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Direct Yen-Yuan Trading to Launch 1 June

Japan and China will start direct trading between the yen and the yuan on the interbank foreign exchange markets in Tokyo and Shanghai tomorrow (1 June), following an agreement made in late 2011.

Japan and China currently use the US dollar as the intermediary settlement currency of choice. The yen-yuan direct exchange system is expected to help promote trade between Asia’s two biggest economies.

The decision follows an agreement put in place in December 2011 by leaders of the countries  to mutually promote direct trading between the two currencies. The decision was reinforced three months ago when Japan purchased Chinese government bonds for its reserves, indicating that a shift away from a reliance on the dollar could be imminent.

Participating banks will trade the yen and the yuan at an exchange rate calculated on the basis of actual supply and demand, as well as other conditions. There will be no limit to the fluctuation range in the Tokyo market.

In Japan, the Bank of Tokyo Mitsubishi, Sumitomo Mitsui Banking, Mizuho Corporate Bank and Mizuho Bank will join the direct exchange system.

In Shanghai, the China Foreign Exchange Trade System, which handles FX trading in China, will announce every morning a mid-point rate, which is the average of yen-yuan exchange rates used by several designated banks. Unlike the Tokyo market, daily fluctuations will be limited to 3% above or below the mid-point rate.

HBSC was yesterday approved as a market maker for direct trading between the yen and yuan by the Chinese central bank. According to a Dow Jones Newswires report, citing two people familiar with the situation, the People’s Bank of China has invited 19 banks to make the market onshore for direct trading in the two currencies.

Japanese finance minister, Jun Azumi, told Reuters, “By conducting transactions without using the third country’s currency, it will bring merits of reducing transaction costs and lowering risks involved in settlements at financial institutions. That will contribute to improving convenience of both countries’ currencies and reinvigorate the Tokyo market.”

Michael Derks, chief strategist at FXPro, says: “Beijing’s determination to internationalise the renminbi was in evidence again overnight following the PBOC’s announcement that it had authorised direct trading between the yuan and the Japanese yen from this Friday. Policy officials recognise that the capital account must be opened up in order to increase the renminbi’s acceptance as a major international currency.

“This latest move follows last month’s decision to widen the daily trading band for the yuan, and to raise the quotas for global funds investing directly into Chinese securities from $30 billion to $80 billion. Direct yuan-yen trading will reduce the costs of currency transactions between the two countries and further reduce the dependence on the dollar, which has been a long-term aim for Chinese policy-makers. It should also facilitate improved trading and investment opportunities between the two economies. Trade between the world’s second and third largest economies is huge, totalling $350 billion in 2011.”

Derks says London and Singapore will certainly take notice of the plans. “These centres have been urging China to allow yuan trading out of their respective financial centres, so the fact that Tokyo has essentially been selected represents a comparative advantage in terms of attracting business from those seeking to trade directly in the yuan/yen cross.”

Some currency strategists, however, have played down the impact of the move. “First of all, the numbers will not be that large…This is a part of the liberalisation process that China is trying to work toward at this stage. It also helps China to diversify some of its exchange rate exposure,” says Geoff Yu, G10 FX strategist at UBS.

"This news may have an effect on margins but we need to bring back into context what it will entail, i.e. who is going to trade this. The problem here is that most Chinese and Japanese exporters settle in dollars. This is something that both governments have been trying to get their companies to change for many years, but with great difficulty.”

Yu continues, “Volumes may rise over the next few weeks or months and this is a step in the right direction. I would expect China to promote this globally over the coming years, starting with Japan then moving toward the Korean won and then onto the rest of south east Asia because that’s where the bulk of trading will be conducted.

“There is a lot of potential but both sides need to start avoiding settling in dollars and start using their own currencies or using non-dollar FX, and that is proving difficult in the Japanese market,” he says.

On whether this agreement will have much of an effect on global markets, Yu says, “In the short term, not really, and in the longer term, it will depend on volumes; there may be a difference, but I am not expecting anything drastic. If China wants the CNY to become a reserve currency then it has to be traded across the board; you have to allow access to it. But again, this is a longer term plan, rather than something we would see soon.”

Ilya Spivak, currency strategist at DailyFX, the research arm of FXCM, says that the system announcement was no surprise to the markets.

“The move does not materially impact near-term trends prevailing across financial markets at large and in the FX space in particular. On balance, this means its immediate effect on price action is unlikely to prove significant. Longer term, the arrangement fits into China’s overall strategic push toward renminbi internationalisation, an initiative that reflects Beijing’s desire to transition from an economy reliant overwhelmingly on exports to one driven by domestic consumption.”

Spivak concludes, “In the coming years, the emergence of a healthy JPY/CNY market is likely to prove mutually beneficial, stoking economic activity and growth. If it leads to a future relaxation of capital controls on investment flows, it will also help mitigate the destabilising effects of China’s savings glut while opening Chinese markets to Japanese investors.

“While that may to some extent disrupt the long-term relationship between the yen and US Treasury yields – a link primarily shaped by US/Japan trade flows – such an outcome is unlikely to threaten the greenback’s status as the benchmark international medium of exchange. To put the situation in context, yearly bilateral trade between China and Japan amounted to $358 billion in 2011. That amounts to just 21% of daily US dollar turnover in the FX markets.”

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