Location, Location, Location

by David Blair, Managing Director, Acarate Consulting

With Hong Kong very publicly gunning for Singapore’s pre-eminence, treasury centre location has become a hot topic again. What are the key success factors? And who is likely to win this round in the RTC wars?

RTC (regional treasury centre) location has always been a lively debate within treasury circles. First, there is the basic decision – centralise or not? I have always thought this a rather crude distinction, and I argue that the decision must be taken at a more granular level. For example, it might make sense to centralise foreign exchange dealing for internal control and scale economy reasons. Likewise, funding from banks and markets – although things like umbrella facilities may reduce the need for some corporates. On the other hand, many corporates will prefer to keep collection management in country because they value customer proximity for that function.

This granularity also brings up the important distinction between RTCs and SSCs (shared service centres). Most would agree that RTCs handle funding (loans) and investment (deposits et al), which means centralising corporate interactions with money and debt markets. Most would also include foreign exchange dealing. Likewise the related derivatives. On the other hand, core SSC activities typically include high volume commercial (as opposed to treasury) transactions – receivables, payables, accounting, reporting, payroll, fixed assets, etc.

Things get more interesting at the borderline – in-house bank (IHB), multilateral payment netting (Netting), payment factory (PF). IHB in particular normally includes elements of intercompany funding as well as commercial payment processing. Often elements of RTC and SSC will be housed under the same roof. The objective here is not to recommend organisational design, but rather to make the distinction between relatively low volume treasury transactions in MM and FX, as opposed to relatively high volume commercial flows like AR and AP. For the purposes of this article, I will refer to RTCs as handling the low volume (and often high value) treasury transactions.[[[PAGE]]]

Two kinds of in-house bank

Analogous to the distinction between RTC and SSC, it is important to be clear about the distinction between two very different understandings of in-house bank.

One understanding is that a (regional) treasury centre (RTC) is an IHB. The understanding here is that an RTC acts as a bank towards subsidiaries with respect to treasury transaction like loans, deposits, foreign exchange, etc. An RTC takes intercompany deposits from and extends intercompany loans to subsidiaries and covers the net position with banks, in a similar way to banks which take deposits and make loans and cover their net interbank, except that RTCs exclusively serve related group companies – hence the ‘in-house’ bit. Such treasury as opposed to commercial transactions tend to be relatively low volume.

In the other understanding, an IHB is providing bank like payment and account holding services. An IHB makes payments and collections on behalf of subsidiaries and debits and credits the proceeds to subsidiaries’ intercompany current accounts with the IHB. These are mainly commercial payments and collections, and therefore tend to be high volume.

The end state for this current account style IHB is to eliminate subsidiary (external or real as opposed to IHB) bank accounts altogether. The IHB handles all payments and collections on behalf of the subsidiary through IHB owned external bank accounts so that the subsidiary no longer needs an external bank account in its own name. Many companies have achieved this in many countries, moving towards one external bank account per currency for the whole group.

Of course the two kinds of IHB can work together and may co-locate organisationally and / or geographically. In summary, the loan and deposit IHB is like an RTC, and will have similar location requirements; whereas the current account IHB is like an SSC, and need low costs and scale efficiencies.

RTC flux

Fashions change. The tides of centralisation and decentralisation ebb and flow. Centralise to cut costs and regain control. Decentralise to localise and grow market intimacy. To some extent this is common across industries, but often each corporate seems to be on its own rhythm.

More and more corporates are finding that granularity is key – identify which activities yield scale economies and benefit from centralised control, and which activities are better localised. There is no right answer. It will depend on the market, corporate culture, systems, and so on.

Many corporates, outside a few heavily regulated industries, have concluded that treasury transactions (MM and FX) benefit from centralisation. They want tight control over high value transactions, and that control is hard to localise. Segregation of duties alone implies serious headcount, which is unlikely to be cost effective when localised in each country.

Over the years, Asia has seen successive waves of RTCs come and go – happily for the profession as a whole they are normally not synchronised. There is also the global – regional – local dimension. Corporates often set up RTCs for Asia, then hit bad times and – aided by improving technology – centralise all treasury back to head office. If they do not get the regional knowledge part of the equation right, they sometimes come back with new RTCs at a later date.

I was surprised to meet the local treasurer of a previous employer recently. A few years ago they had closed regional treasury and pulled back to head office to cut costs. The cycle has turned and they now feel the need for local feet on the ground (although more processes remain centralised to head office).

