China’s two-prong capital retention strategy could hit MNC RMB pooling.
It’s not an official decree yet, but restrictions on cash pooling verbally expressed to banks by the People’s Bank of China at the start of the year will for all practical purposes have the impact of actual regulations, at least while the Chinese renminbi remains volatile, according to market observers. The restrictions appear to be part of a larger plan to keep capital in-country, and multinational corporations (MNCs) should consider their potential impact before transferring funds via pooling structures.
Jennifer Huang, the general manager of corporate banking at the Beijing Financial Education Co., the authorized training provider for the Certified Treasury Professional designation, spoke to two treasury executives in China about the restrictions. One said that the restrictions verbalized to banks in January appear to still be effective as of late May, although the PBOC hasn’t said anything further about them officially. Nor does it appear intent on codifying them as regulations.
“We haven’t found any official responses from the PBOC, or any evidence whether the instructions will be written into regulations,” Ms. Huang said in an email.
That may be precisely the PBOC’s plan that’s unfolding in two main parts. On April 29, the PBOC issued regulations that expand a program to allow financial and nonfinancial organizations to bring capital into China. The move aims to counter the impact of a weaker RMB and the resulting capital outflows.
“In short, this recent circular, effective May 3, 2016, allows nationwide nonfinancial enterprises (excluding real estate enterprises and local government financing vehicles) and financial enterprises established in China to raise funds from overseas,” said Jackit Wong, an economist at credit insurer Coface.
Ms. Wong noted that the inflows are subject to risk-weighted cross-border financing caps, according to a specified formula, but prior regulatory approval from the PBOC and State Administration of Foreign Exchange (SAFE) will no longer be necessary. She added that the rule marks an important milestone, in part because it initially became effective Jan. 25 in four free trade zones and took an atypically short time to be adopted nationwide. She said that indicates “the commitment of the Chinese government to speeding up reforms.”
In addition, the rules released earlier this month are simpler and clearer, she said, reducing the administrative burden for Chinese enterprises. “This also increased the policy transparency, as prior approval is no longer required and the cap formula has been provided,” Ms. Wong said. “So this would encourage more Chinese enterprises to tap into offshore funding channels.”
MNCs are not so fortunate. Hong Kong law firm Deacons said in a client memo in February that the PBOC held a meeting January 18, 2016 to instruct banks providing pooling services to MNCs to take additional measures to monitor and regulate the outflows of money from mainland China. Deacons noted that cash pooling refers to a framework for centralizing and allocating funds between the accounts of affiliates which operate inside and outside Mainland China.
“In general, cross-border cash pooling can assist companies by better addressing working capital requirements with on and offshore surplus funds,” said Dubos Masson, clinical associate professor of finance at Indiana University’s Kelly School of Business. “Where its use is available, it also allows corporate entities to operate more in line with their global enterprise cash management practices through the reduction of cross-border payment fees, the streamlining cross-border settlement and the standardization of processing flows.”
Such pooling structures have enabled MNCs to move RMB across borders among their invested companies and affiliates with relatively few restrictions.
No longer. Under the verbalized restrictions, banks providing RMB pooling services must limit currency outflows so there’s no net outflow of capital. “In the event that there is a net outflow at the RMB cash pool, and a bank continues to affect any outbound remittance, the bank would be required to pay additional deposit reserves for 100% of the excessive amount,” Deacons says. “In a serious case, the bank may be disqualified from continuing the provision of the cash pooling services.”
Ms. Wong said that normally such “advice” provided by the PBOC is not mandatory. However, banks appear to be taking it very seriously. Several global banks contacted by iTreasurer declined to comment, and a spokesperson at one said the central bank is permitting bankers to discuss the issue with corporate clients but not the media.
The reason for the unusual approach, Ms. Wong said, appears to be that the central bank views the restrictions as temporary, to prevent panic-spurred capital outflows, compared to the more recent regulations aiming to draw capital to mainland China over the long-term. She added that she anticipates few restrictions on Chinese companies investing in assets overseas, a part of China’s long-term plan to internationalize the RMB.
Nevertheless, there doesn’t appear to be any definitive end to the cash-pooling restrictions and until there is MNCs may get some unpleasant news from their banks, which the PBOC apparently is monitoring more aggressively. “Although this is hearsay, it seems like regulators are monitoring banks very seriously. [Any funds] that are going out they’re really questioning a lot,” said a treasury executive at a major industrial MNC.
One of the treasury executives Ms. Huang spoke to noted that some MNCs have applied to the PBOC to set up cross-border RMB pools to sweep out surplus cash, and its verbal instructions to tighten RMB outflows has unexpectedly disrupted their cash repatriation plans.
This is viewed as a significant retrogression from China’s FX deregulation in the past few years, the executive told Ms. Huang. Treasurers who want to leverage the structure to send surplus cash out might have to go back to the old ways to manage their surplus in China. This expert added that treasury executives must explain the nature of the “verbal guidance” to their home offices and update them, to ensure the necessary understanding and support, and they should also be prepared for adverse impact on the CNH currency traded in Hong Kong and Singapore.
The other treasury executive said MNCs should anticipate regulators investigating bank clients’ dividend distributions, trading-related document compliance, and FX transaction compliance, as well as audits of overseas payments, both trade and nontrade. The executive listed several direct impacts on MNCs:
- They’ll have to devote more resources to compliance and audit defenses.
- They may have more idle cash reserves in China in the event cross-border fund transfers become suddenly unavailable.
- Their use of cash may become less efficient, as China essentially becomes an isolated island in terms of capital flows.
- FX risk may increase; for example, transferring idle RMB to USD may become more difficult.
- They’ll likely have to change payment and collection terms. For example, down payments to overseas vendors will become more difficult.