Guy Debelle: Developments in global FX markets and challenges in
currency internationalisation from an Australian perspective
Speech by Mr Guy Debelle, Assistant Governor (Financial Markets) of the Reserve Bank of
Australia, at the RMB FX Forum (appearance via video link), Beijing, 18 May 2016.
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Thanks to David Halperin and Eden Hatzvi for their help in compiling these remarks.
I am very pleased to have the opportunity to speak at this event today. Australia takes a keen
interest in the ongoing process of internationalisation and liberalisation of the renminbi
(RMB). I am sure you will hear many interesting perspectives on that subject today.
I would like to talk about three things. First, I will talk a little about the use of the RMB in
Australia. Second, I will talk about the RMB's increasing role in the global economy and
relate that to the work I am leading on the Global Code of Conduct for the Foreign Exchange
Market. Finally, I will provide an Australian perspective on currency internationalisation and
capital account liberalisation, reflecting on the challenges that emerged as Australia went
through this process in the late 1970s/early1980s.1
Turning to the use of the RMB in Australia. First, from the RBA's own point of view, we have
invested a portion of our foreign exchange reserves in RMB since 2013. This has allowed us
to get direct insight into the way the FX and bond markets function in China, and has also
allowed us to experience first-hand the benefits of the ongoing liberalisation that has
occurred in recent years. In June 2015, the People's Bank of China (PBC) reported that
foreign central banks and monetary authorities held over RMB650 billion in RMB
denominated assets and that has almost certainly grown larger today. The RBA and PBC
also established a bilateral currency swap in 2012 for RMB200 billion that was renewed last
year. The swap line highlights and supports the growing financial linkages between the two
economies as well as trade and investment.
To help further remove possible impediments to the use of RMB in Australia, an official RMB
clearing bank began operation in Sydney in February 2015. In addition, Australia was
granted an RMB50 billion RQFII quota for portfolio investments. Finally, for a number of
years now, the Australian dollar has been directly traded against the RMB in the onshore FX
market.
This has allowed for the growing use of RMB in Australia. That said, the use of RMB remains
noticeably less than the value of trade between China and Australia. In the RBA's
conversations with Australian businesses that trade with China, one repeated concern raised
that inhibits greater use of the RMB is the limited scope to hedge. In that regard, it is pleasing
to see that RMB hedging instruments and markets are growing rapidly.
The ability to hedge was a very important development in the internationalisation of the
Australian dollar. I will come back to this later on in my talk.
I will now talk about the increasing growth of RMB turnover in the foreign exchange (FX)
market and relate to that the work on the Global Code of Conduct.
One of the most noteworthy developments in the 2013 Triennial survey of FX turnover,
compiled by the Markets Committee that I chair at the BIS, was the rapid growth of RMB
turnover since the 2010 survey. In particular, RMB turnover increased from US$34 billion per
day in 2010 to US$120 billion per day in 2013.2 The data for the 2016 Triennial FX turnover
survey is in the process of being compiled now, based on a comprehensive survey of the FX
market in April. I would presume that the 2016 survey is likely to show similarly rapid growth
in RMB turnover over the past three years. In particular, turnover is likely to be bolstered by
measures taken by the PBC to increase trade settlement and investment in RMB, as well as
the various exchange rate initiatives that the PBC has taken since 2013. This includes
increasing the flexibility of the RMB against the US dollar, with the trading band being
widened to ±2 per cent from early 2014 and, more recently, the adjustment last August to the
methodology for calculating the daily RMB fixing rate to make it more market-determined.
The 2016 Triennial FX turnover survey will likely confirm that the RMB is solidly in the top
10 currencies in terms of turnover, and may indeed be closing in on the Australian dollar,
which is in fifth place in terms of turnover. Along with the RMB's recent inclusion in the SDR,
this confirms the RMB's status as a global currency. With that prominence, comes an
expectation that the functioning of the market will evolve towards the standards of behaviour
and operation of the global FX market.
In that regard, some of you may be aware that a Global Code of Conduct for the FX market
is being developed. I will now summarise that work for you and its potential relevance for the
FX market in China.
Why is the Global Code being developed? As you are probably aware, the various scandals
and evidence of inappropriate behaviour in the global FX market that have come to light over
recent years have seen an erosion of trust in the FX industry, which is impeding its
functioning. This lack of trust is evident both between participants in the market, but at least
as importantly, between the public and the market. The global FX market needs to move
toward a more favourable and desirable location, and allow participants to have much
greater confidence that the market is functioning appropriately.
A well-functioning foreign exchange market is very much in the interest of all market
participants. This clearly includes central banks, both in their own role as market participants
but also as the exchange rate is an important channel of monetary policy transmission. In a
globalised world, the foreign exchange market is one of the most vital parts of the financial
plumbing.
The Global Code aims to set out global principles of good practice in the foreign exchange
market to provide a common set of guidance to the market, including in areas where there is
a degree of uncertainty about what sort of practices are acceptable, and what are not. This
should help to address the lack of trust as well as promote the effective functioning of the
wholesale FX market.
To that end, one of the guiding principles underpinning the work on the Code is that it should
promote a robust, fair, liquid, open, and transparent market. A diverse set of buyers and
sellers, supported by resilient infrastructure, should be able to confidently and effectively
transact at competitive prices that reflect available market information and in a manner that
conforms to acceptable standards of behaviour. I am confident that a similar set of principles
are guiding the reforms to the FX market in China.
The work to develop the Global Code commenced in May last year, when the Bank for
International Settlements (BIS) Governors commissioned a working group of the Markets
Committee of the BIS to facilitate the establishment of a single Global Code of Conduct for
the wholesale FX market and to come up with mechanisms to promote greater adherence to
the Code3.
