Published: March 01, 2014
There can be few business leaders today who do not recognise that securing access to liquidity is critical to business continuity. Indeed, declining or negative free cash flow and unresolved future debt maturities are amongst the strongest warning signs of a company in distress. Regulation such as Basel III is putting pressure on corporations’ ability to finance their business using bank debt. Equally significantly, companies need to compete effectively with corporations that have greater access to liquidity in their home markets, such as China. Consequently, treasurers are – and should be - looking to a wider range of markets and funding sources than ever before.
With both China and India reporting a slowdown in growth (although levels are still well in excess of most Western markets), companies need to be more innovative in finding ways to sustain growth, both by looking to new markets and driving improved operational and financial efficiency. Kaushik Shaparia, Asia Pacific Head of Trade Finance and Cash Management for Corporates, Global Transaction Banking, Deutsche Bank outlines,
“Sustaining growth is becoming more of a challenge in Asia, so companies are looking to access new markets to increase their competitiveness. As a result, we are seeing an expansion in trade finance activity, particularly within Asia, which is growing more quickly than inbound or outbound trade.”
Banks in Asia have high levels of liquidity and traditional lending is a major business activity for local banks.
The growth of intra-regional trade in Asia has a variety of implications. In many cases, these trade flows are, of course, between entities of foreign multinationals. However, competition from local and regional players is increasing, and will continue to do so. One point of differentiation between these regional players and foreign multinationals is the way in which they are financed. In most cases, Western corporations will finance their business centrally, usually in or close to their home or core traditional markets in Europe or North America. In these markets, constrained liquidity and growing regulatory demands are making it more difficult for companies that are not at the top of the ratings table to access traditional sources of finance. In contrast, Asian multinationals or those financing locally may not be subject to the same level of constraint, with the potential for accessing keener pricing through local markets. Vishal Kapoor, North Asia Structured Trade Head, Global Transaction Banking, Citi suggests,
“Banks in Asia have high levels of liquidity and traditional lending is a major business activity for local banks. The lending environment remains benign, with high confidence in corporate lending, resulting in tighter spreads than in other regions.”
Kaushik Shaparia, Deutsche Bank explains, however, that liquidity is more readily available for shorter-term borrowing, particularly outside China,
“At the shorter end, regional banks – including those from Japan, Australia as well as Asian banks that are in expansion mode – often have high levels of liquidity and may not yet have adopted global regulations such as Basel III. At the longer end, prices are increasing and with reduced availability, the priority for treasurers is access to financing rather than pricing.”
He notes, however,
“While there is a difference in the behaviour and priorities of Asian versus foreign multinationals, the distinctions are starting to blur. Non-Asian multinationals would typically arrange financing globally through group treasury, including bilateral lending and global supply chain finance programmes. These companies typically work with fewer banks and maintain global relationships. The regional treasury centre is therefore less concerned with the cost of financing while transaction banking services and reducing costs through operational efficiency is a greater priority. Multinationals headquartered in Asia are more motivated by financing costs and are less focused on operational and process efficiency. However, these characteristics are now becoming less apparent as corporations become global in their reach and the distinction between Asian and foreign multinationals disappears.”
Financing requirements, constraints and opportunities are issues for all organisations, and the differences between corporations headquartered in various parts of the world may be becoming less apparent; however, access to financing remains a competitive differentiator that no company can ignore. Kaushik Shaparia, Deutsche Bank comments,
“Companies that are able to secure longer-term financing have a competitive edge, particularly to finance large scale capital projects. Chinese companies are often able to access programme-related investments or export credit agency financing, while corporations headquartered elsewhere are seeking support from their banks to compete on an equivalent basis.”
This creates a dilemma not only for treasurers of multinationals headquartered outside Asia, particularly China, but also their banks, particularly amongst those that are already, or close to complying with Basel III. After all, as Kaushik Shaparia continues,
“The implications of Basel III are considerable for banks, not least as trade finance and some forms of off-balance sheet financing impact on ratios. This, in turn, is affecting the availability and cost of both long- and short- term financing.”
