which forces the retailer to add a 5% to 8% buffer to all similar transactions.

Taken together over the course of a year, this process adds billions of dollars to the prices of imported goods, a real and significant cost to Canadians. It is little wonder that Canada's trade with China, while significant, still appears to have significant room to grow. The establishment of a trading hub allows Canadian financial institutions to purchase renminbi on the open market on behalf of their clients. In the case of a Canadian retailer, such a company will be able to acquire renminbi at a market price, hold the currency in an account here in Canada, and then cut a cheque in renminbi when they need to pay their suppliers. Added cost from multiple foreign exchange transactions will disappear. Several RMB hubs have already been established elsewhere in the world, such as those in the U.K. and in Singapore. If patterns seen elsewhere are replicated here, we can expect to see a significant increase in total trade between Canada and China once the hub is up and running.

This committee will already know that the Canadian banking system has been rated the soundest in the world for the past seven years by the World Economic Forum. The renminbi hub will provide a further benefit to the financial sector as well. It will increase the sector's diversity and make Canada an even more appealing place in which to invest and do business.

The announcement in November of the agreement to establish the RMB hub here in Canada was fantastic news for Canadian companies. The Prime Minister and officials at the municipal and provincial levels across the country are to be commended for both their vision and their efforts. On behalf of BMO, I would like to thank them for getting this initiative to the goal line.

At BMO our capabilities in China are unmatched by our peers. In fact, we have been building relationships in China almost as long as the bank has been in business. We undertook our first foreign exchange transaction back in 1818. In 1961, with Canada's first major wheat sales to China, BMO became one of the first western banks to have direct ties with the Bank of China. Today, we are the only Canadian bank and one of only three North American banks to have a wholly-owned Chinese subsidiary.

The renminbi hub is yet another milestone for our enduring relationship with China. We look forward to using our strong foreign exchange capabilities to support our customers as they expand their businesses into China. We also look forward to working with all the stakeholders to make the hub the success we know it can be.

Mr. Chair, thank you for the opportunity to address the committee today. I look forward to answering any questions.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll now hear from Mr. Hall from EDC, please.

[Peter Hall, Vice-President and Chief Economist, Economics, Export Development Canada]

Thank you, Mr. Chair.

I'm very happy to be here today to discuss Export Development Canada's perspectives when it comes to

the renminbi hub establishment and the internationalization process.

EDC's interest in China's renminbi internationalization process and the establishment of renminbi hubs around the world has grown significantly. We've been especially interested in how the evolution of the renminbi is relevant to Canadian exporters. I'll get to this in a minute.

We've also been active in the renminbi bond market. As you may be aware, EDC became the first Canadian entity to issue a renminbi bond in July 2013, and one of the first sovereigns outside of China to do so. We then issued a second renminbi bond in November of last year. We would be happy to discuss these bonds with the committee, but my presentation is going to concentrate on the practical implications of the renminbi hub for the Canadian export community. In particular, I plan to address the questions that have been captivating many of our clients. These are, first, why the internationalization of the renminbi is an important issue for Canada, and second, how this will actually help Canadian exporters.

On the first question, China's development of renminbi hubs around the world is creating more demand for renminbi denominated trade, and Canadian exporters need to prepare themselves accordingly. It's clear to us that very significant competitors of Canada are already testing the waters on this front. If Canadian companies are not willing to do the same, they could find themselves in a position of competitive disadvantage. It is equally noteworthy that China is one of our most important trading partners. It has already been mentioned, but around $77 billion in two-way merchandise trade is currently happening. That's roughly about 8% of Canada's total trade on an average basis. China stands alone as our number two trading partner, and this means that all of the standard incentives for renminbi denominated trade definitely apply for Canada.

Having said that, we have interviewed Canadian companies, both large and small, about their renminbi strategies. As a general rule, the large companies are aware and quite cognizant of the benefits. We're more concerned about the preparedness and awareness of small and medium-sized enterprises, which clearly do not have as many resources to devote to the latest foreign exchange strategies. The risk here is that Canadian small and medium-sized enterprises could be caught off guard by a rising renminbi, and wind up losing their competitive edge.

