No Easy Ride for Yuan Through Hong Kong

By ALEX FRANGOS

When is a yuan not a yuan? When it is in Hong Kong.

Bankers are giddy with excitement over the recent liberalization of trading in the Chinese currency in Hong Kong, even raising notions that a flood of yuan into the city will erode the logic behind the Hong Kong dollar's peg to the greenback.

It is unlikely the territory's vaunted peg—in place since 1983—is going anywhere soon. Hong Kong Monetary Authority Chief Executive Norman Chan has four criteria before Hong Kong will switch currency allegiances. These include an open capital account in China, a freely convertible currency, a mature financial system and a Hong Kong economy more closely aligned with China's. How many have been met? None, he says.

Still, the yuan certainly is flooding in. Deposits of the Chinese currency in the Hong Kong banking system have mushroomed to the equivalent of $32.6 billion in October, up from $8.4 billion a year earlier.

Partly this is a result of a Chinese regulatory change in July, which freed the yuan to be used for private investment, setting off a parade of bond issuances in the Hong Kong market by companies, most recently including a Russian bank and a Macau-based casino. Caterpillar andMcDonald's have also tested the market with yuan-denominated bond issues to help fund their China operations at lower interest rates. Billionaire Li Ka-shing is said to be planning the first Hong Kong yuan-denominated IPO tied to a collection of mainland real estate holdings.

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Deposits of the Chinese yuan in the Hong Kong banking system have mushroomed to the equivalent of $32.6 billion in October, up from $8.4 billion a year earlier.

An even bigger factor was China's expansion of a trade-settlement program that lets Chinese companies pay for imports with yuan instead of dollars. As a result, foreign companies and individuals in Hong Kong are building up yuan deposits, figuring it is a currency that is only going up.

But here is the rub: Only a limited amount of yuan can be brought from Hong Kong to China and vice versa without permission. That means little has actually changed when it comes to China's steel-gated policy of controlling capital flows and investment. As HSBC currency strategist Daniel Hui writes, the Hong Kong yuan "is effectively a separate currency," that while it allows exposure to China's currency, it is "not a perfect proxy."

The spread between the value of the Hong Kong yuan and the onshore variety is small and shrinking. The only means for moving Hong Kong-based yuan onshore is through the trade-settlement program or with permission from authorities in Beijing. Hong Kong government officials are hopeful any spread between the two versions of the currency will be arbitraged away as mainland companies exploit the difference by choosing one market over the other in deciding where to raise yuan-denominated capital or which currency to use when settling trades.

Still, the opposite could happen. In the absence of a true free flow of capital, financial markets can do funny things. Investors looking at the Hong Kong version of the yuan might consider the gap in valuations between Chinese companies with shares listed in both Hong Kong and Shanghai. Right now those traded in the closed-off Shanghai market trade roughly at par with their brothers in Hong Kong. But the difference was as wide as 23% higher in early 2010 and a distorted 108% in January 2008.

It won't get that bad when it comes to the different flavors of the yuan. But investors looking to ride China's currency through Hong Kong should still mind the gap.

Soaring office rents in Hong Kong

Firms to Shift

By Kelvin Wong and Bei Hu - Dec 15, 2010 12:01 AM GMT+0800

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One International Finance Centre, center right, and Two International Finance Centre, center, are illuminated on the skyline in Hong Kong on Dec. 13, 2010. Photographer: Dale de la Rey/Bloomberg

Surging office rents in Hong Kong are prompting firms including Allianz Global Investors to shift out of the city’s most expensive towers as competition for prime space heats up along with the region’s growth.

Prime office rents in the Central business district soared 34 percent in the six months ended September from a year earlier, the biggest gain worldwide, according to property broker CB Richard Ellis Group Inc. Office rents in the area may climb as much as 30 percent next year, said Gavin Morgan, head of markets at Jones Lang LaSalle Inc.