I am chairing this work, with Simon Potter of the Federal Reserve Bank of New York leading
the work on developing the Code and Chris Salmon of the Bank of England leading the
adherence work. Our working group comprises representatives of the central banks of all the
major FX centres, including China, drawing on the membership of the Markets Committee
which is comprised of heads of the market operations areas of the 15 major currency areas.4
Given our roles, we are all very much interested in the effective functioning of the FX market.
Again, it is very much a global effort reflecting the global nature of the foreign exchange
market.
This work is also very much a public sector-private sector partnership. In that regard, we are
being ably and vigorously supported in this work by a group of market participants, chaired
by David Puth, CEO of our conference host CLS. The group contains people from all around
the world, including China, on both the buy side, including corporates and asset managers,
and the sell side, along with trading platforms, ECNs and non-bank participants. Hence all
parts of the market are involved in the drafting of the Code to make sure all perspectives are
heard and appropriately reflected.
At the outset we decided to split the topics we intend to cover in the Code into two parts. The
first phase covers areas such as ethics, information sharing, execution (including mark-up)
and confirmation and settlement. The second phase will cover topics such as governance,
risk management and compliance, as well as further aspects of execution including e-trading
and platforms (including last look), prime brokerage, and the unique features of FX swap,
forward, and option transactions.
The first phase of the Code has been completed and is set to be released next week on
26 May in New York following the meeting of the Global Foreign Exchange Committees. I
would hope that you, as participants in the FX market in China, find the Code useful,
readable and relevant to the functioning of the market here.
Work on the second phase of the Code is already underway. Our intention is that the
complete Code will be released following the Global Foreign Exchange Committees meeting
in London in May 2017. At the end of that process, for the Code to be effective and for it to
achieve what we want it to achieve, it will need to be accepted and endorsed by market
participants. While the Code is a voluntary code, to ensure greater adherence to the Code,
we will also be outlining some steps we are taking in that regard next week in New York and
will have a fuller suite of adherence mechanisms in London next year.
Finally, let me turn to discussing some of the challenges that Australia faced as the
Australian dollar became an internationalised currency.
The Australian dollar was floated in 1983, as large net capital inflows (in part resulting from
the relaxation of capital controls in the 1970s) made it difficult to control both the exchange
rate and domestic monetary conditions. At the same time, most of the remaining capital
controls were removed as these were only seen as a tool for maintaining the fixed exchange
rate, and hence were no longer necessary.
In the decade prior to moving to a freely floating currency in 1983, Australia had been
through almost all other forms of exchange rate regimes: a peg to the US dollar (as part of
the Bretton Woods exchange rate regime); a peg to a trade-weighted basket; and an
adjustable peg, where the frequency of adjustment increased substantially up until the time
of the float.
Both capital inflows and outflows increased substantially following the float in 1983
(Graph 1). The benefits of the floating exchange rate in assisting the Australian economy to
respond to shocks are documented extensively elsewhere, as are the benefits in allowing
greater independence of domestic monetary policy settings.5 One clear demonstration of this
is in the reduced volatility of domestic interest rates and the increased volatility of the
Australian dollar (Graph 2). But the increased volatility of the Australian dollar is generally
regarded as a positive development (as a mechanism of adjusting to shocks) and not a
threat.
Graph 1
Graph 2
The increase in gross capital flows encouraged the development of domestic FX and
hedging markets, to the point where, as I mentioned earlier, the Australian dollar is now one
of the world's most traded currencies, including a large swaps market. Australian corporates
(particularly financial institutions) regularly issue debt in foreign currency, which is then
swapped into Australian dollars. An active 'kangaroo' market (Australian dollar-denominated
bonds issued by non-residents) provides natural counterparties to these swaps.
Deep hedging markets allow Australian firms to hedge foreign currency risk relatively
cheaply. This is important because Australia's history of current account deficits means that it
has accumulated a fairly large net foreign liability position. In the absence of hedging, this
could be problematic were the Australian dollar to depreciate significantly. But after taking
hedging into account, Australia has a positive net foreign currency asset position.6 The
existence of deep hedging markets further ensures that the benefits of a flexible exchange
rate policy outweigh the costs.
However, this process was not smooth. In the 1980s and early 1990s Australia experienced
two painful episodes, one relating to residents undertaking unhedged foreign currency
borrowing and the other to lax lending standards that, following the opening up of the
banking sector to foreign entrants, led to a boom and bust in commercial property prices.
Both these episodes contributed to better risk management practices for banks and
regulators, including greater demand for hedging products, contributing to their development
and a deeper financial market.
Australia's experience with the internationalisation of its currency is not the only possible
path. But the path of Australia and other countries that have pursued financial reform and
capital account liberalisation at the same time, nearly all of whom then experienced episodes
of financial instability, suggests that it can be beneficial to establish a strong prudential
supervision framework before the financial sector and capital account are fully liberalised.
This mitigates subsequent risks to financial stability. In light of this history, and given the
importance of China to the global economy, China's authorities have good reason to
continue pursuing a cautious and gradual program of financial reform.
Conclusion
Let me conclude. Australia has a deep interest in following the ongoing liberalisation of
China's financial markets and internationalisation of the RMB, given the strong linkages
between the two economies. We welcome the steps that have been taken that have already
significantly increased the role of the RMB in global financial markets. As the FX market in
China becomes increasingly integrated into the global FX market, I would hope that the
Global Code of Conduct for the FX market that is to be released (in part) next week can
serve as a useful benchmark for the functioning of the FX market in China as much as we
intend it to be for the global FX market.