Fortunately for them, we have not yet seen a significant shift to renminbi denominated real economy business. One of the key reasons for this is that global value chain financing practices are very U.S. dollar centred. Even in China, Chinese simply can't switch to renminbi denominated trade without repercussions, given the way that trade is organized at the moment.

Another reason that Chinese companies have preferred to conduct business in U.S. dollars until now is rooted in the relatively cheap U.S. currency, although we see that in the last little while that is evaporating. As the U.S. is leading the charge in the rest of the world, their structural strength and a number of other factors are leading to an appreciation of their currency.

Those are all reasons that this is important to Canada. How this will help Canadian exporters, I will summarize very quickly inside of six key points.

First, the establishment of the Canadian renminbi hub will allow our exporters to access a wider universe of Chinese importers.

Second is the awareness effect, both the effect of the awareness of the establishing of the hub on Canadian businesses large and small, and also awareness in China of Canada having actually made the advent of this, and thus increasing our visibility in that market.

Third, the hub should also stimulate the development of a more robust renminbi derivatives market in Canada, which will allow Canadian companies to more effectively hedge foreign exchange risk.

Fourth, hub agreement included an RQFII quota. This is an important detail that will allow Canadian institutional investors the ability to access China's onshore securities market and thus expand the menu of renminbi denominated investment options which would help to further deepen Canada's renminbi liquidity pool.

Fifth, the establishment of a clearing bank in Canada will help to reduce foreign exchange fees and make renminbi denominated transactions more cost-effective.

Sixth, there is evidence, although it's anecdotal, of discounted transactions for those actually using the renminbi.

What this all means is that renminbi hubs in Canada, Asia, and Europe are rewriting the rules of engagement and in the process altering the demand structure for renminbi business, which is not going to change overnight, but it is changing. We are hoping that in this case Canada can be ahead of the curve. It certainly pays to be ahead of the curve.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Hall.

We'll now go to the Industrial and Commercial Bank of China, Mr. Zhu, please, for your presentation.

[MingXuan, William) Zhu (President and Chief Executive Officer, Canada, Industrial and Commercial Bank of China]

Mr. Chairman, good morning. It's my great honour to be here. My name is William Zhu. I'm the president and CEO of the Industrial and Commercial Bank of China (Canada).

The Industrial and Commercial Bank of China is one of the world's leading commercial banks. In terms of total assets, our group has over 20 trillion renminbi, which is under a network consisting of more than 17,500 domestic institutions, over 400 overseas subsidiaries in 41 countries and territories, over 4.8 million corporate clients, and 430 million individual clients. Our bank subsidiary in Canada established our presence in Canada in 2010. Unlike our parent bank, the size of our subsidiary here is quite small in terms of total assets. RBC is over 900 times bigger than the bank. Now we have one head office and nine branches across Canada. We have over 94% of staff hired in Canada. On November 9, 2014, the Industrial and Commercial Bank of China (Canada) was proudly appointed as the first renminbi carrying bank in North America, and it is the first commercial bank providing 24/7 renminbi carrying services globally with a direct connection with China's central bank's carrying system. Now the bank can provide a great price and faster door-to-door renminbi carrying services in Canada. We are in the same time zone. We are seated here by your side to help Canada fully utilize the renminbi currency for great potential.

Today I want to talk about three main points regarding the Canadian renminbi trading centre.

First, why are we talking about renminbi and not yen or euro? No matter what kind of view you have about China, there are some facts you cannot ignore. China has changed a lot in the past three decades. Now China is the world's largest trading country and has the second to largest economy. China is now, and in future still will be the most potential market in the world; hence, the renminbi is the best way to reach the Chinese market and to do business with China, to serve your Chinese clients and their counterparts.

