By Geri Westphal
Are treasurers taking too long to embrace the surging RMB and its benefits?
As with any new change there are some companies who forge ahead to be at the forefront while others hang back to wait to see what problems pop up before committing. And what’s been clear after three stops of a five-city renminbi roundtable roadshow sponsored by The NeuGroup and Standard Chartered is that many treasurers are still taking a wait-and-see approach to their RMB internationalization strategies. What’s the hold up?
Be ready for change
The conundrum is that the velocity change in the RMB landscape could catch US MNCs off-guard and unprepared if they are not monitoring the situation closely. They need to take the initial steps now to lay a strong foundation that will be necessary to support the exchange of RMB. If treasurers fail to grasp the pace of the RMB changes and the opportunities associated with these changes, it could be at the expense of their business.
A common takeaway so far from the RMB Roundtable series, called “The Path to Bolder RMB Implementation,” was the clear judgment that now is the time to take steps to implement two very basic strategies for RMB internationalization:
1) redenomination of trade to RMB and
2) the creation of a cross-border lending program.
Both of these strategies are seen as clear winners and can help lay the foundation for future enhancements as regulations continue to change.
Redenomination of Trade
We hear many MNCs comment that “we settle in USD, so there’s no exposure for us in China.” This may not really be the case since most Chinese companies that are accepting USD as a form of payment have already built a currency component into the contract. By changing the USD invoice to an RMB invoice, MNCs have the immediate ability to more closely monitor and manage the currency exposure.
“…start this process very early-on. Meet with your local auditors and make sure they understand and agree with your program.”
— RMB Roundtable attendee.
By taking a big-picture view, Standard Chartered Bank estimates that companies can realize cost savings of 2-3 percent based on the elimination of a lack of price transparency of the underlying cost of good. In addition, the increase in the yuan trading band has increased the propensity of the two-way movement of CNY, thus making it more costly to manage FX risk onshore. By managing FX risk directly, US MNCs can eliminate the FX premium and ultimately make contracts cheaper. Do the math. This can have a significant impact and can add up quickly.
“You want to switch to RMB invoicing proactively when you have the time to undertake what will be a significant project, and not reactively when an important supplier calls and says suddenly that they want to be billed in RMB,” said a recent attendee to the NY RMB Roundtable Meeting. As internationalization continues, there may come a time when suppliers or regulators demand RMB invoices.
“This is the future,” said Tina Kobetsky, Vice President and Treasurer at VMware. “Set yourself up to win by redenominating your trade now. Test it first with intercompany trade and then with one or two trusted Chinese counterparties. You can take it slow, but you are strongly encouraged to begin as soon as possible.”
RMB in the SDR?
The International Monetary Fund will this year conduct its twice-a-decade review of its Special Drawing Rights (SDR), an international reserve asset based on a basket of four major international currencies: the dollar, euro, pound and yen. There is speculation the IMF, based on the growth of the RMB so far, will add it to the basket. If this happens, its internationalization prospects would get a hefty boost. That’s because central banks would become holders of RMB exposure through their SDR assets. This official recognition of the RMB’s reserve currency status would likely then spur RMB investment by central banks all over the world, particularly those in developing countries looking to hold yuan assets and diversify away from dollars. Inclusion could propel the RMB past sterling and yen in usage.
RMB Cross-border Lending Program
Another great strategy for using excess cash in RMB is to create a cross-border lending program that allows you to move funds in and out of China. When asked the question at a recent RMB Roundtable meeting of why would you want to lend money offshore, a large MNC with a strong presence in China said, “We felt like the balances in-country were increasingly significantly and we just wanted to reduce them. Creating the cross-border lending program allows us to move funds out of China to areas of our business that need the excess cash.”
Two common structures most often implemented as part of a global liquidity solution include the one-way and two-way RMB cross-border lending programs. The one-way program is best used for trapped cash and allows for pool participants to consolidate funds to an RMB header account using entrustment loans. The funds are then moved to an RMB Special Account for movement offshore via intercompany loans. Based on new guidelines, the documentation required for offshore trades is significantly easier that it has been in the past. Before, it meant stacks of supporting documentation and now it is one double-sided piece of paper.
The two-way structure is best used for operational cash and allows borrowers in the Shanghai Free Trade Zone to borrow funds from offshore for the purposes of working capital requirements.
“There is a first-mover advantage [to dealing with the Chinese government]…they are willing to listen to your input.”
— RMB Roundtable attendee
This flow of funds does not require Peoples Bank of China (PBOC) approval and does not consume Foreign Debt Quota (FDQ). Using this structure, there is a two-way flow between the RMB Special Account and the Global Offshore Pool Header.
review and approval hurdle
Based on feedback from roundtable attendees who have already embarked on this type of strategy, the most time-consuming task is to have your transfer pricing plan reviewed and approved by the appropriate agencies.
“I would recommend you start this process very early-on,” said one attendee. “Meet with your local auditors and make sure they understand and agree with your program. You will need their buy-in.”
The attendee added that the transfer pricing program is critical. “It must include a reputable market rate and must be considered arm’s-length,” she said. “Talk to the authorities that audit your books. Get them comfortable with what you are trying to do and why you just don’t want to pay a dividend.”
The biggest challenge with setting up cross-border lending for China is getting an arm’s-length interest rate for the intercompany loan. China shares this problem with many developing markets in that there is not a well-established benchmark rate that everyone identifies with. Given the significance of the China market, it pays to do the work internally with tax and legal and external experts to conduct a thorough transfer pricing study to justify the rate choice in the context of the loan structure.
Communicate, communicate
Walking through this study with local Chinese tax authorities will help increase their comfort level that the choice is an acceptable one.
“There is a first-mover advantage because they are willing to listen to your input and suggestions,” said one Chicago RMB Roundtable attendee.
“The PBOC is very open,” another attendee said. “From a policy perspective, they are trying to accommodate you but they are unable to guide you through any of the implementation process. It is very important that you speak to your local tax authorities; they are the organization that needs to buy-in to your structure and understand your policies. You need to have their blessing.”
The internationalization of the RMB is an irreversible trend and the speed of adoption across the globe will only increase. US MNCs would be wise to move the priority of this project to the forefront and work to lay the foundation now. Continuing to “wait-and-see” could prove to be a very expensive decision.