Vital conduit for financial flows

Luxembourg to play key role in expanding Bank of China's overseas yuan business

Bank of China will draw on its strong connections in the Grand Duchy of Luxembourg to further expand yuan business in Europe, a top official of the bank's European operations says.

Zhou Lihong, general manager of Bank of China Luxembourg, says the bank is looking to create a wider customer base that will include customers from Europe and the rest of the world, for its yuan-related product offerings.

"Our operations will cover all kinds of yuan activities, including loans, trade finance, foreign exchange, clearing and settlement," Zhou says. "We want to have a good mix of customers, including Chinese and Western companies."

The bank established a branch in the grand duchy in 1979 and has since served many companies and individuals across Europe with both commercial banking and investment activities.

The bank recently took a major step in upgrading its European operations by becoming the first Chinese lender to issue a yuan bond in Luxembourg. The 1.5 billion yuan ($240 million, 170 million euros) bond, with a three-year tenure, was issued in Luxembourg on May 8.

The issue was about two times oversubscribed and will be listed on the Luxembourg Stock Exchange, making it the first Chinese bond to be listed in the euro zone.

The issue is being called Schengen bonds to symbolize its cross-border investor base, Zhou says. Schengen, the name of a small village on the border of Luxembourg, France and Germany, is synonymous with free travel within Europe on a single visa.

The bank's decision to list the bonds on the Luxembourg exchange also reflects the popularity of the Chinese currency in the Grand Duchy. By February, there were 44 yuan bonds listed on the Luxembourg Stock Exchange. In comparison, the London Stock Exchange had only four.

The Luxembourg Stock Exchange accounts for the third-largest number of offshore yuan bonds globally after Hong Kong and Singapore.

Robert Scharfe, CEO of the Luxembourg exchange, in a recent interview, said listing yuan bonds on the Luxembourg exchange would bring numerous benefits to the local economy.

In addition to the listing fees received by the stock exchange, Luxembourg's local law firms and banks also gain from such moves as they can provide services to bond issuers. Their proximity to and understanding of the investment in Luxembourg is also of great help to the bond issuers, Scharfe says.

Since most of the bond listings are structured using a special purpose vehicle for legal and tax reasons, many of these SPVs are based in Luxembourg. Clearstream, a clearing house based in Luxembourg, clears most of the bond transactions.

Zhou says Luxembourg's favorable investment climate has greatly helped the growth of Bank of China in the financial center, and was a part of the consideration for choosing Luxembourg as a base the bank's European headquarters.

"As our European operations expanded, we wanted to expand into other countries, initially in Benelux, and then more widely across Europe," Zhou says.

The bank opened a subsidiary in 1991, to prepare for the bank's expansion using the European Union's single-passport policy.

Different from a branch, which is the overseas operation of a Chinese bank, a subsidiary is a separate legal entity that can be regulated in the same way as local banks are, and can act as the European headquarters for managing other branches within the EU.

Five branches managed by Bank of China's Luxembourg subsidiary were established later, in Rotterdam, Brussels, Warsaw, Stockholm and Lisbon.

"Opening a subsidiary in Luxembourg allowed us to access some EU markets quickly," Zhou says.

The expansion also made Bank of China Luxembourg a regional headquarters. Together with its five European branches, staff numbers have grown to about 140, of which 80 are based in Luxembourg.

Around a third of the bank's Luxembourg employees are seconded from China, and the rest are local hires. Altogether, they represent 14 nationalities.

The bank's yuan bond in Luxembourg marks a step forward in the internationalization of the yuan, which began after the 2008 financial crisis when the Chinese government realized the danger of over-reliance on the US dollar.

Since then, international financial centers including New York, London, Frankfurt, Paris and Luxembourg have been keen on growing offshore yuan activities, including yuan trading, deposits, foreign exchange and bond issuance.

Figures from December show that Luxembourg has the largest pool of yuan in the eurozone with 64 billion yuan in deposits, 53.8 billion yuan in loans, 24.7 billion yuan in yuan bond listings and 256.4 billion yuan in renminbi-denominated assets held in investment funds. Yuan trade finance in Luxembourg last year was 86.8 billion yuan.

Luxembourg is the third city outside China in which Bank of China has chosen to issue an offshore yuan bond. In January it issued 2.5 billion yuan of bonds in London, and in February it issued 3 billion yuan of "Lion City" bonds in Singapore.

The fast expansion of Bank of China and other lenders in Luxembourg comes amid controversial talk of Chinese banks in London shifting their investment focus from London to Luxembourg in response to tightening regulatory pressures.

The issue first emerged in 2012 when a group of Chinese banks expressed frustration over regulatory matters in a letter the Association of Foreign Banks sent to Britain's Treasury.

Their main complaint concerned the British regulator's refusal to let them open branches, which would have lending and financing capacity proportional to the parent company's balance sheet.

Currently, Bank of China, the Industrial and Commercial Bank of China and China Construction Bank all have branches in Luxembourg. However, in London all Chinese banks only operate subsidiaries with the exception of Bank of China, which established its branch before the British regulators tightened the rules.

Subsidiaries, in contrast, are subject to strict capital requirements that apply to Britain's local banks, hence lending and financing capacity is proportional to the balance sheet of the subsidiary itself.

Zhou says she believes much of the discussion about Chinese banks shifting from London to Luxembourg is based on an incorrect understanding of Luxembourg's financial regulation as being relaxed.

"On the contrary, Luxembourg's regulators have extremely strict standards. As Luxembourg's own laws follow EU laws, there is no way Luxembourg regulators can be less strict than other EU countries."

"Where Luxembourg regulators have an advantage is their flexibility, efficiency and pragmatism. They are accessible and listen to our questions. I think it is a very open relationship. We are working toward the same goal."

The Luxembourg regulator, Commission de Surveillance du Secteur Financier, visits Zhou's offices more than once a year. It also checks financial and other statements produced by the five European branches managed by Bank of China Luxembourg, Zhou says.

In addition, the regulator regularly meets its Chinese counterpart, from China Banking Regulatory Commission, to discuss regulatory issues at the cross-country level.

As a Chinese bank operating in Luxembourg, Bank of China Luxembourg strives to maintain good communications with Luxembourg regulators at all levels of the bank group.

Zhou says her team will work hard to make Bank of China the bank of choice in Luxembourg for Chinese and Western customers.

"We are not the biggest Chinese bank but we want to be the best. As we are in Europe, we want to be a bridge between China and Europe, helping Chinese companies in Europe and European businesses in China."

cecily.liu@chinadaily.com.cn

(China Daily European Weekly 05/16/2014 page21)