China Puts “Mr. Chen” Out Of Business

Capital flight from China is a hot topic these days.

Indeed, this week’s overnight news feed was dominated by headlines out of China and Hong Kong, where money market rates (e.g. various tenors of HIBOR, depo rates, etc.) soared following reports that Beijing is set to implement a new set of measures designed to stanch the outbound flow.

The market seemed to think that the new rules would somehow affect residents’ conversion quotas. While increased scrutiny will undoubtedly help to discourage shenanigans (you’ll forgive the colloquialism), Deutsche Bank notes that the main target of the new regulations may be China’s infamous “Mr. Chens,” who WSJ profiled in October, 2015.

Essentially, underground banks masquerading as innocuous shops and vendors allow Chinese citizens to skirt the $50,000 yearly quota on money that can be sent out of the country. Here’s how the Journal explained the illicit process:

Give the underground bank a sum, and a matching sum appears in Hong Kong, minus a cut of anywhere between 0.3% and 3%. No money physically or electronically crosses the border; the match is built on networks on both sides controlled by the underground bank.

Well it looks like Beijing is about to put “Chen” out of business. Here’s a bit of color and a great diagram out early this morning from Deutsche Bank:

The Dec-31 Decree could potentially pose a severe hit to “capital flight without cross-border fund flows”. Figure 2 shows an illustrative example. Previously, domestic residents who cannot directly convert and transfer their RMB assets abroad could do so via an underground bank: The underground bank “intercepts” FX inflows and transfers them to domestic residents offshore. Meanwhile, it would receive RMB payments from domestic residents onshore and transfer the fund to the exporter who sold FX to it offshore. Under the new decree, these onshore RMB transfers would easily show up on the regulators’ radar. This week, USDCNH showed unusual strengthening for two consecutive days, from 6.9588 (Jan 3 closing) to 6.7886 at the close of Jan 5. While some suspected this was due to liquidity tightening by the PBoC (sudden decline in offshore RMB supply), open USD position adjustment by offshore underground banks (sudden increase in offshore RMB demand) could be another factor behind the volatility.