Published: June 01, 2014
The weekend that has just passed has reminded me why I am not that interested in sport. In one weekend we have had two Wimbledon finals (which I quite like and sadly had to turn down the opportunity to go to the ladies’ final), the British Grand Prix (rather more successful for the home crowd), the Tour de France in the UK (I don’t know why either), all on top of the soccer World Cup. There are many thousands of children around the world (and indeed their parents too) who dream of holding up a trophy in their chosen sport with their respective national anthem played in acknowledgement of their success. While international success will always be the privilege of a few, it is impossible to win without taking part. I’m sure there are many treasurers reading this who are proud of their past or present sporting prowess (achievements under the age of 10 don’t count); however, treasurers are sometimes a little more reluctant to learn a new game. Today, the game that every treasurer needs to learn to help their company to win is managing RMB. While the rules may be changing fast, the rewards can be substantial.
For treasurers, it should be something of a relief that China is no longer experiencing the double-digit growth spurt that it enjoyed in the 2000s. While quarterly growth remains volatile, the annual growth rate is now a more consistent, but nonetheless attractive 7.5% (source: World Bank). For foreign multinationals, greater stability lends itself to a longer-term sustainable business strategy; furthermore, companies that have been cautious that rapid growth could lead to a boom-bust cycle can now approach their investment in China with more confidence. Slower (but potentially more sustainable) growth is also motivating the Chinese government to pursue its financial liberalisation programme with more vigour, which is translating into significant new opportunities for treasurers of both Chinese and foreign multinationals.
According to the World Bank’s June 2014 China Economic Report, China’s output grew by 7.7% in 2013, matching its 2012 growth rate and exceeding the government’s 7.5% indicative target (figure 1). In the same report, the World Bank predicts that China’s growth will continue to moderate over the medium term (7.6% and 7.5% in 2015) as structural shifts become more evident.
Key to maintaining this growth is facilitating business enterprise, particularly amongst Chinese corporations. This has been a primary driver behind initiatives to facilitate international use of RMB, both for trade and investment, and liquidity management, such as cross-border intercompany lending. However, these opportunities benefit not only Chinese corporations seeking overseas expansion but also foreign multinationals doing business in China.
Although the ability to settle cross-border trade in goods and services in RMB was first introduced in 2009, adoption was relatively limited initially (apart from intercompany trade) until the scheme was opened up to all companies and regions in China. As Vina Cheung, Global Head of RMB Internationalisation, HSBC Payments and Cash Management, highlights,
“Since July 2013, cross-border RMB trade has been simplified and available throughout China, which is very encouraging for both importers and exporters and a key milestone in the development of cross-border trade.”
Cross-border trade and currency liberalisation is advancing rapidly in China.
Sandip Patil, Managing Director and Region Head, Global Liquidity and Investments, Asia Pacific, Citi Global Transaction Services, emphasises some of the advantages of using RMB for cross-border trade,
“The advantages of RMB cross-border trade settlement for foreign multinationals include better commercial conditions (as counterparties’ FX risk is eliminated), greater flexibility in managing cash, liquidity and risk within China and access to a wider community of buyers and/or sellers. Documentation is less onerous when using RMB rather than foreign currencies, accelerating the trading process, e.g., export reporting and payment terms can also be more attractive: up to 210 days when using RMB compared with 90 days in foreign currency, resulting in obvious benefits.”