As banks increasingly adopt Basel III, the discrepancies in the financing landscape may become less apparent; however, there are other positive changes too. The recent announcement that Chaori Solar Energy Science and Technology Co had defaulted on an interest payment on its RMB 1bn bond reflects a move forward in China’s transition from a controlled economy to a market economy in that risk is being introduced to the market. This is positive in terms of market dynamics as it shows that risk, which is essential the workings of a market economy, is being introduced, which will in turn impact on pricing and credit.[[[PAGE]]]
Multinationals headquartered in China and other parts of Asia are not complacent in developing and maintaining a competitive position, and like their counterparts in other regions, they are expanding their funding mix. Vishal Kapoor, Citi explains,
“Large Asian multinationals are becoming increasingly sophisticated in the way that they finance their business. For example, while in the past they may have taken out working capital or term financing from local banks, they are now exploring working capital tools such as financial supply chain optimisation and supply chain financing, which have typically been better established in Europe and North America.”
Kaushik Shaparia, Deutsche Bank concurs,
Treasurers and business leaders are placing a greater emphasis on the stability of the supply chain
“Treasurers and business leaders are placing a greater emphasis on the stability of the supply chain, so they are seeking solutions from their banks to help them to achieve this, including both suppliers and dealers. The use of dealers was previously seen as a way of offloading risk, whereas now, the ability to streamline processes is also recognised.
As a result of this renewed focus on the supply chain, we are seeing a shift away from traditional forms of financing –such as bilateral loans in favour of supply chain financing. This allows both the originating company and its suppliers or dealers to derive the value of credit arbitrage between their relative credit standing. In some cases, companies are rolling out supply chain finance programmes regionally or globally, and in others, they are implementing them on a market by market basis.”
As in other regions, supply chain finance programmes are maturing, with a greater emphasis on onboarding suppliers efficiently and maximising the working capital benefits. Kaushik Shaparia, Deutsche Bank discusses,
“As demand for supply chain financing programmes grows, we are seeing a change from earlier programmes. For example, in the past, a company that had a mandate with a bank would often simply recommend that their suppliers work with the same bank to access financing under the programme. Today, an important criterion when setting up a programme is the bank’s ability to onboard suppliers, with supplier adoption and utilisation being a key performance indicator.”
In addition to leveraging diverse financing opportunities, particularly for working capital financing, multinational corporations (whether Asian or Western) often have large untapped liquidity reserves in China. Despite the gradual deregulation that has been taking place in China over the past few years, there remains a widespread view that this cash is ‘trapped’ and cannot be accessed from outside China or integrated within a regional or global financing or liquidity strategy. For many companies that are cash-rich in China, however, this is no longer the case, whether funds are held in RMB or foreign currency.
Vishal Kapoor, Citi describes how,
“Companies are often seeking to minimise onshore working capital in China; one important means of doing this is through intra-group trade flows. Consequently, while in the past financing discussions were often around facilities and working capital, these conversations are more to do with flows and how to use these flows to improve financing.”
Since the introduction of RMB cross-border trade settlement in 2009, the majority of cross-border trade flows have been intra-group, primarily as a means of offshoring funds (although third party trade flows are also increasingly). However, there are other means too to repatriate or leverage balances in China.
At a basic level, dividends can be used to repatriate cash. Since February 2014, there has been no limit on the amount or frequency of dividends; furthermore, no documentation is required for payments under USD 50,000 equivalent. This is a useful option for companies that are seeking to transfer cash permanently out of China, such as to fund capital investment elsewhere. However, there are also alternatives for treasurers that are seeking to incorporate liquidity held in China within a regional or global liquidity framework, but may not be in a position to extract cash permanently.
The cross-border, back-to-back financing arrangement, known as ‘panda’ is also suitable for leveraging balances in either RMB or foreign currency. This involves the Chinese entity placing a deposit with its bank, which in turn issues a CNH standby letter of credit to its overseas branch. This can then be used as collateral for financing to another group entity. Furthermore, such a solution can be useful in leveraging both higher onshore deposit rates in China and lower funding costs offshore. As Vishal Kapoor, Citi adds,
“In China, there are still huge arbitrage opportunities between onshore and offshore lending, so counterparties with trade flows to China are leveraging offshore markets wherever possible, now a huge business in Hong Kong.”
