Does Trapped Cash Really Matter?

‘Trapped cash’, or more precisely, cash that cannot be transferred from a country due to capital or currency controls, is not a new problem for treasurers. It’s also not a problem that is going away. Cash sitting securely in an account or investment that is generating a return, in a currency that is quietly appreciating, may not cause treasurers too much of a headache. However, this is rarely the reality in locations where trapped cash is an issue, typically ‘emerging’ markets, such as in parts of Asia, on which this article is focused. In writing this article, I am delighted to introduce Ann Lin Khoo, Asia Pacific Head of Market Management – Liquidity Structures, Treasury and Trade Solutions at Citi, and Shi Wei Ong, Head of Cash Liquidity Management Products at Standard Chartered Bank.

A worsening situation?

Although trapped cash has been going up the list of treasury priorities over the past two years or so, Shi Wei Ong, Standard Chartered explains that the regulatory fundamentals that result in trapped cash remain largely unchanged,

“Trapped cash has been a long-standing issue in parts of Asia, and while there may be regulatory changes that deepen the challenge in individual countries in the short term, in the longer term this issue is not going away. Countries that have been liberal in the past, such as Australia and Singapore, are likely to remain as such, while cash will continue to be trapped in countries such as Vietnam, Sri Lanka and India. Similarly, we don’t expect to see any fundamental change in semi-regulated countries, such as Malaysia and Indonesia, where foreign currency can be moved cross-border but local currency is retained in-country.”

The issue is not, therefore, that cash is becoming trapped in more countries, but regulations in countries where capital and currency controls already exist are, in some instances, becoming more stringent, reflecting geopolitical and economic uncertainties. However, more important is the changing market and credit environment, and an evolution in companies’ own business strategies, which together are making it more important than ever to manage in-country liquidity effectively, leverage cross-border liquidity and interest optimisation strategies, and reduce the incidence of trapped cash wherever possible.

Changing priorities

Despite its negative connotations, cash ‘trapped’ in-country has not always been a problem. In the past, many companies were happy to hold surplus funds in China, for example. The level of investment that they were making into their Chinese businesses meant that there was a reason to hold cash locally, and meanwhile, RMB was steadily appreciating. Even so, many corporations found that revenues were continuing to outstrip costs by a growing margin, and surplus cash balances were building up. As a result, treasurers welcomed China’s gradual liberalisation of cross-border trade, capital and currency controls that allowed funds in China to be transferred more easily offshore and included into regional or global liquidity management structures, therefore offering greater flexibility to utilise cash at a group level.

Although 2014 - mid-2016 saw a number of important opportunities for foreign investors opening up, we have seen a modest step back in recent months, with less certainty over the guidelines on cross-border liquidity, which corporations are not inclined to risk breaching. This is not a situation unique to China: other countries too are placing greater restrictions on cross-border liquidity, whether of foreign or local currency, including Malaysia and Indonesia, as well as the effects of demonetisation in India. Effectively, as countries across Asia react uneasily to political and economic issues such as a new US administration and its uncertain relationships in Asia, and an ongoing market correction in China, it seems that the walls are going up, at least temporarily. Shi Wei Ong, Standard Chartered comments,

“Recent trends show that we may be entering an era of protectionism. Even those countries that were opening up, such as China, are taking a step back and looking into a long-term path towards liberalisation of their regulations and currencies.”

Resurgence of familiar issues

While regulatory change may create difficulty in unlocking trapped cash in some cases, it is not typically the reason why treasurers are becoming more concerned about the level of trapped cash they hold in-country. Instead, there are a variety of both external and internal factors that together emphasise the importance of effective cash, liquidity and risk management:

 

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Currency volatility 

One key factor is the changing currency situation. Looking at China, for example, since the RMB devaluation in August 2015, followed by the increase in guidance rate in January 2016, further weakening the value of the currency, treasurers have had to contend with far greater volatility than in the past, both in the regulated onshore RMB (CNY) and offshore RMB (CNH) markets. As a result, treasurers are inclined to manage their RMB risk more closely than they have done in the past. Similarly, the value of other Asian currencies is volatile, and highly dependent on the value of USD. As Ann Lin Khoo, Citi discusses,

“While every year brings challenge and uncertainty, we appear to be at a flexion point, with a variety of factors coalescing. Emerging markets are particularly vulnerable to volatility in the global markets, and policies that impact on the value of USD: as USD strengthens, for example, emerging currencies and the economies on which they are based are adversely affected. At the same time, the perceived direction of the new US administration in trade and international affairs, including a potentially uneasy relationship with China, creates uncertainty, added to possible changes to the tax regime, such as homeland investment and border taxes.”

Credit risk

Increased credit risk also elevates the priority of trapped cash. In China, the number of bankruptcies has increased over the past 18 months, including amongst state-owned enterprises. Similarly, countries such as Hong Kong, Vietnam, Australia and Taiwan that are heavily dependent on China, as well as other commodity-producing countries, have seen a higher rate of bankruptcies. The financial sector is as susceptible as commodity producers and industrial sectors, and adds to treasurers’ concerns about holding cash with local banks. This is exacerbated further by several high profile exits by foreign banks, particularly European banks, from some Asian markets, which gives treasurers fewer choices of highly rated banks with which to hold cash. 

Changing business dynamics

As Ann Lin Khoo, Citi outlines,

“It is not only the environment in which corporations are operating that is changing, but also their own business. Supply chain disruption, new sales models, unpredictable sales and cash flow, for example, are all adding to the difficulties faced by treasurers and finance managers trying to navigate through uncertain times.”