Top-tier buildings such as Cheung Kong Center andInternational Finance Centre have raised rents as banks including HSBC Holdings Plc and Barclays Plc expand after the financial crisis. The city now has the world’s most expensive occupancy costs after London’s West End.

Tenants in Central “are reassessing whether it’s still within their budget to stay in the district,” said Simon Lo, Hong Kong-based director of research and advisory at Colliers International. Some tenants such as professional services or consulting firms “have a much lower threshold for rents,” he said.

Cheung Kong Center, the 12-year-old office building owned by Li Ka-shing, Hong Kong’s richest man, may see as many as five tenants move out by the end of 2011, according to people with knowledge of the matter.

The IFC towers I and II, both owned by Sun Hung Kai Properties Ltd. and Henderson Land Development Co., are seeing at least three tenants depart this year and next.

Hongkong Land Holdings Ltd.’s Exchange Square complex will lose another tenant to Sun Hung Kai’s International Commerce Centre in West Kowloon, across Victoria Harbour, following moves by Morgan Stanley and Credit Suisse Group AG.

Allianz, McKinsey

Allianz Global, the investment unit of Allianz SE, Europe’s largest insurer, which occupies about 20,500 square feet in Cheung Kong Center, will shift to nearby Citibank Plaza, according to three people with knowledge of the matter. McKinsey & Co. is also looking at moving, according to two people.

Patience Chan, a spokeswoman for Allianz in Hong Kong, declined to comment, as did Glenn Leibowitz, a Shanghai-based McKinsey spokesman. Laura Cheung, a spokeswoman forHutchison Whampoa Ltd., which owns and operates Cheung Kong Center, declined to comment on its tenants. Hutchison is 49.9 percent- owned by Li’s developer Cheung Kong (Holdings) Ltd.

PricewaterhouseCoopers LLP, whose current lease for its 85,000 square feet of space expires in November 2011, is in discussion with Cheung Kong Center’s building management about a possible renewal, Joanne Oswin, a Hong Kong-based operation partner at the accounting firm, said in an interview.

Cheung Kong Center

Even with such departures, Cheung Kong Center won’t have problems attracting new tenants, said John Siu, general manager for southern China at real estate services firm Cushman & Wakefield Ltd. in Hong Kong. Barclays, the U.K.’s third-largest bank, moved into the building earlier this year.

“It is one of the few top-tier office buildings in Hong Kong and many companies believe that being there gives you a sense of prestige and market influence,” said Siu.

Cheung Kong Center, built on the site of the former Hilton hotel, charges its new tenants between HK$140 ($18) and HK$150 a square foot per month on average, according to Seattle-based Colliers and Cushman & Wakefield of New York. The average rent in Citibank Plaza, owned by Champion REIT, is HK$110 per square foot and in Swire Pacific Ltd.’s Pacific Place in Admiralty district from HK$95 to HK$100, according to Colliers.

“We’re seeing a change in the profile of tenants in Central’s top office buildings,” said Jones Lang LaSalle’s Morgan, who is based in Hong Kong. “Many of the support departments in the big banks or professional firms providing these services to them are moving their operations away to non- core districts.”

Citic Tower

Accounting firm Ernst & Young LLP is moving its entire local operation, now in IFC II and Li’s Hutchison House, to Citic Tower in Admiralty, adjacent to Central, next year, according to spokeswoman Queenie Yuen. The firm has agreed to take up nine floors at the tower, owned and run by Citic Pacific Ltd., an arm of China’s biggest state-owned investment company.

ING Groep NV, the biggest Dutch financial-services company, in October moved its investment management and insurance units to the ICC from IFC I, said spokeswoman Jessie Hsieh. London Stock Exchange Group Plc in July moved its Hong Kong office from IFC II to ICC.

Rents in IFC II, Hong Kong’s second-tallest skyscraper after the ICC, and IFC I, are about HK$140 per square foot, according to Chicago-based Jones Lang LaSalle, the second- largest publicly traded commercial property broker. Rents at ICC are about HK$55 and may rise as much as 30 percent over the next two years, according to property consultant Knight Frank LLP.

