Published: September 01, 2013
The rapid pace of the renminbi’s (RMB’s) internationalisation over the last 12 months has fundamental implications for corporate treasury, to the point where immediate action is required. It is no longer a case of considering what to do about the RMB, it is about actually doing it. As this article explains, it is now possible to integrate the currency into a corporate’s global working capital and liquidity management and achieve major benefits.
At virtually every step along its road to internationalisation the RMB has thrown up a succession of opportunities for corporate treasuries. Cost savings, process efficiencies, strategic flexibility and improved control and risk management are just some examples. Individually attractive, but collectively they now make the adoption and incorporation of the RMB into corporate processes virtually compulsory.
The control benefits of RMB adoption come in a number of forms. As its share of global gross domestic product (GDP) increases (see Figure 1), China is likely to be an increasingly important part of many international corporates’ supply chains and customer bases in the future.
It is important that these corporates are able to take control of the foreign exchange (FX) risks implicit in this shift. This is now possible by centralising FX risk management offshore in a regional treasury centre (RTC) that can take advantage of the depth and breadth of the offshore FX market, as well as being able to choose from the most advantageous onshore/offshore market rate. Improved control of overall FX exposure is now also possible through natural hedging. Instead of having to conduct unnecessary FX transactions, RMB receipts can be directly used to make RMB payments.
Once a corporate adopts the RMB, greater efficiencies become available through more effective control of end-to-end transaction processing costs. This is particularly true in the context of China’s initiative to simplify documentation checking and policy support intended to encourage the use of RMB for cross-border trade.
Corporates that adopt RMB can improve control of their sales and purchasing processes as well. If a corporate is able to pay and receive in RMB, Chinese customers and suppliers that are unwilling or unable to pay in foreign currency immediately become accessible. An additional consideration is that where existing customers/suppliers are prepared to pay/receive foreign currency they will build their hedging costs into the price they are prepared to pay or sell at.
In most cases, this implicit hedging cost will be higher than a multinational corporate could achieve, especially as managing FX risk has become more challenging since the widening of onshore RMB FX trading band to +/-1%, which has increasing currency volatility. By contrast, a multinational corporate may even achieve near zero hedging costs if it can take advantage of the natural hedging mentioned earlier.
The adoption of RMB also provides a corporate with greater flexibility in any sales or procurement negotiations. By being able to offer RMB as an invoicing currency, corporates’ Chinese counterparties have the option of being billed or paid in their domestic currency and so avoiding any FX risk. Therefore adopting the RMB provides better control of multiple aspects of the sales and procurement process.[[[PAGE]]]
Bringing China ‘into the fold’ in terms of global treasury and working capital has major and beneficial consequences for the bottom line, as a slew of costs can be reduced or possibly entirely removed.
Financing is one of the most obvious and important examples of these cost opportunities, especially where a corporate currently has subsidiaries in China borrowing RMB onshore. At present, the differential between onshore and offshore funding costs is approximately 2% in favour of offshore borrowing.
There is therefore an opportunity for these subsidiaries’ offshore trade counterparties to obtain liquidity offshore at a lower cost and expedite their trade payments into China to minimise the subsidiaries’ financing cost. Similar opportunities apply to imports to China, where offshore trade counterparties can access less costly offshore funding to allow more favourable payment terms for China subsidiaries that will relieve their financing burden.
The differential between the movement of the onshore and offshore FX curves presents additional opportunities for those engaged in genuine trade transactions, as they have access to both onshore and offshore spot FX rates. They can therefore select the most favourable FX rate to use for a particular transaction.
There are also more general savings possible across a range of hedging instruments. Since the permitted RMB/USD daily fixing band was widened to +/-1% in April 2012, it has become costly to manage FX, which was often left unmanaged due to the low volatility of the RMB/USD exchange rate. The offshore FX market offers additional flexibility and choice for managing FX exposures and making cost savings possible – particularly if payables and receivables can potentially be matched, thereby minimising unnecessary hedging activity and costs.
Historically, one primary concern about settling cross-border transactions in RMB has been the demanding documentation process laid down by regulation. However, this situation has radically changed for the better over the past year or so. In June 2012 the People’s Bank of China (PBOC) launched a pilot programme in Shanghai aimed at improving this situation – the Simplified RMB Cross-border Payment (SRCP) scheme – which was subsequently extended to nine other locations.
Under the scheme, with appropriate bank know-your-customer, know-your-business and due diligence processes in place, eligible companies were permitted to invoice and settle cross-border trades in RMB without the need to provide documentation for verification against cross-border payments. Instead, eligible corporates making a trade payment only had to submit a payment instruction and purpose-of-payment declaration and the bank no longer had to check the hard copy documentary proof for every underlying transaction.
This greatly reduced the operational burden of making cross-border RMB payments for trade transactions. Total payment processing times were shortened, delays caused by documents going missing in transit no longer occurred and full straight-through-processing became possible. As a result, corporations also benefited from a faster cash conversion cycle, an improved working capital position and reduced financing costs.
When applied to Shanghai and the nine other locations, this was obviously valuable - but more recently there has been another enhancement. In July 2013, the PBOC announced a further regulatory relaxation whereby the SRCP scheme now applies to all of China.