For balances held in foreign currency, companies can make intercompany entrust loans between their Chinese entities and an offshore entity within the same group, whether in- or outbound. The offshore entity could, for example, be the regional treasury centre. Since February 2014, there has been no limit on the tenor of foreign currency entrust loans, no bank guarantee is required and withholding tax is not payable on the loan principal. Transactions need to be registered with SAFE, and incoming funds are subject to the foreign debt quota, but this remains a viable option for many organisations. Similarly, companies registered in Beijing or Shanghai can include balances held in domestic foreign currency cash pools in China within an offshore cash pool, as long as transactions are within the overseas lending quota and foreign debt quota. While approval is required from SAFE for this arrangement, it is an important step towards enabling treasurers to integrate China within a wider financing and liquidity strategy.
For funds held in RMB, a similar range of solutions is available. Since July 2013, Chinese entities have been able to issue cross-border loans to overseas entities within the same group, through a dedicated RMB deposit account. No PBoC approval is required and the bank manages the reporting process. In addition, companies registered in the China (Shanghai) Free Trade Zone (SFTZ) can set up a two-way cross-border cash pool with a free trade account (FTA) as the master account. While this opportunity has only emerged recently, it potentially represents a compelling proposition for companies seeking to finance the group efficiently.
Since the dim sum (offshore RMB) bond market was deregulated in 2010, the market has soared
As Vishal Kapoor, Citi noted earlier, the offshore RMB (CNH) market offers considerable opportunity for financing with strong investor demand. Since the dim sum (offshore RMB) bond market was deregulated in 2010, the market has soared. Issuance during the first two months of this year exceeded $6bn compared with $2.3bn for the same period in 2013. This has included high levels of corporate issuance from companies such as Caterpillar, BP, Unilever and Volkswagen, keen to take advantage of continued appetite by both European and Asian investors, with a short supply of available investments and continued demand for strong household names.
While Hong Kong remains the largest dim sum market, London is growing quickly, with Luxembourg also a potential centre. However, despite strong growth in the offshore RMB bond market, treasurers should still be cautious. One of the drivers of the dim sum market has been the widespread belief that RMB will continue to appreciate; however, the unexpected dip in value against USD in late February 2014 was a useful reminder as RMB continues on its journey to becoming a convertible currency that investor appetite cannot be guaranteed; similarly, the arbitrage opportunities between the on- and offshore market are likely to be a short- to medium-term market aberration.[[[PAGE]]]
Based on my conversations with both corporates and banks over recent weeks, during which Asia, and particularly China has consistently been a priority topic, a few trends have emerged.
Firstly, corporate distinctions between their ‘home’ and ‘overseas’ markets are no longer relevant and can be unhelpful. In particular, there is a risk that centralised treasury functions can lose sight of the opportunities for financing that exist in other markets and currencies, particularly those in which the company has strong commercial activities. To understand and take advantage of these opportunities, it may be necessary to establish a local treasury presence in key markets, operating within the parameters and control of the regional or group treasury centre.
Secondly, while many treasurers are very familiar with financing and liquidity management opportunities in Europe and North America, they are cautious about applying these in Asia, particularly China. In some cases, this reticence is due to a lack of information about available solutions in Asia, while others are adopting a ‘wait and see’ approach in anticipation of future changes. In the latter case, if either the surplus cash in China (or another regulated economy) is material, or where financing is critical to a company’s competitive position, it may be beneficial to act now and evolve treasury strategies incrementally rather than waiting indefinitely, and potentially losing out on opportunity in the meantime.
Finally, treasurers are not engaging closely enough with their banks to discuss solutions. In some cases, treasurers need to be more proactive in doing this, but banks are not always good at co-ordinating the right expertise. The value of early and regular engagement can be considerable, to identify opportunities and create competitive advantage.
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