Asia’s strict regulatory environment has long been a problem for corporate treasurers seeking to optimise their group’s liquidity in the region. But with the pace of regulatory liberalisation increasing, the situation is improving. This article looks at some of the new options available to corporate treasurers trying to tackle the problem.
China is regarded as both the most important and most restrictive market in terms of liquidity management, but this is changing. A few years ago, the options for multinational companies (MNCs) in China wishing to repatriate excess liquidity were limited. Due to various restrictions on renminbi (RMB) conversion imposed by the People’s Bank of China (PBoC), companies could either release their trapped cash through dividend, royalty or service payments – which all have withholding tax implications – or through entrustment loans.
But there has been much change since then. Regulatory reforms are easing the cross-border flow of funds and helping companies to strengthen their liquidity management across the whole business.
In line with its long-term objective of improving the convertibility of RMB, the PBoC has relaxed controls on cross-border RMB flows through the introduction of schemes for inter-company lending, in both RMB and foreign currencies, and cross-border netting. Companies are now taking full advantage of the new rules. In early September, Kunshan President Enterprises Food Company Limited successfully completed a two-way cross-border RMB lending transaction. A few days before, Coca-Cola Beverages in Shanghai announced it had made an RMB 250m ($40.85m) inter-company loan to a London-based subsidiary.
Incremental reforms are also taking place in other historically restrictive Asian markets. In Malaysia, for example, the capital account restrictions introduced in the wake of the 1997 Asian financial crisis are now being lifted.
India, meanwhile, is now permitting companies to perform lending transactions to their overseas subsidiaries – providing, that is, the transactions do not exceed 400% of the company’s net worth.
The trend towards deregulation is an important development for corporates that are holding onto historically high levels of cash. Apple, for example, has built up over $100 billion in excess cash, albeit not all of it is sitting in Asia. Liquidity security is of primary concern for corporates following the financial crisis, which means that cash accumulation and deployment has become their biggest burden.
Cash management in a changing region
Companies are increasingly taking a global approach to liquidity management and want not just visibility and control but, most importantly, access to their cash. They need to be able to consolidate their cash and get their hands on it quickly. The problem is keeping up with the rules in all the countries that a company operates in.
Understanding just how to navigate these rapidly changing regulatory environments is crucial for companies wishing to take advantage of the new opportunities springing up in China and elsewhere, according to Andrew Ong, Asia Head of Liquidity Management at Bank of America Merrill Lynch (BofAML). Banks can help their clients navigate this complexity.
“For companies in Asia, a solid banking relationship characterised by local expertise, product innovation and global platforms is absolutely essential for unlocking trapped cash,” he says. “Corporations need to be confident that the organisations they bank with maintain strong relationships with local regulators, and are able to help them understand how and why policy is changing.”
Thomas Schickler, Global Head of Liquidity and Investment Products for HSBC’s Global Payments and Cash Management Business, agrees that a close banking relationship will be important to companies as the region continues to develop new rules. “We work very closely with our clients to help them to understand the direction of the regulations, plan for how this can impact the way they manage their liquidity and, where relevant, guide them through the process to seek the necessary regulatory approvals. At HSBC, we maintain relationships with regulators at all levels and participate in discussions with them about how the pilots should proceed, including the implications thereof for all of the concerned parties: regulators, banks and corporates.”
Due to the potential impact of Basel III on the availability of bank funding and the prospective higher cost thereof, corporates have heightened their focus on identifying diverse sources of liquidity. In a shift from legacy practices, in which liquidity was managed on a regional or single currency basis, treasurers are now focused on globalising their approach to liquidity management, says Schickler.
To that end, they are increasingly willing to trade off operational efficiency in order to be able to maximise the centralisation of their liquidity. “When treasurers look at the situation – particularly at the excess cash which is available to them in markets such as China, and even Indonesia and the Philippines – they will accept a more operational approach to tap the material excess liquidity that otherwise would have remained isolated.”
But there is a caveat to cross-border lending which treasurers need to be aware of, says Ong. Companies participating in the schemes are still subject to existing foreign debt quotas. This can be executed by establishing a new foreign currency international header account in a cross-border foreign currency sweep structure, thereby limiting all foreign currency movements between the international header account and the domestic foreign currency account to the specified State Administration of Foreign Exchange (SAFE) or PBoC quotas.
Key steps to unlocking your trapped cash
Drawing on his 17 years of experience working in treasury and cash management in the Asia Pacific region, ANZ’s Global Head of Liquidity Management at ANZ Transaction Banking, Philippe Jaccard, shares with Treasury Today his top tips for managing trapped cash in the region’s tightly regulated markets.
Do not underestimate the importance of cash flow forecasting. “First, I think it is important to put in a process to determine the true excess,” says Jaccard. A treasurer must know the right amount of cash to keep in a country in a normal business environment and, something which is of increasing relevance in the current climate, the right amount to keep in a stress environment. “There has been a lot of talk lately in the industry that cash flow forecasting is inadequate, which I think is a true assessment,” he adds.
