Opening of won clearance centers will help to boost bilateral trade between Beijing and Seoul and cut foreign exchange costs by bypassing dollar

South Korea is playing an increasingly active role in the internationalization of the yuan. From June, the country's central bank will operate two new won-yuan clearance centers in Shanghai to make direct trades between the two currencies possible in the city.

A NOTE-COUNTING MACHINE tallies up yuan notes in a bank in Shanghai. The South Korean central bank has opened two won-yuan clearance centers in Shanghai, which will boost the use of the yuan by traders. AFP

"South Korea becoming the hub for renminbi trading should be not only possible, but also highly feasible," said Vishnu Varathan, senior economist and head of the Asia and Oceania treasury department at Mizuho Bank, a Japanese bank.

"Increasingly, as more Korean exporters and importers continue to use the currency, there will be a demand for that currency onshore.

"This isn't speculative, it's a real need."

The Shanghai branches of KEB Hana Bank and Woori Bank were selected as the clearing houses for the won-yuan trading market in the city.

Two other major South Korean lenders, Shinhan Bank and KB Kookmin Bank, also applied to become clearing centers but did not make the cut.

In December, South Korea launched its first yuan-denominated sovereign bond in China. It was South Korea's first issue of a bond outside the country that was not denominated in dollars or euros.

Speaking to China Daily Asia Weekly, Chung Jin Woo, senior manager of the Korea Trade-Investment Promotion Agency (KOTRA), said: "The won-yuan direct trading market and the improved transaction environment are facilitating the use of the yuan in trading activities."

South Korea's push to become an offshore yuan hub dates back to 2012 and is gaining traction, partly thanks to the China-South Korea Free Trade Agreement, which was launched in December.

This deal and the close trade links between the two countries make the setting up of clearing centers in China a natural step. China is South Korea's biggest trading partner and South Korea is China's sixth largest trading partner.

A yuan clearing center was established in Seoul in June 2014, a busy month for the internationalization of the yuan. Seoul became the third city in less than three weeks to be assigned such a center after London and Frankfurt.

The won-yuan direct trading market opened in December 2014 through the Seoul branch of China's Bank of Communications, the fifth biggest lender in China.

The growth of yuan-won clearing services could have a direct impact on trade by reducing transaction costs for companies involved in trade or investment with China.

Bypassing the use of a cross rate with the dollar — trading from won to the dollar and into the yuan — and making it possible to trade directly between the two currencies helped cut foreign exchange costs and boost bilateral investment.

In addition to establishing a clearing center, South Korean investors were also granted a large quota under China's Qualified Foreign Institutional Investor program of $12.9 billion for them to invest in Chinese stocks and bonds.

Quotas are being phased out, but the granting of the quota was aimed at boosting South Korean foreign direct investment in the country.

And the efforts worked. Adoption of the yuan in South Korea has jumped, particularly to make trade payments.

Just last year, the total value of South Korea's yuan-denominated payments in both the Chinese mainland and Hong Kong jumped 173 percent year-on-year, showing the steepest increase of any country, according a report by the Society for Worldwide Interbank Financial Telecommunication (SWIFT).

The growth of South Korea's yuan payments has been driven by customer payments. And because the increase in yuan payments can be used as a good proxy for the growth of trade settlements, it suggests trade is on the rise.

The SWIFT report noted that next to Singapore, South Korea has shown the greatest increase in yuan payments with the Chinese mainland and Hong Kong compared to last year.

By September 2015, South Koreans were using the yuan in 84 percent of cross-border payments with the mainland and Hong Kong.

And the private sector has also been quick to adopt the yuan. In February 2015, for example, South Korea's technology giant Samsung started buying and selling yuan against the won from the local market in Seoul.

But despite the relatively rapid adoption of the yuan and the South Korean government's encouragement to do so, there is still room for growth when it comes to settling trade using the Chinese currency.

Total trade between the two countries is much larger than the total of cross-border payments made in yuan.

"The actual transaction (total) in yuan denomination is very low," said Varathan of Mizuho Bank. "A lot of exporters and importers, they want the currency used … to be able to exchange for something else. As such, the US dollar is dominant in that area."

The dollar is used in 93 percent of total trade transactions between South Korea and China, while the yuan and the won make up 3 percent and 2 percent, respectively, as of last September.

"For the use of yuan as the trade currency between Korea and China to catch up and reach the levels of trade, it's still a work in progress," said Varathan.

"We can agree early on that the complete alignment of trade concentration is not going to happen. The further adoption of renminbi-denominated trade is taking place, but nowhere (is it) going to correspond between the sheer volume of bilateral trade between Korea and China."

South Korea's Ministry of Finance and the central bank expect the South Korea-China currency trading volume to continue expanding when the direct trading market is established in China. So far, there has been a small uptick.

Chung of KOTRA said: "We assume that over 80 percent of trading is done in dollars, not renminbi. But we do see that there is an increasing amount of trading transactions done in yuan.

"Companies prefer the US dollar because paying commissions in US dollars is easier. There are still many inconveniences when paying in renminbi."

Despite the yuan's recent inclusion in the International Monetary Fund's special drawing rights (SDR) basket — a group of international reserve assets — the internationalization of the currency still has a long way to go.

Varathan said: "The yuan's inclusion in the SDR basket it still to some degree symbolic. For global central banks to accumulate reserves, the commercial reality is that they look at the volatility and the liquidity of the currency. The yuan is volatile in some sense."

China has been making efforts to promote the yuan as an alternative to the US dollar as a global trade and reserve currency but one hurdle is the country's financial architecture, which is being reformed.

"The internationalization process at some point will slow down. The initial gains will be easy but to gain prevlance as a currency, to gain dominace, it will take a much longer time," said Varathan.