Treasury
Management in China
Corporate treasury management is a complex
term. Loosely defined as the management of a company’s monetary
assets and liabilities, financial risks and banking relationships
the term also encompasses processes of cash management, managing foreign
exchange and interest rate exposures. It really is an onion with many
different layers!
In China, as ever, things can be even more complex
and the rules of treasury management are a little different from other
parts of the world. In fact, not only are the rules a little different,
a few years ago it might have seemed like a totally different game
altogether. World Trade Organisation (WTO) entry may not be the miracle
needed to revolutionise treasury operations in China, but companies
are certainly starting to benefit from gradual improvements in the
system.
The
Problems in China
In assessing the various treasury management options
currently available to foreign enterprises operating in China, it’s
important to begin by examining the inherent problems. First and foremost,
and potentially the biggest hurdle to the continued growth of the
Chinese economy, is the sick state of China’s banking system.
Just last week the head of the newly created China Banking Regulatory
Committee declared that “time is running out for the banks.”
Officially, non-performing loans in China’s
state-owned banks amount to about US$500 billion, 25% of total outstanding
loans, though this figure might be much higher, with some estimates
as high as 50%. Whatever the case, China’s banking system is
dangerously weak. The Chinese government has suggested that China
can simply outgrow these bad loans. This option however would put
Chinese banks in an unfavourable position whereby they would be unable
to operate according to international standards and also making banking
reform increasingly difficult.
Not so long ago, cash management in China was a hair-pulling
event. Couriers travelled miles, hauling bags of cash to settle payments.
Progress has been made however following the implementation of a national
inter-bank clearing system called the China National Payments Network
(CNAPS) at the beginning of 2000. Introduced by the People’s
Bank of China (PBOC), the country’s central bank, there are
now over 20,000 direct clearing members and 80% of the transfers arrive
within twenty-four hours.
As foreign investment in China continues to grow,
so will the demands of multi-national companies for banks in China
to provide more efficient cash management solutions. The introduction
of CNAPS has certainly made things easier but the banks still lack
the level of sophistication and array of products available at foreign
banks. A mainly paper based system means there are still delays in
payments and collections. Most importantly, all foreign exchange dealings
are still closely monitored by the State Administration for Foreign
Exchange (SAFE).
Another obstacle to the efficient management of a
company’s cash flow is the regulations in China concerning borrowing
and lending between different companies and even between subsidiaries
of the same company. As far as cash management is concerned related
companies are in fact very much unrelated. As such, subsidiaries with
surplus funds cannot technically support subsidiaries in deficit,
primarily due to restrictions of business scopes.
More
Than Just a Survivial Tool?
In Asia, most companies still view cash and treasury
management as nothing more than survival tools; processes to ensure
that payments are made on time and receivables are collected quickly
to keep the business running. Why then is treasury management becoming
increasingly important for companies on China?
The Asian economies have enjoyed something of a roller
coaster ride since the financial crisis of 1997. Treasurers in China
need to prove they can manage their assets around the risk provided
by such a turbulent economic environment. In short, managing such
risks are essential in order to minimise future cash flow problems
and provide for careful financial planning and forecasting. It is
important for foreign companies in China to identify those risks that
offer the biggest threat and implement a system of tracking such risks.
Generally companies are not in the financial risk
game. Rather, depending on the nature of the company's business, the
primary concerns, particularly for the treasury department, will be
to minimise interest costs while at the same time managing financial
risk within limits established by senior management or the board of
directors.
China
as a Treasury Hub?
One sign that corporate treasurers are beginning
to get serious about China is a readiness to set up regional treasury
centres in the country. Regulations concerning the development of
regional headquarters in Shanghai issued in July 2002 stipulated that
Shanghai headquarters would benefit from further regulations designed
to improve their efficiency in cash and treasury management in the
future. When, in October 2002, JPMorgan announced the introduction
of a full range of RMB services in four Chinese cities by 2003, the
bank also announced the introduction to China of its global risk management
tools and capabilities. JPMorgan's Chairman for Asia Pacific declared:
"With the increasing challenge of competing
in a global environment, Chinese enterprises and foreign-invested
entities require more sophisticated and effective asset and liability
management tools to reduce their funding costs and financial risks
as well as to increase cash management flexibilities. The current
environment of low interest rates, weak equity valuations and high
foreign exchange volatilities provides the ideal backdrop for the
introduction of these new services.”
