China: Realising or Inhibiting Potential

by Helen Sanders, Editor

Ensuring the safety, integrity and genuineness of products will continue to pose a major challenge for the Chinese government.

This month I visited China for the first time in eight or nine months. My visit was just after Golden Week, when the country shuts down for nearly a week’s holiday. And what do people do during this week? They shop. Even a few months on from my last visit, the changes in the major cities are very noticeable. The number of sleek new malls, sporting only the top designer brands, is growing rapidly, and the appetite for French brands in particular seems unquenchable. The roads are ever more crowded with shiny vehicles, each passing a new skyscraper every couple of weeks in Shanghai alone.

The genuine article?

Despite the significant growth and opportunity, there remain significant challenges in China. Lack of confidence in the genuineness and integrity of goods continues to encourage those consumers who are able to go to Hong Kong for their purchases. Indeed, over a million extra Chinese visitors filled the Hong Kong malls over the weekend of Golden Week. After numerous scandals and contaminations, from baby milk and pharmaceuticals, to toilet paper and noodles, this lack of confidence is also becoming increasingly apparent amongst the business community. After all, a company may have no involvement at all in fake production of its goods, but the damage to its brand could be considerable should a scandal emerge. Consequently, ensuring the safety, integrity and genuineness of products will continue to pose a major challenge for the Chinese government, to increase confidence and encourage investment within the country.

Addressing inequalities

There are other challenges too. The story of the coastal cities is not yet the same as that of the inland provinces, and indeed parts of the major eastern cities, where prosperity, urbanisation and electrification have yet to have a major effect. To address this, the need for government action, investment, and natural resources to create the necessary infrastructure and service the growing demands of a newly prosperous population, is formidable. As Lisa Robins, Head of Treasury & Securities Services, China, J.P. Morgan summarises, 

"Within China, we see a tremendous focus on expanding the domestic consumer base and reducing the gap between the coastal cities and the inland areas in the west of the country, both in terms of infrastructure and the economy. Looking outside of the country, there is a significant focus on Chinese foreign direct investment (FDI) particularly to satisfy China’s needs for natural resources.”

Bearing in mind the sheer scale and diversity in China, foreign companies seeking to establish, consolidate or expand their presence in the country need to establish different strategic approaches to the emerging and emerged economies within China. This potentially impacts not only sales and distribution, but also production, as inland regions become more attractive for sourcing than the more expensive coastal regions. Furthermore, North American and European corporations will need to address competition not only from growing Chinese companies within the country, but also beyond as companies in all industries, including banking, look to expand their activities overseas. As Sam Xu, Senior Product Manager, J.P. Morgan Treasury Services explains,

“In addition to FDI by corporations, the largest Chinese banks are also establishing an overseas presence in both developed and emerging countries to satisfy the growing international needs of their Chinese corporate client base. As both corporations and banks seek to expand overseas, M&A offers a convenient and quick way of achieving this.”

Consequently, whilst on one hand the population in China is becoming increasingly accustomed to western brands, consumers in established markets are also likely to become more exposed to Chinese brands, and familiar brands will become Chinese-owned.[[[PAGE]]]

The growth of RMB trade

So in an environment of both opportunity and challenge, how are these trends being demonstrated in treasury and cash management? One of the most important initiatives for cross-border trade in recent years, both for Chinese companies and their foreign trading partners, is the RMB cross-border trade settlement scheme (see TMI edition 182, February 2010) which has expanded significantly since the last time it was discussed in TMI (see box 1). Most significantly, companies in all regions are now entitled to conduct cross-border trade in RMB, subject to the relevant authorities. As Tan Kah Chye, Standard Chartered, comments,

“A year ago, we would not have expected to see such a strong pick-up rate in RMB trade settlement. Hong Kong is the most active market for RMB, but perhaps more surprisingly, Switzerland ranks second, reflecting the strength of its commodity business and the opportunity for arbitrage.”

He continues,

“While many of the early transactions in RMB were intercompany, we now see significant two-way trade between unrelated counterparties.”

The ability to settle trade in RMB is a major step forward for both Chinese and foreign companies alike and is one factor that will drive the continued development of the RMB as an international currency. Lisa Robins, J.P.Morgan urges caution, however,

“While the government has now allowed the RMB to replace the USD or EUR for cross-border trade, other restrictions, such as liquidity and documentation, remain unchanged. The RMB will undoubtedly become an international currency in its full sense, but this is not yet the case. However, developments in the inter-bank bond market mean that banks now have greater opportunity to invest in RMB, and overseas banks can now invest in RMB assets, which will benefit international corporates holding RMB.”

The investment potential that Lisa describes is significant for corporates seeking to leverage their financial assets in China, so this cash works for them as opposed to simply being considered ‘trapped’ cash, as is often the case. Furthermore, as Tan Kah Chye, Standard Chartered, explains, the ability to obtain financing in RMB is also significant, 

“With corporations such as McDonalds now issuing bonds in RMB, there are increasing incentives to also sell and retain liquidity in RMB.”