Look at the options for inter-company lending. Once the true excess has been determined, an investigation can begin into where that excess has come from. If there is a month-on-month accumulation because the company is unable to spend it locally, then inter-company lending might be considered, either through physical or notional pooling.
Use ‘leading and lagging’. If an MNC has a distributor in China which is consistently long in cash, then the transfer pricing in accordance with country tax regulations could be adjusted so the value China buys at is more appropriate – a process referred to as ‘leading’. ‘Lagging’ is the reverse. “A firm with a manufacturing entity that is chronically long could, instead of collecting payments immediately, give their group buyer longer payment terms so that, in effect, they use their excess to finance operations offshore,” he says.
Work with your tax planner. If you’ve tried both cross-border inter-group lending, as well as leading and lagging, but you still have an excess of cash then you should begin looking at how you repatriate. “Once you get to this point, the problem is rarely an inability to do it – but rather the cost of doing it,” he says. In the US, for example, repatriation payments are subject to a tax rate of 35%. But this can be made more cost efficient by careful planning. One example would be to pool the equity investments of subsidiaries into a location where the profit and loss positions net each other off, thereby delivering the company a lower effective rate of tax.
A new dawn for Asia?
Despite the advent of limited cross-border lending in China, treasurers are not anticipating cash management within the region to be completely transformed overnight.
For example, in the 2012 Treasury Today Asia Pacific Corporate Treasury Benchmarking Study, almost a third of respondents stated that they do not see CNH/CNY actively being used for inter-company and third-party trade settlements. It will be interesting to see how much this changes in this year’s survey.
The ‘nirvana’ from a treasury perspective is to be able to pool cash in the same way as one can in Europe. “But that is almost impossible at the moment in Asia,” says Greenwich Associates’ Markus Ohlig. Although no one outside of the PBoC is entirely sure as to the exact timetable for the full internationalisation of the RMB, “the overall direction is now becoming clear. And looking back over the past year, the regulators have moved much quicker than a lot of people initially expected.”
Ong thinks that the pace of reform in China over the past year has been encouraging. “What was impossible just a few months ago is now a reality for some companies,” he says. Recent moves in Asia’s largest and most important economy might also signal the beginning of a wider shift towards currency liberalisation within the region.
The cross-border lending schemes that have been introduced by SAFE and the PBoC over the past year was an important step and one which Ohlig thinks will be followed by similar initiatives in the regions other emerging markets. “Over the past decade there has been a steady blurring of the boundaries between highly and lightly regulated markets. Although the changes in China in recent months have been more dramatic than those in other countries in Asia Pacific, they only serve to highlight the direction regulation is taking in the region.”
Good management of trapped cash requires effort
The experts all agree that companies should also focus on what can be done with the cash if it can be centralised and controlled more effectively. With relatively low interest rates persisting globally, cash held can be a drag on the overall return on capital. Therefore, getting hold of cash only resolves part of the problem.
Some companies are looking to invest longer term in an attempt to get yield, whereas others may accept more risk. Is there value in consolidating cash back home or in-region? Reducing or freeing up sovereign exposure may be a driver for others.
The shrewdest companies plan ahead and think about all these issues at the outset before expanding into a new jurisdiction. The way an investment is structured and funded can help lessen the amounts of cash that gets trapped. The objectives and capabilities of the company, as well as the involvement of local partners together with advice from your bankers and tax consultants, will all be needed to make prudent decisions – 20/20 hindsight is not enough. However, any structure will only be partly effective and you will need to be able to manage any amount of cash that is trapped.
Coping with nuanced regulatory regimes takes effort and may involve delving deep into a treasury’s workflow. For example, in certain markets such as Indonesia and Thailand, the local currency is not transferrable on a cross-border basis. Thus if a company wants to lend on a cross-border basis, they need to convert the currency, usually into US dollars.
Due to foreign exchange (FX) cost considerations, companies will accumulate a ‘normal amount’ of at least $1m or more that is truly excess cash before making the conversion, in order to receive more favourable pricing. However, to do this efficiently, a company needs to establish the accuracy of its cash flow forecast in order to truly understand what cash is surplus.
Looking to the future
Most observers agree there is a continuing trend to liberalisation. Countries are trying to protect but not inhibit growth and progress. Some bankers see the introduction of Basel III as providing an opportunity to harmonise approaches – Malaysia, for example, is one of the first adopters. Others are less certain and point out that investor flows out of the region are slowing government and central banks’ desire to continue along the path of deregulation.
Given the market stress recently affecting some Asian currencies – the Indian rupee in particular – might there not now be some hesitancy about following China’s path? “China has become a role model for other nations in the region. I think others will follow its lead, but each country has its own considerations and therefore its own agenda and schedule,” says ANZ’s Jaccard.
Companies are well advised to keep watching new developments closely, concentrate on their biggest amounts of surplus cash and stay abreast of what can be done now and in the future.