Asia’s FX Landscape – Managing Complexity

An end-to-end approach for FX payments and risk management

by Sunil Bhatia, Head of Clearing and FX Products Asia Pacific, Global Transaction Services, Bank of America Merrill Lynch

Change is in the air. Across Asia Pacific, corporate treasurers are required to look at the bigger picture. They are monitoring the global economy more diligently. They are debating the implications of regulatory change more strategically. They are analysing currency volatility more stringently.

While treasurers are required to provide a more detailed view, this does not imply approaching foreign exchange (FX) management differently than in previous cycles. However, from where we stand, this shift is consistent with broader developments in the treasury space and emblematic of a deeper market transition that brings both added complexities and potential benefits.

Today, as companies seek new markets to expand their geographical coverage across the region, treasurers have to look beyond the traditional objectives of reducing cost and enhancing margins. To drive international business, treasurers are now expected to understand and manage complex changes, many of which are being driven at the onshore regulatory level. Developing an appropriate risk management strategy is now essential FX management.

For corporate treasurers, operating in Asia Pacific presents its own set of market-unique challenges. They come in the form of different currencies, regulations (onshore/offshore restrictions and requirements), physical management of operational cash flow, and supporting documentation for payments. For example, China’s introduction of structures like cash pooling is a good example of an onshore requirement which forces companies to strategically review their onshore FX management.

In addition to doing business internationally, changes in the global macroeconomic outlook, such as the growth of cross-border payments and considerable global currency volatility, are forcing Asia’s treasurers to adopt a holistic end-to-end approach to FX risk management. This approach encompasses reviewing and enhancing policies and processes, seeking new, more cost effective methods of settlements, adopting new and sometimes unfamiliar hedging strategies to manage FX exposures, and taking a more proactive approach to risk management when dealing with emerging global currencies such as China’s renminbi (RMB). Essentially, treasurers are looking at end-to-end solutions in two key components – transactional FX and strategic risk management. This is treasury transition in action.[[[PAGE]]]

Transactional FX

Transactional FX is at the centre of this transitioning process. This critical function refers to payments due to counterparties in a foreign currency. Transactional FX typically relates to vendor payments, which are often non-material in size from a financial risk perspective and can be operationally burdensome yet require flawless execution and timely delivery to the beneficiary. Removing any manual nature of processing for these transactions reduces operational risk. It frees up time to concentrate on other core competencies. It can help to improve the efficiency of working capital. Hence, the importance of understanding transactional FX for the transitional treasurer in Asia Pacific cannot be overstated.

Bank of America Merrill Lynch’s recently published Asia Pacific Treasury Management Barometer reinforces this need and the themes associated with transactional FX. Some of the key takeaways supporting the strategic importance of transactional FX include:

• 40% of companies are operating in 10 or more global markets
• 66% of treasurers are utilising some form of manual spreadsheet and process for their treasury management including FX payments
• 36% of treasurers in the region are moving towards electronic dealing and are using single bank platforms for their FX transactions
• 16% are using independent multi-bank portals

Several banks in the region now provide solutions based on online platforms to address these needs, streamlining processes for their clients by using the payment bank to undertake FX transactions. Such solutions tend to be operationally efficient and enable pre-agreed margins to be applied to payments. As a result, companies are able to achieve full transparency over the process itself and understand more clearly how rates are being applied.

These online platforms also open up avenues for cost reduction in the form of alternate settlement methods. For example, digital bank platforms allow treasurers improved access to the domestic Automated Clearing House (ACH) channels for final settlement to beneficiaries, where funding from an offshore foreign currency account can significantly reduce wire processing fees.

In addition, some companies, particularly those which engage frequently in eCommerce activities and high volumes of online trading, are looking for fixed rates to be applied over a period of longer than a day. They are taking this decision to better manage their positions and exposures more effectively. Banks with a sizable technology investment are taking advantage of this strategic treasury shift.

Bank account structure

Numerous companies are increasingly analysing their bank account structures and re-assessing the currencies in which they continue to maintain accounts. In some cases it may be necessary to hold an account in a particular currency and manage the related exposure. In other cases, it may be possible to manage exposures using an FX payments approach, whereby exposures are managed out of the US$ account or other major currency accounts. Funds can then be converted from the major currency into other currencies when a payment needs to be executed.

This approach avoids the need to maintain positions in all of the currencies in which the company operates, bringing several significant advantages. Most importantly, when the FX transaction is associated with the payment, the company is just dealing in the spot market, with rates fixed over the two days before the payment needs to be made. This scenario depends on the volumes the company deals with in a particular currency. In other words, if the flows are large the company may decide to manage exposures more actively. But if flows are not significant, the treasurer may find it preferable to have fewer currencies to consider so that the company just manages the relevant payments and receipts via the major currency account.

If, for example, the buyer is purchasing goods in RMB but does not maintain an onshore or offshore RMB account, it may be advantageous to manage the risk through an FX payments approach. Instead of keeping balances and maintaining positions in RMB, the company can make the payment out of its dominant currency.

Rise of the RMB

China’s currency is, of course, attracting widespread attention both across the region and on the international stage as an emerging payments currency. The RMB recently became the world’s fifth largest currency for payments. Research published by Bank of America Merrill Lynch found that 35% of the companies surveyed use RMB for cross-border trade, compared with 16% in 2013.

This leap has been driven by a growing number of companies choosing to invoice their overseas buyers in local currency, as well as by regulatory adjustments which have made invoicing in RMB a more attractive proposition. However, transacting in RMB is not all plain sailing, as companies are beginning to discover, and risks that didn’t exist previously are brewing as more flexibility comes to define this currency. For treasurers working with RMB, the recent events have served, and will continue to serve, as a timely reminder that the currency can move both ways, underlining the importance of having a strategy in place to manage the relevant exposures.[[[PAGE]]]

In our view, treasurers operating in the complex markets of Asia Pacific are developing an increasingly strategic skill set as the role of the treasurer evolves. Where FX payments and FX risks are concerned, this is leading to a greater focus on both micro and macro factors as well as on technological change and regulatory developments in individual countries. As they take on a more strategic role, treasurers also need to consider how particular approaches, such as a differentiated process for transactional FX payments or a change in the company’s bank account structure, can bring greater efficiency.

Against this backdrop, it is more important than ever for treasurers to build relationships with global banks which can support their needs with sophisticated platforms, expertise and advisory services. By taking advantage of these attributes, treasurers can navigate the changing market more successfully while enhancing their own standing within the organisation. With the treasurer’s role in a state of transition, treasurers need to leverage all the tools and resources available to them in order to take a more strategic approach to FX.