By Bryan Richardson
China moving away from the roach motel model where cash checks in but never checks out.
There is a little bit to be excited about in the world of treasury management in China. In case you haven’t heard, the border is opening up to currency flow, at least on a limited basis. But while it is in the early stages, the initiative being tested by the Chinese financial regulators is big news and is a big step for the country.
The Chinese financial regulatory bodies, SAFE (State Administration of Foreign Exchange) and the PBOC (People’s Bank of China) are both testing several schemes where currency can cross the border for both incoming and outgoing transactions. For a country that historically has been known for its very strict currency controls, this is major progress. So, one might wonder, “why the change of heart?” Locals on the ground cite several reasons.
China has been actively reaching out to Western firms and banks.
First, it is common knowledge that China wants the RMB to become more of a globally accepted and utilized currency and ultimately a reserve currency. None of that will ever happen if the currency can’t trade freely.
Second, China wants Shanghai to evolve toward becoming a global financial center on par with New York, London, Hong Kong and Singapore. To make this happen, the country can’t be perceived as one where cash goes in and never comes out. China is acknowledging that these old policies severely limit their ability to draw foreign business investment. As much as it has occurred already, foreign business investment would be even greater if companies knew they could get their profits out.
Third, China wants to be the location of choice for Asia-based regional treasury centers (RTCs). Many companies such as Ford, GM, P&G and Cargill have substantial treasury operations already based in China but many others are evaluating where to set up an RTC as their business seeks to expand in the region. In the current state, Singapore and Hong Kong often win out as the best location. However, given the growing importance of China for western businesses, RTCs based there would make good sense provided the business needs can be met.
Acknowledging their policies present significant challenges for Western firms wanting to do business in China, the Chinese government has been actively reaching out to Western firms and banks to solicit input on what they need to be more productive. Clearly they are listening and are moving to make life less painful.
Regulations are fluid and numerous—but positive. Lewis Sun, head of sales for HSBC’s Global Payments and Cash Management team, notes that 2012 and 2013 to date have seen both SAFE and the PBOC loosen their respective rules for the purpose of “foreign currency control reform.” SAFE is relaxing the administrative requirements while PBOC is broadening the role of the RMB. The overall focus has been on three areas:
- Exchange-rate liberalization
- Interest-rate liberalization
- Full convertibility
Mr. Sun says that “these are more fundamental to cash and trading than even the pilots.”
The cross-border currency programs being piloted are of keen interest to most MNCs, but particularly those with cash accumulating in significant quantities. For companies that are heavy users of cash, the pilots are less applicable. But several NeuGroup members are participating or preparing to participate in the various pilots. The topic has come up at peer group meetings in Singapore, China and the US, which gives further evidence of the level of interest globally.
Pilot Highlights
HSBC, a recent NeuGroup China peer group meeting sponsor, notes that there are multiple pilots between SAFE and PBOC for three different purposes and that there are three different types of customers that benefit from the pilots:
- Those with trapped cash in China
- Those who need to borrow offshore
- Those with cash pools outside of China
The pilots seek to ease restrictions associated with these circumstances and specifically moving RMB and USD in and out of the country. Following are summaries of three pilots:
1) SAFE’s cross-border foreign currency (FCY) centralized management. This pilot is for cash sweeping and foreign currency payments/loans between onshore and offshore legal entities. The scheme requires an International FCY Master Account and a Domestic FCY Master Account be set up with the same bank. (See illustration below.)
2) PBOC’s cross-border lending. This pilot is aimed at broadening the channels for onshore RMB flowing into the offshore RMB market. Eligible participants must be a “holding company” or “regional RTC,” “genuinely cash rich” and “self-funding,” or funding from RMB cash pooling.
Mr. Sun outlined some key considerations around this pilot:
- This is one alternative to deal with excess liquidity in China.
- Transfer pricing issue—must be an “arm’s-length” basis for inter-company loan rates.
- Potential tax impact with onshore/offshore transactions.
- Single company or via cash pooling— determines different lending quotas.
- Usage of the RMB funds in the overseas market.
3) PBOC’s simplified documentation for RMB cross-border settlement. The objective for this pilot is to further simplify the process of using RMB for international trade by allowing qualified entities to pilot RMB cross-border settlements without supporting documents. Criteria for participation includes:
- More than one year of sound relationship maintained with the pilot bank.
- Relatively stable global trade counterparties.
- Comparatively stable in nature, frequency and scale for its cross-border settlements.
- No bad records on credit, operational fraud, etc.
4) SAFE’s cross-border netting. Target is for inter-company netting of payables and receivables. Companies expect this program will ease FX transactions.
5) SAFE’s centralized payment and collection. Similar to number 4, it is intended to do just as the name implies and allow payments and collections in RMB from a centralized corporate entity such as an RHQ, holding company or even an SSC, on behalf of other company entities.
There are limits
The pilots do not allow unlimited volume. Quotas vary by pilot but are based on total investment in China for the sweeping pilot or the net outstanding balances for the inter-company settlements. However, quotas are not necessarily set in stone. One pilot participant observed different quotas between SAFE and PBOC and negotiated a higher quota with one regulator by referencing the higher quota allowed by the other regulator.
Are the challenges worth the benefits? This same pilot participant highlighted the big benefit of freeing up otherwise trapped cash to be used much more efficiently.
However, he also highlighted some drawbacks:
- Resource implications. The application process and subsequent reporting requirements and monthly meetings with regulators are a huge strain on resources.
- Tax implications. Consultation with your tax department is recommended. Also note that inter-company loans are likely to attract a 5 percent business tax and dividend payments can garner a 10 percent withholding tax.
- Scalability of the pilot program. It is uncertain how these pilot programs will evolve. In their current form, expanding the resource strains could be a non-starter.
need the right bank partners
These programs require a partnership with a participating bank. The Chinese regulators prefer participants use Chinese banks but that is not required. Naturally, Western firms will be more comfortable with Western banks. Deutsche Bank, JP Morgan and HSBC have been cited as qualified partners.
“But wait, I don’t want to move my cash.” An irony in this situation is that interest rates in China are notably higher than in other regions. Consequently, excess cash there will earn a much better return than in an investment portfolio somewhere else. The Chinese authorities frown on participants who don’t actually move any money. Mr. Sun advises, “Don’t apply unless you plan to act.”
The five-year plan
Opening the currency borders in China is a huge step toward globalizing the RMB and for making investment in the country more palatable. It also demonstrates how serious China is about bringing the RMB to full convertibility and a more dominant role in global markets.
Mr. Sun says HSBC believes the RMB will be fully convertible within five years. As everyone knows, Chinese regulators are very slow and cautious to evolve. But the Chinese government has been is driven by a strong desire to internationalize the RMB and broaden its financial influence globally.
In the meantime, not all is lost. As mentioned, interest rates in China are notably high, so your trapped cash is at least working for you. Additionally, some companies have used their trapped cash as guarantees to foreign loans to reduce their borrowing costs.