A growing number of companies (both Chinese and foreign multinationals) are recognising these advantages. According to SWIFT, RMB is now the second most used currency (for cross-border payments with China and Hong Kong – SWIFT RMB Tracker, June 2014) after USD and ahead of HKD. In May 2014, 12% of cross-border payments with China and Hong Kong were conducted in RMB, a year-on-year increase of 36%. Julien Martin, Head of RMB Competence Centre, BNP Paribas, emphasises the significance of this growth,
“Cross-border trade and currency liberalisation is advancing rapidly in China. The government’s target is that one third of cross-border trade should be conducted in RMB by 2020, and we have already passed 20% in 2014. The next important milestone will be the ability to use RMB to purchase commodities and there are already initiatives in progress to achieve this for vital commodities such as oil and metals.” [[[PAGE]]]
With a growing number of companies adopting RMB for cross-border trade, an associated challenge is how to manage the resulting RMB balances. While this is straightforward both onshore and through the burgeoning offshore RMB centres (discussed further below), it is essential for both Chinese and foreign multinationals that they can transfer RMB into and out of China. Until recently, the primary means of achieving this was through dividends and entrust loans. These are often time-consuming to set up, require regulatory approval and are subject to quotas. Consequently, they have typically been ‘one off’ rather than regular transactions. However, there have been substantial developments in cross-border RMB liquidity over the past twelve months. As Vina Cheung, HSBC explains,
“From a liquidity perspective, growing opportunities for intercompany lending are important for both Chinese and foreign corporations to leverage internal liquidity more effectively. July 2013 represented a breakthrough, as entities in China were given authorisation to lend to any offshore group company (with or without participation in an offshore cash pool structure), which had previously been difficult to achieve. This was a one-way process, however, which has since been expanded this year to entities registered in the China (Shanghai) Free Trade Zone (SFTZ), allowing two-way intercompany lending. Corporate interest, and in some cases, adoption of this opportunity has been significant, so much so that by June 2014, it is already anticipated that this scheme will be expanded nationwide, although the operational details and guidelines are not yet clear.”
There are two noteworthy issues here: firstly, the opportunity for one-way intercompany lending (i.e., from China to entities offshore); secondly, the opportunities that are emerging through the SFTZ. Looking first at the former, the ability to transfer surplus funds out of China to any group entity offshore is a major advantage for both Chinese and foreign multinationals. Chinese companies seeking to invest in international expansion can do so without the need to source offshore financing, while foreign multinationals with large surplus cash balances in China can now transfer these funds out of China more systematically, and incorporate them within a cash pool. For example, a logical approach for many companies is to transfer RMB to the entity that heads the regional cash pool, such as in Hong Kong. The RMB balance can then be managed in the same way as any other (tradable) currency or converted. Furthermore, RMB balances can be included in a multi-currency notional cash pool.
The second issue that Cheung mentions relates to the SFTZ. Since the SFTZ was launched in September 2013, a very large number of corporations have set up an entity, but foreign multinationals have been far slower than their Chinese peers to leverage the advantages. Julien Martin, BNP Paribas explains,
“The SFTZ has been a headline story despite being established less than a year ago; however, the drivers behind the SFTZ, like the developments we are seeing in the RMB space, are primarily the interests of Chinese corporations rather than foreign multinationals. Around 8,000 companies had set up an entity in the Shanghai bonded zones even before it was launched, and now there are around 9,500 new corporates registered (17,000 in total), less than 10% of which are foreign corporations. Registered entities span a wide range of industry sectors, most of which are ‘placeholders’ at this stage as companies wait to see how opportunities in the SFTZ develop.”
As Cheung emphasised, entities registered in the SFTZ can now achieve two-way intercompany lending. This is a far more straightforward process than setting up entrust loans or paying dividends and enables balances in China to be included within a regional (or global) liquidity management structure. Julien Martin, BNP Paribas continues,
“Based on the experiences of customers with whom we have already set up RMB cross-border cash pooling, companies with surplus cash in China who have typically depended a great deal on banks in China, can now repatriate cash overseas more easily. Although they could usually use intercompany lending to repatriate cash, using a cash pool is more straightforward. Furthermore, companies can centralise their trade payment infrastructure and channel trade imports through a cash pool, therefore centralising current account items through a single entity. Entities that have a working capital deficit, but who do not wish to go through the foreign direct investment process for working capital purposes, can now fund working capital requirements through a cross-border cash pool so long as the cash inflow is proportionate to the economic activities of the Chinese entity. This is managed by the company’s bank, rather than the regulators, which makes it far less bureaucratic and time-consuming as it is part of the reinforced KYC and due diligence process that the Chinese regulators are putting in place.”