The creation earlier this year of a new independent
banking regulator has left the Central bank, PBOC, free to concentrate
on monetary policy, and in particular on the much-needed needed liberalization
of interest rates. The government also seems keen to revive its programme
to clear up the bank’s bad loans, and late last year allowed
Goldman Sachs and Morgan Stanley to form joint ventures with one of
four asset management companies set up in 1999.
The
Growing Demand in China
It’s apparent then that in the current economic
environment, demand for more efficient cash management and treasury
services in China is on the rise. Just as the introduction of an inter-bank
clearing system helped to ease the restrictions in moving cash, so
have other barriers fallen by the wayside. Finance managers in China
are discovering that strategies to get around the problems do exist.
Previously companies would bypass the restrictions on inter-company
loans through back-to-back loans. Under this arrangement a company
in surplus would deposit a sum of money to a bank, which would then
lend the same amount to the depositor's related company, at commercial
interest rates.
Recently however, company's have taken advantage
of a WTO concession to introduce a new financing scheme called entrust
loans.. Under the scheme one subsidiary can lend its own funds, at
its own interest rate, to another subsidiary. All the former subsidiary
has to do is entrust a bank that will deliver the funds to the latter.
Entrust loans are cheaper since the former subsidiary determines its
own interest rate, and only pays the bank an administrative fee of
about 0.5 percent of the loan amount. As one CFO in China explained,
it's just like transferring funds from my left pocket to my right
pocket.”
Alternative
Strategies
In China it is also common for foreign companies
to have multiple sales branches scattered throughout the country,
collecting sales products locally, resulting in idle balances left
in branch accounts and inadequate central control over branch bank
accounts. These issues can be addressed via establishing a sweeping
structure whereby all branch offices open collection accounts with
one foreign bank.
If a particular branch is located outside of a foreign
bank's permitted area of RMB business, then the foreign bank should
arrange to open a collection accounts with a partner local bank. Headquarters
should set a minimum branch account threshold and when the funds in
a branch account fall below the minimum amount, they will automatically
be swept to the company's main concentration account.
Currency risk represents a considerable threat to
a foreign companies operating in China since the RMB is non-convertible
on the capital account. The PBOC has been so far reluctant to launch
RMB derivatives instruments on domestic interest rates and currency,
partly due to concerns about the stability of the onshore market.
Currently the only RMB derivatives product available to domestic and
foreign companies is a six-month RMB forwards market.
Hedging in China is primarily designed for short
term trade related purposes, to lock in payment for imports, for example,
and the size of the trade is limited to the value of the imported
or exported goods. Documentary evidence and proof of payment must
be provided which can prove problematic if the company does not receive
an invoice in time. As long as the documentary evidence is procured
however, the market functions satisfactorily.
An alternative option in China since foreign exchange
is strictly regulated by the central bank is the non-deliverable forwards
(NDF) market, based offshore and settled in US dollars. By some estimates,
volume in the RMB NDF market has increased by 30% since China's accession
to the WTO. Trading in the NDF market can be expensive however and
most agree that a truly effective tool for hedging RMB does not yet
exist. Foreign companies tend to use simpler strategies such as matching
debts and assets, and sourcing products onshore to avoid currency
risk. A large majority of profits in RMB generated by foreign entities
are used to build the business and the infrastructure of the company's
China operations. Elsewhere, companies are increasingly relying on
RMB-denominated loans for projects in China to offset currency risk.
In order to further minimise risks resulted from
deferred payment such as interest rate risk, currency risk, credit
risk and political risk companies might consider forfaiting. A form
of non-recourse financing, forfaiting is the discounting of an exporter's
future receivables on a without recourse basis. Forfaiting helps to
improve a company's cash flow because current trade receivables become
current cash inflow and it helps the exporter improve its financial
status and liquidity, whilst also enhancing the exporter's fund raising
capability.
The
Road Ahead
While utilising some of the above methods can help
to considerably improve the efficiency of a foreign company’s
treasury operations in China, it’s very clear that there is
still along way to go. China's entry into WTO has made life that bit
easier, but has by no means solved all of China’s cash management
problems. Cash management is becoming increasingly efficient, but
maximising returns from excess funds is a still a tricky procedure.
A complete liberalisation of the market in the near
future is unlikely and a great deal of uncertainty surrounds the future
of the country's banking system. It is evident that, above all, any
company looking to improve the efficiency of their treasury operations
in China should first seek expert advice from a bank or a suitable
business advisory firm.
Treasury management in China is changing
rapidly. The road ahead will require a great deal of patience but
offers potentially massive rewards.
Michael Pennington,
LehmanBrown, Shanghai