Hong Kong vs Singapore

The prime RTC locations in Asia have always been HK and SG. Both free developed well connected cities with deep financial markets and relatively deep talent pools. High costs are acceptable for generally small staffed RTCs, but make them unsuitable for the large teams at SSCs.

Kuala Lumpur and Manila have had some success for SSC activities because they have cheap (reasonably) English speaking labour pools. But both are currency controlled and not at all financially free places with shallow and purely local financial markets, so they are not at all suitable for RTCs. Traditionally, Hong Kong has been preferred by corporates focused on China for its proximity to China. Singapore has a better coverage for Asia Pacific as whole. Hong Kong, with China in its back yard sucking in as much money as it could, traditionally had deeper capital markets. Singapore has deeper more liquid FX markets.

Corporates choose their RTC location based on their specific priorities. Often regional head quarter location, presumably reflecting those priorities, was (and still is) a deciding factor.

What is Hong Kong offering?

The first thing to make clear is that the Hong Kong proposal is just that. As of Q2 2015, they are in consultation regarding changes to the tax code which may take place in 2015/2016 fiscal year (Hong Kong fiscal year runs April through March). Certain anti-avoidance provisions in the current Hong Kong tax code (which are designed to eliminate tax reduction on onshore activities) result in intercompany loan interest being taxed at the full rate of 16.5%. Hong Kong proposes to carve out qualifying treasury centre intercompany loan interest. The new law, which is currently under consultation, will spell out the qualification criteria. There is no analogous issue in Singapore.

Hong Kong further proposes to reduce by 50% the income tax rate on qualifying treasury activities to 8.25% - compared to Singapore’s 10%. Again, the new law will have to spell out what constitutes qualifying activities.

These changes would make Hong Kong broadly fiscally competitive with Singapore. In summary:

• Treasury activities attract 10% tax in Singapore and 8.25% in Hong Kong, and
• Withholding tax on interest is waived in Singapore and does not exist in Hong Kong.

Tax is not the only issue, and here are some common factors:

• Tax is broadly similar (see above)
• Costs are broadly similar
• Quality of life is subjective; Hong Kong pollution makes Singapore more attractive for families
• Talent: both have deep talent pools with Singapore having better English skills and deeper corporate treasury talent simply from having been the predominant treasury location for decades
• MNC population: Hong Kong has some 8,000 MNCs including mainland companies operating in the territory; Singapore has 12,000 multinationals; this probably reflects Singapore’s broader APAC focus
• Telecoms are excellent in both locations
• Transport: Hong Kong saw 63 million passengers and Singapore 54 million in 2014; Hong Kong serves 180 cities and Singapore 300; Hong Kong’s passenger volumes reflect its status as an international hub for mainland China whereas Singapore is a true international gateway

Then of course there are many company specific factors like China or APAC focused, regional headquarters location, and so forth.

Shanghai 2020

China has stated that it wants Shanghai to be an International Financial Centre by 2020. This and the increasing heft of China – now the world’s biggest economy by PPP – has encouraged corporates to move RHQs (regional headquarters) to Shanghai and in some cases other Chinese cities. This, together with regulatory moves from SAFE (State Administration for Foreign Exchange) and PBoC (People’s Bank of China) to make treasury management easier in China, might drive interest in setting up RTCs or even SSCs in China. On the other hand, past efforts have floundered because of weak language skills in mainland China.

Despite rapid recent improvement, China remains complicated from both tax and regulatory perspectives, and this will be a challenge for RTC operations going forward. On the SSC side, Chinese companies (and Western manufacturers) are already heading inland in search of lower costs and to escape the tight talent markets in the more developed coastal cities.

On the one hand, Shanghai 2020 poses a real challenge to Hong Kong as a treasury location – if a corporation wants to base a treasury centre in Greater China, why not go all the way and locate in Shanghai? This will help with China government relations. On the other hand, Shanghai suffers from high costs, high turnover and weak language skills, and these can be a significant constraint for regional operations. So perhaps Hong Kong still has a benefit compared to Shanghai.

But if the corporation has a more regional and less mainland China focus, then Singapore is likely to be the more attractive choice. This threatens to leave Hong Kong caught in the middle between Shanghai becoming pre-eminent for China-focused operations, and Singapore covering more regional-focused operations. In fact, it is likely that HKMA has reached similar conclusions, and that is what has prompted it to launch such an aggressive campaign to lure treasurers to Hong Kong.

This article was also published in GTNews. gtnews.afponline.org