Moving Out

Simmons & Simmons, a London-based law firm, will move out of its 21,000 square-foot space on the 35th floor of Cheung Kong Center in May for Pacific Place, Paul Li, Simmons & Simmons’s China head, said in a phone interview.

Deutsche Bank AG will complete its relocation to the ICC from Cheung Kong Center this year, said Singapore-based spokesman Mark Bennewith. Bloomberg LP, the parent company of Bloomberg News, is a tenant in Cheung Kong Center.

“The reason why we haven’t heard new tenants moving in yet is because some of the ones that are moving out still have a few months to a year in their contract and landlords won’t normally need to rush to sign up new tenants,” said Cushman & Wakefield’s Siu.

That space will probably be filled by separate small offices of hedge funds or investment banks, he said.

Gateway to China

Occupancy costs, which include rent, taxes and service fees, were $184.21 a square foot a year in Central, compared with $193.69 in London’s West End, according to a report from Los Angeles-based CB Richard Ellis, the world’s largest commercial property broker.

Hong Kong’s government raised this year’s growth forecast to 6.5 percent as the city, a gateway to China, benefits from growth on the mainland.

The jobless rate fell to 4.2 percent for the three months ended Oct. 31, the lowest level in 20 months. The city’s number of financial professionals rose to a record 37,694 by July, eclipsing the previous high reached in November 2008, the Securities and Futures Commission said in August.

PwC, which also has offices at the Edinburgh Tower and Prince’s Building in Central, leased about 100,000 square feet of office space in 2008 at the Manulife Financial Centre in the Kowloon East district. Rents in that district, a 30-minute subway ride from Central, are currently between HK$20 and HK$30 a square foot, said Colliers’ Lo.

Professional services’ firms “are going to be reviewing their cost base as a result of rising rents in Central,” said Rhodri James, Hong Kong-based executive director of office services at CB Richard Ellis. “Some of them will be moving all or part of their operations to more cost-efficient buildings outside the area.”

Offshore Trading in Yuan Takes Off

• MARKETS
• DECEMBER 14, 2010

By SHAI OSTER in Hong Kong, DINNY MCMAHON in Beijing and TOM LAURICELLA in New York

China's currency, pent up inside the country's borders for decades, is emerging as a hot property in global foreign-exchange markets, just months after Beijing allowed the yuan to be bought and sold outside the mainland for the first time.

Daily trading in the yuan has grown from zero to $400 million in the past few months, as the currency of the world's second-biggest economy begins to flow around the globe. Global trading in yuan allows businesses to buy and sell the currency to finance trade, investment and borrowing. It's an important step for the yuan to play a role in global financial markets.

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The yuan makes up a sliver of the $4 trillion daily trading in currency markets and is dwarfed by trading in the dollar, yen and euro. But traders are surprised at how quickly it is gaining critical mass.

The value of the yuan remains tightly controlled by China, so its value won't rise and fall to the same extent as the dollar or euro, in spite of the new trading. Even so, foreign-exchange traders who are embracing the currency see demand for yuan rising sharply. Bankers in New York, London and Tokyo are rushing to set up new trading systems and back offices to trade in yuan.

"This is the beginning of a new era," said Norman Chan, head of Hong Kong's central bank. "This is a step moving to full convertibility of the yuan, and is a major change of the international financial landscape."

The yuan makes up a sliver of the $4 trillion daily trading in currency markets and is dwarfed by trading in the dollar, yen and euro. But traders are surprised at how quickly it is gaining critical mass. Chinese companies are placing yuan into accounts in Hong Kong, where the offshore trading is allowed, and could have as much as 300 billion yuan ($45 billion) there by the end of the year.

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The yuan, which closed official trading Monday at 6.6670 per dollar, down slightly on the day, has risen 2.4% against the greenback since mid-June, when China loosened the currency's peg against the dollar and allowed the yuan greater flexibility to rise or fall in value.