Corporations also now have greater flexibility to manage their liquidity pool in China as part of their overall global or regional liquidity management structures, enabling further cost savings. A PBOC pilot initiative that permitted approved corporations to move RMB offshore from China as an intra-group company loan began in late 2012. In November 2012, Standard Chartered Bank was the first foreign bank to secure a quota from the PBOC Shanghai Branch for a client under the scheme – RMB3.3bn for a US manufacturing and technology firm.
However, in July 2013, the PBOC expanded the scheme to apply on a pan-China basis. Corporates in China can therefore now apply through their banks in China and channel surplus RMB cash in mainland China to fund RMB-denominated activities overseas, such as participation in global liquidity management, balance sheet management, or yield enhancement via offshore investment structures.
These changes neatly demonstrates how the RMB is now (or soon will be) part of many corporates’ global working capital picture. The new scheme is also a natural fit with the simplified documentation for trade settlement and with the growing trend among Chinese domiciled corporates of establishing regional dim sum treasury centres.
While RTCs are not a new concept, adding RMB to the portfolio creates the need for the more specific expertise of a dim sum treasury RTC, as few companies have this expertise onshore. There are a number of areas in which this expertise is vital:
Bond issuance:
Knowledge of the dim sum bond market, especially factors such as pricing considerations and the likely source of RMB repayments.
Funding management:
Understanding the current regulatory environment and its implications. For example, how to maximise the advantage of cross-border RMB intra-group lending and cross-border RMB shareholder loans. Also how best to integrate these with global liquidity and trade finance solutions to optimise global liquidity and working capital management.
Hedging and managing RMB exposure:
Understanding how the various RMB FX derivatives and structured investments available in the offshore RMB (or CNH) market can assist in managing FX and interest rate risk, whilst also optimising investment yield.[[[PAGE]]]
Although the benefits of RMB adoption are attractive, for a sophisticated corporate to enable RMB invoicing it is likely to require significant change management and stakeholder engagement led by the corporate treasury. There are a number of key points (see Figure 2) that must be dealt with if the advantages of adoption are to be maximised.
One of the most fundamental is the order in which counterparties are engaged in the transition. In order to minimise any change risks, and to allow sufficient time to re-negotiate pricing terms for RMB-settled trade, it is advisable to focus on related companies or China-based subsidiaries first. Then, when the corporation later progresses to engaging third party buyers/suppliers in China, the change process will already be tried and tested.
This gradual approach also means that by the time external parties are involved, the corporation will already have a strong understanding of the underlying mechanics that will maximise the efficiency of cross-border trade settled in RMB. Therefore the corporation will have greater flexibility in refining its RMB-related process if the initial phase only involves ‘internal’ counterparties.
Additionally, it will be able to gather valuable insight into the specific benefits of using RMB, which will be a good point of reference in subsequent pricing negotiations with external buyers/suppliers. Finally, the corporation can use the initial implementation phase to investigate potential new buyers/suppliers that might offer competitive terms for RMB-denominated business.
Another important consideration is the effect that adopting the RMB will have on day-to-day business operations. Some adjustments will be needed to accommodate this, so it is advisable for treasury to run internal training and briefing sessions with other departments in the corporation. Important topics to cover include the types of transactions that will be RMB denominated, how the various internal systems (treasury management, enterprise resource planning, accounting, sales) can or will incorporate the currency, as well as any specific restrictions. This last point is important as it is essential that all affected departments understand points such as the onshore FX rate only being available for China trade in ‘goods’.
The accounting consequences of RMB adoption also need to be considered. Some companies may need to reflect their latest market risk exposure on their books on a mark-to-market basis. If they have open deliverable or non-deliverable forward hedging positions, they may need to set/fine-tune their systems to be able to track both deliverable/non-deliverable onshore and offshore FX curves. They may also need to consider how they will handle the various onshore/offshore RMB asset classes in their financial reporting, especially if any translation to the corporate base currency is involved.
This is an area where the need for checking systems capability mentioned above can be critical. Some systems use the same currency code for both the onshore and offshore flavours of the RMB, which causes major problems if both forward curves need to be tracked for accounting or risk management reporting. The addition of RMB to a corporate currency portfolio can obviously have major implications for hedging and funding activities. It is therefore advisable for treasury to review whether any action may be required to align with the corporation’s hedging policy. It is increasingly common for corporations adopting the RMB to extend the capabilities of their existing RTC to manage RMB exposure effectively alongside other currencies. In some cases, it may even be the catalyst for establishing a new dim sum RTC. However, this may also necessitate a broader project to deal with matters such as the best location for the RTC in terms of tax implications (such as withholding tax) or government incentives for RTCs.
Dealing effectively with all these various considerations is best accomplished if a cross-function project team is established – with appropriate senior sponsorship – that works in conjunction with a suitable banking partner. This will maximise knowledge dissemination throughout the organisation and by being able to tap into the banking partner’s expertise will minimise the risk of any unexpected problems arising.
The process of RMB internationalisation has made the adoption of the currency a priority for any international corporation doing business in and growing its business with China. Over the past year, the business case for doing so has moved from compelling to overwhelming. Previously regulatory barriers have fallen and continue to fall, and the potential advantages for just liquidity management can be a major competitive differentiator.
Nevertheless, and particularly in view of the pace of regulatory change, successful RMB adoption is heavily dependent upon a combination of careful planning and local expertise. Therefore, any banking partner involved in this project must be able to demonstrate strong regulatory relationships at the highest level and a profound understanding of the financial infrastructure relating to the RMB. Both are critical for your mission.
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