Significantly, this opportunity is already available to SFTZ-registered entities and there are already discussions on expanding this capability countrywide, although the timescale for this development has not yet been announced. However, the speed with which two-way intercompany lending is being extended from the SFTZ more widely emphasises the role of the SFTZ, which is named the China (Shanghai) Pilot Free Trade Zone. Many of the initiatives that are taking place there are likely to be pilot projects that will then be rolled out more widely. Evan Goldstein, Global Head of RMB Services, Deutsche Bank suggests,
“The cross-border two-way intercompany lending scheme is currently available to entities registered in the SFTZ, and will be expanded country-wide. This announcement on 11th June suggests that the reform process may be accelerating as compared with previous initiatives that had far longer pilot schemes. This of course, remains to be seen.”
Secondly, it is entirely feasible that FTZs in other cities will be launched in the future. If companies that have not registered in the SFTZ are set to gain some of the same benefits, it may be questionable whether it is worthwhile registering an entity. Julien Martin, BNP Paribas expresses his view that it may still be worthwhile,
“Even though it may appear that companies do not need to register in the SFTZ, there may still be advantages to doing so. For example, in addition to cross-border cash pooling:
He continues,
“Although the SFTZ is still in its early stages, we are bullish about the opportunities that it offers, and will offer in the future, and we have set up a number of entities with our customers. Its success relies on the strength of the Shanghai Municipal Government, but there are other municipal governments that are seeking equal treatment, and therefore, we should expect to see fast-moving changes.”
There is a range of other developments taking place in China that have a direct impact on cash and treasury management, particularly affecting cross-border flows. A double taxation treaty agreed between China and Germany now means that withholding tax payable on dividends has been reduced from 10% to 5%, with similar agreements in place with the Netherlands, UK, Belgium, Switzerland and France. Julien Martin, BNP Paribas notes some other important recent announcements,
As the balances that need to be managed offshore are growing, so too are the opportunities for doing so.
“Firstly, SAFE has issued a new regulation to allow foreign currency cross-border cash pooling and secondly, foreign currency cross-border guarantees. Foreign currency cross-border cash pooling is probably the less significant of the two as RMB cross-border cash pooling is usually a more compelling proposition. However, the ability to use foreign currency cross-border guarantees without quota restriction is an important development as it avoids the problem of using letters of credit, usually from a Chinese bank, for sourcing offshore financing. This is significant for foreign multinationals as they can obtain a guarantee from an offshore entity to improve their credit profile when obtaining onshore financing. In the past, a Chinese entity of a foreign multinational found it difficult to finance the business onshore, such as by issuing bonds, as foreign subsidiaries often had a lower credit standing than Chinese parent companies and were therefore disadvantaged.”
As the balances that need to be managed offshore are growing, so too are the opportunities for doing so. Evan Goldstein, Deutsche Bank explains,
“There remains considerable advantage to holding RMB offshore rather than onshore. Cash in China is subject to a variety of regulations and reporting requirements whereas offshore RMB is far easier to manage, with a wide range of investment, liquidity and hedging solutions available that may also be more cost-effective than those available onshore. The growth of centres such as London and Frankfurt are significant as multinational corporations are already connected to clearing systems so that their RMB processes can be consistent with other currencies.” [[[PAGE]]]
Vina Cheung, HSBC continues,
“The Chinese regulators are taking a three-pronged approach to RMB internationalisation: trade, investment and the development of RMB offshore centres. The latter is an important element in promoting RMB for international business, and we are seeing an expanding liquidity pool in offshore markets and considerable interest by foreign governments, such as in UK, Germany and France in developing RMB hubs to promote cross-border business with China and use of RMB as a currency of international trade and investment.”
Until relatively recently, Hong Kong has been the primary centre for offshore RMB but this is changing. Evan Goldstein, Deutsche Bank discusses,
“Hong Kong will continue to lead the field as an offshore RMB centre due to its proximity to China but there is undoubtedly significant potential in other global locations to support global corporations in managing offshore RMB effectively.”