There is massive speculation about how the RMB will continue to grow as an international currency, and as it does so, how China will further consolidate its position on the world stage. There are signs that China is becoming more aggressive in promoting its currency and trading links, not least through its strengthening trading partnerships in other parts of Asia, Latin America and Africa, such as sourcing natural resources. In addition, as Tan Kah Chye, Standard Chartered describes,

“In some cases, Chinese entities are starting to insist on RMB, such as providing a portion of African aid in RMB so that countries are obliged to buy from China.”

Despite the heightening ‘currency wars’, Tan Kah Chye emphasises that speculation about how the RMB will develop, however, is largely irrelevant,

“In some respects, it makes little difference whether the growth of RMB proceeds steadily or exponentially, as either way, it is an increasingly meaningful currency and is becoming a reserve currency of a sort for corporations - a trend that we expect to see continue. After all, Asian companies in particular are more exposed to China than any other country, so holding RMB makes sense, particularly as the RMB continues to appreciate.”

Although the RMB cross-border trade settlement scheme presents opportunities for companies doing business in China, and the ability to lend across entities has been somewhat increased through the use of multilateral entrust loan arrangements, the challenges for foreign multinationals doing business in China remain formidable. As Lisa Robins, J.P. Morgan outlines,

“With the range of investment opportunities remaining reasonably narrow, there are ample opportunities for the development of new channels, which will ultimately allow clients to invest, lend and centralise their cash operations in China. Hedging risk also remains a key challenge, with non-deliverable forwards (NDFs) currently not available. A further challenge revolves around establishing visibility over accounts which involve many entities, and this is an area in which J.P. Morgan can offer solutions.”

Lisa continues,

“We focus on three key areas with our clients in China. Firstly, by leveraging our global platforms with our ability to provide real-time access to information, we can help to enhance the visibility of cash and improve the efficiency of financial processes. Secondly, we help clients mitigate their financial risks. Thirdly, we value client partnerships. For example, with J.P. Morgan processing 28% of world’s USD clearing market, we are now established as a leading correspondent bank for Chinese financial institutions while working in close partnership to provide services to our corporate clients.”[[[PAGE]]]

Aligning treasurers’ experiences

The challenges are not restricted to foreign multinationals. After all, as Chinese companies seek to expand their activities into new regions, issues such as cash and working capital, cross-border liquidity, as well as FX, and overseas borrowing and investment become more significant. In some cases, this requires a new breadth of skills and technology solutions as well as banking services. As Lisa Robins, J.P. Morgan explains,

“As the Chinese economy has moved from an entirely state-owned economy to one that now also promotes private enterprise, there is a greater focus on managing cash flow, working capital and liquidity. While the individual elements of payments and collections, among others, have always been important, they have not necessarily been considered on a holistic basis. Recognition of the value of cash management is growing quickly, as are in-house skills to deliver on cash management objectives, and banks such as J.P. Morgan are also playing an important role by delivering training and education on industry best practices.”

Like their peers in other regions, these companies are also seeking to establish additional treasury centres outside China, as Lisa continues,

“Chinese companies are also starting to establish treasury centres in other parts of Asia and beyond, both on a centralised or decentralised basis, a trend which we expect to see growing strongly in the future.”

Although in its early stages, this is likely to become an important trend to which we will revert in a future edition of TMI.

Solving whose problems?

The needs, aspirations and capabilities of Chinese and foreign multinationals are therefore becoming more closely aligned, and looking ahead, dealing with issues such as constrained liquidity and credit risk will feature highly on every treasurer’s list of priorities, wherever their company is headquartered. As we move towards Basel III and other regulatory requirements, however, there seems to be a belief that the greatest impact will be on western banks and their corporate clients. This is not the case, as although designed to address the problems that had emerged in western economies, its impact will be universal, and in many cases, the outcomes will be even more significant outside North America and Europe. As Tan Kah Chye, Standard Chartered warns,

“Many people still consider Basel III as an issue for OECD banks. The The business community as a whole needs to recognise that the implications will be far wider, and the increased cost for banks to do business, together with liquidity constraints, will inevitably be passed on to their customers.”

Tan Kah Chye describes some of the implications of Basel III in Asia in box 2, and as he emphasises, the impact could be devastating,

“If Basel III’s proposed changes take place, we expect the cost of trade financing to increase by 15-37%, and trade finance capacity to fall by 6%. World GDP could arguably fall by 1.5%.”

Whilst operating in China brings challenges, and indeed the country itself faces a range of issues that will need to be addressed to enable its full potential to be realised, globalisation not only of trade but also of regulation connects China even more closely with other parts of the world. While China’s economic journey affects that of every other country, equally, decisions made in remote committees have a major effect on China and other fast-growing economies that may be different from those originally intended. At the end of Golden Week (or some weeks afterwards by the time you read this) China’s future is indeed bright, but at risk of tarnishing not only due to challenges within the country but also as a result of wider global issues.