The UK clears the largest amount of CNY payments and FX transactions. It has a large trade deficit with China, and exports less to China than either France or Germany in absolute terms. In 2018, the UK exported 23.8 billion USD worth of goods to China but had a trade deficit of 33.4 billion USD.12Aided by a business-friendly legal system,13the UK’s large financial and currency markets make up for the smaller amount of trade. In 2014, the UK exported 20 billion GBP worth of financial services to the EU.14European financial markets are open, so companies that earn CNY in other countries can deposit or exchange it in London. The UK financial system then allocates it elsewhere. This network effect makes London an attractive deposit destination for companies from all over Europe.
While the effects of pending Brexit on London’s future role in CNY internationalization are still difficult to assess, China’s January 2020 suspension of the new London-Shanghai Stock Connect has demonstrated how politicized the space of financial cooperation with China still is. According to sources quoted in the media, tensions over Britain’s stance on the protests in Hong Kong caused China to temporarily block the stock connect scheme which had just been launched in 2019 with the aim of attracting more CNY business to the UK.
The stock connect allows equity traders in both cities mutual market access through depositary receipts. This enables London-based financial institutions to buy China-listed, RMB-denominated shares. The connect is also intended to allow Chinese firms to directly list newly issued shares denominated in GBP and USD on the London Stock Exchange, thereby helping them to finance themselves in foreign currencies.
The country initially hoped to establish Frankfurt as the leading European clearing and settling hub for real-economy based business. This focus makes sense as trade in goods dominates Germany’s economic relationship with China, far more so than for the UK and France. But the vision has not yet come to fruition. According to the monthly CNY tracker run by SWIFT’s, the world’s largest payment systems provider, only a small share of Sino-German trade is settled in CNY, with most business still done in other currencies. This is likely because banks that already have other channels (for example through Hong Kong or other European countries) are reluctant to use the clearing center.15
CEINEX is a Sino-German joint venture, an exchange for Chinese financial products between the Shanghai Stock Exchange and Deutsche Börse. Located in Frankfurt, CEINEX allows Chinese companies to list ‘D-shares’, i.e. euro and CNY-denominated shares sold on the Frankfurt Stock Exchange. However, only Shanghai-listed companies with A-shares can list on the Frankfurt exchange. So far, most business has been conducted in euros. In 2018, only 3.5 percent of trades were in CNY. The most notable company to list shares through CEINEX was the white goods maker Qingdao Haier.
France clears the second largest amount of CNY in European markets, under a strategy that sits halfway between that of Germany and the UK. Much of French trade with China is conducted in CNY. More than 55 percent of payments between France and China/HK were cleared in CNY in 2017, according to the SWIFT CNY tracker. But France’s FX market is smaller than the UK’s. In 2016, it handled some 2.7 percent of global FX trades and around six percent of FX trades involving CNY.
The city-state focuses on deposits, lending and bonds and has Europe’s largest pools of CNY deposits, loans and bonds.16It has competed for CNY market share by allowing Chinese banks to set up subsidiaries shipping in their own capital from abroad. Luxembourg’s eurozone membership and ability to offer the European banking passport (which allows banks domiciled there to do business in all member states of the European Economic Area, EEA) offset its small size. The strategy has proved successful: China’s major state banks (except for Bank of China) have established their European HQs in Luxembourg.
Despite London’s dominance, efforts to build CNY markets in continental Europe will continue. Joachim Nagel who served on Deutsche Bundesbank’s executive board from 2010 to 2016, has said17that euro clearing for CNY business should be located in a country which is part of the euro system, as any other arrangement “would not give the best signals.“
However, it will be hard for continental European countries to unseat the UK as the top CNY market without restricting capital flows. The UK has advantages other countries cannot easily compete with: a business-friendly legal system; the world’s largest FX market; a historical connection with Hong Kong (where British banks are common); an English-speaking environment that is easier for Chinese companies to work in and – perhaps most importantly – the sheer size and connectivity of its financial markets. As continental European players cannot simply replicate these advantages, mounting a firm challenge to London would imply self-defeating measures such as restrict their own businesses’ access to the UK markets.
It is very unlikely that capital controls would be imposed, as they are an infringement on property rights hardly ever used by democratic countries. Any restriction on capital flowing between the European mainland and the UK would effectively restrict EU savers and investors to the returns offered there. (Two democratic countries that resorted to such exceptional and temporary measures were Argentina in 2019, and Greece in 2015.) Without capital controls, CNY can still be freely deposited in the UK.
Brexit may take some business away from the UK but is unlikely to push it off the top spot. If on leaving the EU, the UK also quits the EEA – which seems likely – it will lose European banking passport rights that allow UK-based banks to sell financial services directly and actively to EU-based customers. The UK would then have to apply for separate licenses in each member country and find middlemen to work with.18But even without the banking passport, EU-based companies would still be able to buy interest-bearing products directly from UK banks by seeking them out. European companies that earn CNY from trade would therefore still be able to deposit those revenues in London.