As a result, treasurers are keen to optimise liquidity, including cross-border, to invest in business growth and offset borrowings. A related issue is mergers and acquisitions (M&A). With the volume of cross-border M&A transactions at very high levels, trapped cash is often a sticking point between buyers and sellers, and can delay transactions significantly. A buyer, for example, will argue that cash that cannot be repatriated should be valued at a lower level than cash that can be transferred freely cross-border, while a seller will argue that trapped cash can be spent in the country in which it is located, to invest in capex or working capital, or pay down local debt.

Tackling trapped cash

While the risks that affect trapped cash have become more acute, and trapped cash becomes more strategically significant, there have not been significant changes in the techniques available to overcome these risks and challenges. As Shi Wei Ong, Standard Chartered describes,

“Foreign MNCs in particular will continue to use traditional methods for capital repatriation to the corporate HQ or elsewhere, such as dividends, royalties and management fees. Intercompany lending is an option in some cases, but this may be restricted by regulation. Interest rate optimisation also remains important to leverage the value of trapped cash even if the capital is inaccessible outside of the country in which it was generated.”

She continues,

“We are seeing increasing demand amongst customers for techniques to reduce trapped cash, not only for liquidity management purposes, but also to reduce sovereign risk. In addition, treasurers are seeking to simplify their cash management structures and rationalise bank relationships and accounts to optimise visibility and control as far as possible.”

The value of doing so is not only to identify and manage cash in-country, but also to avoid cash becoming trapped in the first place. By optimising cash management structures, implementing an in-house bank, and streamlining payment and collection processes, there is potential to introduce techniques such as POBO (payments on behalf of) and ROBO (receivables on behalf of). As Shi Wei Ong, Standard Chartered suggests,

“Techniques such as POBO and ROBO offer the potential for a new approach to manage cross-border liquidity. There are broadly two types of POBO and ROBO. The more popular approach is the funded scenario with intercompany positions, often implemented in conjunction with virtual accounts. Realistically, this is only achievable in liberal economies. A second approach is an agency or pre-funded concept, which if applied appropriately, could be a way to alleviate the problem of cash becoming trapped. For example, rather than collecting receipts locally, a company may choose to invoice and instruct the payer to pay into an offshore account. Clearly there may be some tax, documentation and service/management fee implications requirements, but it represents a possible strategy for minimising trapped cash alongside other techniques.”

However, visibility over both current and future cash positions, efficient cash and treasury management structures and process efficiency are fundamental, whether to avoid trapped cash or manage it more effectively. For example, reviewing and potentially rationalising bank relationships and accounts is essential achieving visibility over their cash is essential as Shi Wei illustrated earlier, but improving bank communications should also be a priority. While corporate access to SWIFT can be problematic in parts of Asia, the number of organisations to do so is growing, leading to an increase in the level of awareness and expertise amongst banks. Furthermore, most treasury functions undertake cash flow forecasting, but with varying degrees of success, as Citi’s Treasury Diagnostics, which draws on data from more than 400 clients globally, reveals. Ann Lin Khoo, Citi explains,

“Although virtually every treasurer and finance manager says they perform cash flow forecasting, many have considerable flaws in their forecasting process. Major inaccuracies are common, with inconsistent use of templates, insufficient root analysis, and a patchy culture of effective forecasting across the business.”

 

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Beyond trapped cash

While trapped cash has become a higher priority, however, it is not a challenge that treasurers can ‘solve’. Instead the level of cash that is ‘trapped’ can be controlled in some cases, while in others, treasurers will focus more on in-country liquidity and currency risk management. Trapped cash should be viewed proportionately. Few if any industries are planning an exodus from Asia, and while growth rates have eased, they are still highly competitive compared with most other regions. As Ann Lin Khoo, Citi says,

“Together, the combination of external, regulatory and internal pressures is creating a situation of a magnitude that we have not seen before. At the same time, however, the scale of opportunity remains undimmed. Emerging markets continue to grow at an average of 6%, which, while slower than in some previous years, remains highly attractive, with consumption rising amongst a huge population.”

Consequently, trapped cash should not detract from the opportunities that Asia continues to present, but rather be a factor when determining future strategy. Surplus liquidity in a country could, for example, be a contributory element in deciding on where to locate centralised business functions, R&D etc. In addition, when entering new markets, it is important that treasury is involved in designing business structures that minimise surplus cash balances in highly regulated markets. This has not always been the case in the past, such as in China, where widespread expectations regarding the country’s liberalisation agenda have led to large balances building up.

Trapped cash (in Asia specifically) is also typically a more significant issue amongst western than Asian multinationals, as they may not be as invested in the region as their Asian peers. Shi Wei Ong, Standard Chartered suggests,

“For Asian MNCs, trapped cash in Asia is a lower priority, as they are typically looking to develop a deep regional presence, and therefore are happier to maintain balances in-country for ongoing investment, although this is less likely to be the case with cash trapped in other regions, such as Africa or Latin America.”

Corporations that have customers in a country, but that do not have business costs to offset revenues, and those considering divesting parts of their business, should consider how to minimise the cash held in country, using in-house banking, invoicing centres and potentially talk to their banks about different forms of POBO and ROBO. For corporations that are making a strategic, long-term commitment to Asia, the fact that cash is ‘trapped’ is less of an issue than managing the increasing market and credit risk to which it is subject, which are disciplines in which treasurers are already familiar and expert.