On March 12, 2009, the People’s Bank of China (PBC), China’s central bank, announced the establishment of a foreign exchange payment arrangement between mainland China and Hong Kong (the Payment Arrangement). Starting on March 16, 2009, the foreign currencies that may be settled under the Payment Arrangement include Hong Kong dollars, U.S. dollars, Euros, and British pounds. Banking experts have commented that in practice, the Payment Arrangement connects the foreign currency payment clearance system in the mainland with the one in Hong Kong, which will make it easier for funds to flow between banks in the mainland and in Hong Kong, because it allows them to settle the payments through connected networks.  

The Payment Arrangement was established in accordance with the Memorandum of Foreign Exchange Payment Arrangement between Mainland China and Hong Kong  which PBC and the Hong Kong Monetary Authority (HKMA) entered into earlier. PBC will determine in the future whether to expand this program to other foreign currencies based on the market’s demand.  

Before the establishment of the Payment Arrangement, when conducting a cross-border foreign exchange payment, a domestic bank in China would open a foreign exchange account with an agent bank outside of China, and the domestic bank would instruct the agent bank to complete a payment to a designated account after the domestic bank receives its clients’ payment order. In the past, most agent banks outside of China that the domestic banks worked with were foreign banks. This was not due to regulatory barriers, but instead was a result of the Chinese banks’ weaknesses in their networks, pricing, and sizes.  

The Payment Arrangement, however, has designated the banks that may act as agents to handle cross-border foreign currency payment settlements. In the mainland, the designated agent banks are the China Construction Bank (CCB), Bank of China (BOC), the Industrial and Commercial Bank of China (ICBC), and the Shanghai Pudong Development Bank (SPDB) for Hong Kong dollars, U.S. dollars, Euros, and British pounds, respectively. The agent banks in Hong Kong for these four currencies are the Hong Kong Branch of CCB, BOC (Hong Kong), ICBC (Asia), and Citibank (Hong Kong), respectively.  

Industry observers have pointed out thatChina’s central bank has designated three Chinese banks in Hong Kong to act as agent banks mainly because of financial security concerns. Given the impact of the global credit crunch, foreign banks are faced with insolvency threats from time to time; thus, leaving the funds of Chinese banks vulnerable to risks if they heavily rely on offshore agent banks’ settlement services.  

The Payment Arrangement differentiates between the British pounds, and Hong Kong dollars, U.S. dollars and Euros in the procedures of their payment clearances. For the latter three currencies, the mainland bank making a payment will forward its clients’ payment orders to the designated agent banks in the mainland, namely CCB, BOC, and ICBC. CCB, BOC, and ICBC will then transmit the orders to their respective Hong Kong branches through their internal networks, and their Hong Kong branches will forward the payment orders to the receiving banks in Hong Kong through the real-time payment system in Hong Kong. In other words, for these three foreign currencies, the payment clearance system in the mainland is, in essence, directly connected to its counterpart in Hong Kong.  

For British pounds, however, since SPDB is the designated agent bank in the mainland, and Citibank is the designated agent bank in Hong Kong, banks making payments in the mainland will transmit the payment orders to SPDB, which will then transfer the orders to the receiving banks in Hong Kong through Citibank. In other words, under the current Payment Arrangement, China’s domestic payment clearance system for British pounds is directly connected with Citibank’s payment network, as opposed to the real-time payment clearance system in Hong Kong.  

PBC and HKMA have declared that the Payment Arrangement will increase the effectiveness and decrease the risks and costs of cross-border foreign exchange payments between Mainland China and Hong Kong. Therefore, the financial connection between both sides will become closer and tighter. It should be noted, however, that this Payment Arrangement is only a technical measure to streamline the clearance process of those four foreign currencies, and it does not concern Renminbi, the Chinese currency that may not be entirely freely exchanged.