He continues by pointing out some of the important developments that will continue to fuel the growth of RMB centres in Europe,
“In the offshore market, there have been a number of recent headlines. China Construction Bank has been appointed RMB clearing bank in London, with a number of deals announced at the same time. These include both commercial agreements but also the ability to quote direct between RMB – GBP, as opposed to quoting through USD. Secondly, Bank of China has been appointed as clearing bank in Frankfurt. The interesting point here is the official recognition that Germany and continental Europe have significant real economy business with China.”
Julien Martin, BNP Paribas adds,
“Looking at the offshore RMB (CNH) market, the development of European hubs in London but also Frankfurt and Luxembourg will further motivate the use of RMB by multinational corporations, particularly amongst those who have still yet to decide whether to include RMB in their basket of currencies. In FX, we are seeing almost the same market depth and tight spreads in the European time zones as in Asia, illustrating a well-balanced market with a broad range of products to manage CNH liquidity.”
With rapidly changing regulations that impact on cross-border cash and liquidity management, treasurers with responsibility for the company’s Chinese operations have embraced new opportunities with varying degrees of enthusiasm. Vina Cheung, HSBC discusses,
“Inevitably, some corporations are more proactive in their participation in pilot schemes than others according to their business strategy in China. Companies for whom China is pivotal to their growth strategy that have built up a substantial presence adapt their treasury strategies to changes in the regulatory environment. Others, for whom the benefits of regulatory change are less immediately apparent, are adopting a ‘wait and see’ approach. However, the ability to connect China within a regional and global intercompany lending strategy is an important development, although the nature of the opportunity varies according to each company’s profile. For example, Chinese corporations funding their international expansion can leverage domestic RMB balances more easily rather than sourcing offshore financing. Foreign multinationals often have refined liquidity models both regionally and globally, and the opportunity to integrate China into a regional liquidity management framework, therefore leveraging surplus balances in RMB to fund deficits in other currencies offshore, offers significant benefits.”
The pace of change may discourage treasurers from defining new cash and liquidity management strategies that may be superseded quickly; however, the benefits of doing so can be substantial, even if new policies or processes may need to be reviewed and refined regularly. In particular, the potential to connect China into a regional or global liquidity management framework is a compelling proposition for many organisations. However, the opportunities to optimise cash and liquidity management in China extend beyond liquidity, such as centralising payments using a payments-on-behalf-of (POBO) model. As Vina Cheung, HSBC notes,
“Beyond liquidity management initiatives, treasurers need to look at the wider picture in China. In particular, there are increasing opportunities to centralise, standardise and improve efficiency in payments, collections and cash management processes. Without also focusing on these, taking advantage of individual liquidity and FX opportunities may be limited.”
Sandip Patil, Citi outlines some of these opportunities in more detail,
“Just as managing RMB liquidity both domestically and cross-border is becoming easier, opportunities to set up efficient cash management processes are also increasing. Companies can now centralise payments processing through an SSC or payments factory (including POBO – payments on behalf of) and perform payments netting, enabling companies to centralise and streamline payments in a way that is far more consistent with other regions than in the past.”
China is typically seen as an exception not only in liquidity management but also in the financial processes that are in place. The reality is that while there are specific features and nuances of managing cash in China (as there are in every other major market) there are increasingly opportunities to align policy and processes in China with those in other parts of the world.
The journey towards RMB liberalisation, and wider financial reforms in China, will undoubtedly take time but virtually every multinational corporation will ultimately be impacted. With a steadier pace of economic growth facilitating longer-term business strategies, and greater opportunities for cash and liquidity management than at any time in the past, treasurers that have not yet reviewed their China policies and processes in detail, including use of RMB, should now be doing so. As Sandip Patil, Citi comments,
“While the benefits will differ by organisation, ultimately it will be better to learn the game now rather than be beaten later.”
He concludes,
“There will undoubtedly need to be adjustments and revisions in companies’ RMB strategy over time, particularly as regulatory revisions offer new opportunities, but adopting RMB will be critical to cementing a company’s competitive position both within China and potentially globally.”
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