Published: January 01, 2012
Moves towards liberalising the renminbi in China are good news for international companies looking to expand their trade business in the region, as well as for those who are contemplating entering the Chinese market. But making the most of these trade opportunities requires banking relationships that help corporates navigate the financial risks that remain prevalent in the region.
Renminbi (RMB) trade settlement volumes have grown exponentially since the launch of the pilot scheme in April 2009, which has since been expanded to allow enterprises in 20 Chinese mainland provinces and cities to settle their trade in RMB with trading partners globally. Certainly, the scheme’s growing momentum is highlighted by the dramatic increase in Chinese export enterprises registered to settle in RMB (known as Mainland Designated Enterprises) from 350 in 2009 to more than 70,000 today. And with the expansion of the RMB trade settlement scheme, the volume of RMB used for trade settlement has also increased tremendously – from RMB18.35bn (around €2.0bn) in March 2010 to RMB360.32bn (€39.5bn) 12 months later (on an accumulated basis).
The demand for settlement of trade transactions in RMB is expected to continue, reflecting the growing influence of China and the Chinese economy in global affairs, as well as the significant increase in intra-Asian trade. Additionally, as the currency gets liberalised gradually and adds liquidity to the market, and as the regulatory situation settles, growth in RMB payments, liquidity, trade, foreign exchange and the bond market should all follow. Clearly, if corporates want to keep or strengthen their market position in China, it is imperative that they are able to settle in RMB.
Many banks domiciled in Europe and the US have responded to this trend – opening RMB accounts for corporate customers in their home countries, and enabling them to undertake cross-border payments for trade related purposes and to handle documentary business in RMB. Indeed, Commerzbank, for example, expanded its RMB services in Germany in June this year – allowing German corporates to make or receive cross-border payments in RMB directly from customers in China for trade-related purposes.
But in a region that still relies on documentary letters of credit (LCs) as guarantees of trade payment, there are also hazards and complexities to trading in China. To navigate this risky landscape, corporates therefore need the help of banks with the technical expertise and experience of processing trade transactions in the region.
Chinese companies are increasingly asking for business to be conducted in RMB. This is driven primarily by the issue of currency availability, with many local Chinese enterprises unable to source US dollars or euros. Smaller enterprises that were previously unable to trade in USD or EUR, therefore, can now access international markets by trading in RMB. Furthermore, settling in RMB is also beneficial to Chinese corporates as it allows them to transfer the currency risk to their foreign trading partner.[[[PAGE]]]
Yet it is important that foreign corporates trading in the region – or seeking to – see the rise of RMB as an incentive to pursuing their own trade interests. In fact, the potential for trading in China is broadened enormously by the adoption of the RMB as the settlement currency – allowing corporates access to progressively broader swathes of China’s rapidly expanding economy.
And there are yet more advantages – by billing import and export business in CNY (the official currency code for RMB) and instilling fixed price agreements in CNY, corporates can simplify the process of trading with Chinese trading partners. Certainly, these processes can reduce price adjustments and negotiations in case rates change, with large customers able to control the currency centrally. By undertaking the currency risk, the foreign company should also be able to profit from a stronger negotiating position (as their Chinese counterpart no longer has to account for the cost of hedging currency risk) – possibly resulting in reduced prices for Chinese imports or an increase in their own prices when exporting.
What is more, mechanisms such as non-deliverable forwards (NDFs), alongside other FX instruments, allow corporates to negate their exposure to currency volatility by transferring the risk to the global bank. An NDF, for example, allows corporates to hedge their FX exposure by agreeing an exchange rate and a settlement date for the FX transaction with their banking partner. On the settlement date the difference between the previously agreed rate and the spot market rate is then paid to the appropriate party. For example, if the corporate was to receive an order valued at RMB10m from a Chinese importer, it could arrange an NDF with its bank to hedge against volatility in the FX market. An agreement might involve an exchange rate of RMB 9.5 to the euro, maturing in six months’ time. This would equate to approximately €1.05m. If, in the circumstances, the strength of the euro increases over the six months, the NDF ensures that the corporate would still receive the full value of the order.
Yet while the growth of trade settlement in China provides huge opportunities for corporates in the region, the Asian trading landscape remains fraught with risk of non-payment. Indeed, to date, the region’s move towards open account trading (which has become the method of choice to settle trade transactions in the west) has been hampered by a lack of confidence in the region that the exporter will provide the goods and that the importer will pay on time. And it is this lack of confidence that underlies the continued popularity of the Letter of Credit (LC).
It is well known that documents under LCs are checked very strictly by Chinese banks. Certainly, minor discrepancies can cause rejection of documents, and consequently late payment, or even non-payment, of shipments under LCs, which makes the handling of LCs by the opening and confirming banks a vital issue, and one which requires detailed local knowledge and strong relationships with local banks.[[[PAGE]]]
Undoubtedly, the importance and complexity involved in ensuring that documents presented under LCs fully comply with the LC terms and conditions, mean that it is a distinct advantage for documents to be handled by competence centres close to the customer. The modern trend towards outsourcing the checking of documents to elsewhere in the Asian-Pacific region (especially India) is not therefore considered best practice for dealing with China – as it does not allow for advice to be given immediately and for the exchange or amendment of incorrect documents to take place if necessary.
The use of strong correspondent banking relationships to support the handling and generating of LC business is one solution. This structure enables banks to leverage local expertise in the region and open, advise and confirm LCs in close conjunction with both its own clients, and locally via the branches or correspondent banks used by the Chinese corporate. Commerzbank, for example, has a network of partnerships with over 130 local banks to allow it to do exactly this. These partnerships are complemented by 21 documentary competence centres located close to Commerzbank’s Mittelstand customer base in Germany. Furthermore, each of Commerzbank’s foreign branches and subsidiaries, in 19 countries, has its own documentary department for the handling of LCs of its customers abroad.
The reality of implementing the RMB as an international currency is rather more complicated in China. Still, experts predict that the RMB will establish itself in five to eight years as a leading international currency which is freely convertible and tradable. And steps to achieve this have already been put in place. Indeed, earlier in the year, Hong Kong was declared an Offshore Renminbi Centre and now serves as a pioneer for the international use of the RMB – with synthetic offshore CNY (CNH) being traded as a freely convertible currency in the Hong Kong interbank market.
Here, the CNH is not subject to the restrictions of the CNY and is mainly used for foreign exchange business and investments in Hong Kong.
Yet offshore (CNH) and onshore (CNY) liquidity are still effectively separated into different currencies, focused on mainland or Hong Kong settled trades. Furthermore, the utilisation of CNY and possibilities of cross-border payments in CNY remain restricted and regulated, which demonstrates that the intricacies involved in trading with China require good advice from banking partners.
As China increases the size of its footprint on the global trading landscape and the RMB continues to become increasingly important as a global trade settlement currency, it is clear that such ‘on the ground’ expertise will prove vital to corporates looking to increase their business or start new business in the region. As a consequence, partnering with banks that have a global presence, yet are also structured to offer local knowledge, will become more important than ever.
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