Second, why is the Canadian renminbi training centre so important and unique? You can compare the trading volume between the American continent with China to Europe with China. If I remember correctly, the amount of this volume is quite close. However, in Europe, there are four renminbi trading centres: London, Frankfurt, Paris, and Luxembourg. Canada is the only one that has a renminbi trading centre in North America, on the American continent. Consider the time zone difference; the benefit is that it will be fully operational and cover the business hours that Asia cannot. For example, our parent bank will sign an agreement with us to operate the carrying services after the Asia cut-off time.

Third, what are our challenges? I believe there are quite a few, but I am only going to list some of them.

First, there is quite a limited time window for us to implement it because China is liberalizing capital accounts. I'm guessing in the future, in three or four years, China will be liberalizing this more, so we only have four years, with respect to a renminbi carrying centre, to fully utilize our competitive advantages.

The second is the lack of knowledge and awareness of the benefits of using the renminbi for doing business with Chinese counterparts in the private sector. According to a survey by HSBC, only 5% of companies in Canada are aware of the renminbi for doing business with their Chinese counterparts, which is a relatively small number compared with other countries.

Third, Canada as the middle market country cannot stand alone to generate huge trading volumes for the offshore centre we have here, so we need to fully bond with the whole of North America, especially the United States companies, to serve them, to accumulate enough volume to support our having very mature offshore centres in the future.

Fourth, in order to compete with other financial offshore centres on other continent, we need tailor-made renminbi products to fully support the business in this field. There's a long way to go and we are competing with other centres in productivity and efficiency.

I wanted to raise all of those four points.

The Industrial and Commercial Bank of China is quite willing to work with everyone here to promote this initiative in Canada, to make the the improvements in Canada a very successful story, to help Toronto as the second-largest financial centre in North America, to analogize this initiative in Canada.

Thank you very much.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We will now move to members' questions. We'll start with Mr. Cullen, for seven minutes, please.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

Good morning, Chair. Thank you.

Good morning to everyone. Thank you for being here.

I'll start with something you just said, Mr. Zhu—if I'm even close to pronouncing your name correctly—regarding the four-year window you mentioned. Can you explain and elaborate on what that challenge is for the committee, to help us understand what the imperative is for you?

[MingXuan (William) Zhu]

The reason I mentioned a four-year window is that China is liberalizing capital accounts. In the future, after the full liberalization of the capital accounts, there will be no competitive advantage as there may be in offshore centres in North American countries.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

Because the one is not liberalized right now, this is the advantage of opening this renminbi hub.

[MingXuan (William) Zhu]

Yes.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

Your estimate was within four years.

[MingXuan (William) Zhu]

Maybe. It's just an estimate. We are speeding up those processes. I think it will be very short term so we need to fully utilize this...

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

I have a quick question for Mr. Gavsie.

Does it matter where this hub is physically located in Canada?

[C.J. Gavsie]

No, it doesn't. The hub is virtual. If I could describe the end result which I use with a lot of our clients and internal people, we would like for Canadians, for commercial purposes, to be able to walk into any branch of their financial institution of choice in Canada, and to have the ability to conduct their cash management services in renminbi, as they do today in Canadian or U.S. dollars.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

We think of a hub as a physical place, but it's simply a negotiated arrangement to be able to trade in this currency.

[C.J. Gavsie]

That's correct.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

Forgive my ignorance on this. Who picks up these...? You estimate it at as much as 5% to 8% I think. I've seen others as low as 3%, but some transaction costs.... Who receives that cost right now? Help us understand who's getting that money and won't get the money once this is done.

[C.J. Gavsie]

It's the Chinese supplier to the Canadian retailer, as in my example. There are many other types of examples, but basically we're estimating it at 5% to 8% on average as far as what Canadians who have negotiated ongoing contracts with Chinese suppliers are concerned. What we've done to be able to calculate that 5% to 8% is sat down with some of our clients and taken their contracts and deconstructed them using forward hedging pricing, to see if they were to pay in renminbi what would the savings be in Canadian dollars.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

Is part of this imperative now due to the strength of the U.S. dollar coming on?

[C.J. Gavsie]

It was there before.