The continued growth in yuan trading isn't a foregone conclusion. China could reverse itself and slow the growth of the market. China's leaders fear that if too much currency builds up too quickly overseas, they could lose control of inflation and interest rates, said Xiang Songzuo, deputy director of the Center for International Monetary Research at Remin University of China.

Nevertheless, the establishment of offshore trading in yuan is "game changing," said David Mann, head of research in the Americas for Standard Chartered Bank. "It's arrived much faster than anyone expected."

In July, Chinese regulators opened the door by letting banks and individuals freely trade yuan outside of mainland China for the first time. Creating that infrastructure is a necessary step in allowing the yuan to float freely, and have markets set its value. For now, China will keep its tight rein on the value of the yuan even with the parallel market in Hong Kong.

On Dec. 6, Chinese regulators broadened the scope of the program, increasing the number of exporters that can use yuan to trade their goods from a few hundred to nearly 70,000.

Some predict it will only be a few years before 20% to 30% of China's $2.3 trillion of imports could be conducted in yuan rather than U.S. dollars. Today less than 1% is done in yuan, according to Standard Chartered.

Mr. Mann says trading in yuan could match that of the Japanese yen before long as the third most-actively traded currency behind the dollar and the euro.

Until now, investors who wanted to speculate on the yuan, or companies that needed to hedge against its fluctuations, could only do so indirectly, through contracts that tracked the currency's moves. Those contracts were useless for businesses that needed actual yuan to buy or sell goods.

To buy and sell yuan offshore, traders need an account in Hong Kong. Chinese companies can move money to offshore yuan accounts only for business purposes, such as exports or imports. And restrictions remain on repatriating that money.

But as long as that money is in an offshore yuan account, the holder is free to trade with it in any way.

Already, banks such as Citigroup Inc. and HSBC are offering investors yuan-priced options and interest-rate derivatives. Mutual funds dedicated to yuan-priced investments have already been created.

The move has opened the doors to wider issuance of yuan-denominated bonds and other investments. McDonald's Corp. and Caterpillar Inc. recently became the first U.S. non-financial corporations to sell debt priced in yuan, in what is being nicknamed the "Dim Sum" bond market.

A big driver of the increase in yuan holdings offshore is emerging economies, major trading destinations for China. HSBC forecasts that at least half, or nearly $2 trillion worth, of China's cross-border trade with emerging markets could be settled in yuan annually within three to five years.

For example, countries rich in natural resources that export commodities to China could get paid in yuan and then use the yuan to buy finished goods and services from China—cutting out the cost and hassle of converting to dollars.

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The moves come against a broader background of growing Chinese concern over the country's reliance on the dollar.

Long term, the offshore yuan market could decrease demand for the dollar and lower its value. That's in part because Chinese companies doing business with counterparts in other countries wouldn't need U.S. dollars to conduct that business as they do today.

In Hong Kong, where speculation is an obsession, individual investors quickly piled in to yuan, even though they are limited to converting only 20,000 yuan a day. On display by bank teller windows are interest rates for Hong Kong, U.S and now Chinese deposits.

For the yuan to become fully convertible, China would have to allow it to be exchangeable for other currencies at any time, something that's not possible under the new regulations.

The keen level of interest in the offshore yuan trading was evident last week in midtown Manhattan at the headquarters of HSBC. Some 80 traders from 20 banks came to hear a presentation organized by ICAP PLC on offshore yuan trading featuring Esmond Lee, an official from the Hong Kong Monetary Authority. Previous sessions in Hong Kong and London had been similarly packed.

"What makes it exciting is that this is a move by China in a direction that many have been waiting for," said Edward Brown, an executive vice president at ICAP, the world's largest broker of currency trades among banks.

Corrections & Amplifications

The chart showing growth of deposits in a previous version of this article should have been labeled in billions of yuan.

Write to Shai Oster at shai.oster@wsj.com, Dinny McMahon at dinny.mcmahon@wsj.com and Tom Lauricella at tom.lauricella@wsj.com