A couple of years ago, trapped cash in China was a major challenge to MNC treasurers with operations in the country. But in a flurry of regulatory changes, China has freed many restrictions on cross-border cash flows. Are we now witnessing the end of trapped cash in China?
Twenty five years of management and treasury experience in global companies. David Blair was formerly Vice-President Treasury at Huawei where he drove a treasury transformation for this fast-growing Chinese infocomm equipment supplier. Before that Blair was Group Treasurer of Nokia, where he built one of the most respected treasury organisations in the world. He has previous experience with ABB, PriceWaterhouse and Cargill. Blair has extensive experience managing global and diverse treasury teams, as well as playing a leading role in e-commerce standard development and in professional associations. He has counselled corporations and banks as well as governments. He trains treasury teams around the world and serves as a preferred tutor to the EuroFinance treasury and risk management training curriculum.
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Until recently, exchange controls dominated cross-border flows in and out of China. Trade flows were allowed but an arduous process of pre-approval by the State Administration for Foreign Exchange (SAFE) took time and effort from local staff of MNCs in China. Employees had to take stacks of forms, invoices, customs documents, and so on to SAFE offices to be chopped before taking them to their bank for verification and payment. We got this down to a fine art, but it still drove delays and inefficiency.
Capital account flows were much tougher. Long pre-approval through multiple government agencies was the norm, often including the ministry responsible for the industry sector. Short-circuiting the system could have ruinous consequences – for example improperly registered loans might be treated as income, thus taxed at 25%, and then there would be no paperwork to document getting the money out again.
Dividends have always worked – as long as you were prepared to graft to make them work. First you need audited accounts, then sign off from the tax department, then SAFE and possibly ministry approval – all this took three months at best, not to mention the expense and effort required. In short, cross-border loans out from China were only possible on an exceptional basis, with challenging approval requirements.
CNH trade flows
CNH is the unofficial currency code for CNY circulating offshore. The “H” refers to Hong Kong where offshore CNY first started. CNY is the ISO code for Chinese Yuan – sometimes called RMB (‘renminbi’ or ‘people’s money’) – and is the only code recognised by SWIFT and other official platforms. Despite occasional arbitrage, CNH = CNY – just as USD circulating in a developing country behind exchange controls may attract different interest rates than offshore USD, but is still USD.
CNH has been popular in Hong Kong since 2004. So much so that Hong Kong citizens regularly cross the border to Shenzhen to get cheap food and shopping and load up on CNY, well up to CNY 20,000 (sometimes for each child too) which is the cash limit crossing the border.
In June 2009, China allowed selected companies to trade cross-border in CNH. Since September 2011, any Chinese company (both local and foreign owned) can pay and receive CNH cross-border. Furthermore, since CNH is not foreign exchange under the remit of SAFE, cross-border CNH payments are not subject to ex-ante SAFE approval described above. CNH payments are approved by banks, can be 100% electronic (with an obligation to produce paper if audited), and thus fast and efficient. China has deliberately made it easier to pay out in CNH than in foreign currency, to boost internationalisation of CNY.
I still hear people saying that CNH flows are restricted to DMEs (Designated Mainland Entities – the lucky few in 2009), I want to reiterate that since September 2011, all Chinese entities can pay and receive CNH cross-border. This is a substantial benefit to any cross-border business in China from multiple perspectives. It opens the possibility of more efficient FX hedging and streamlined cash and working capital management.
“I still hear people saying that CNH flows are restricted to DMEs (Designated Mainland Entities – the lucky few in 2009), I want to reiterate that since September 2011, all Chinese entities can pay and receive CNH cross border.”
Last year saw the spread of two routes for inter-company lending from China to offshore. SAFE introduced a programme for inter-company loans in foreign currency. This has been popular with MNCs who accumulate FX onshore and do not want to convert to CNY. The downside is that SAFE requires case by case pre-approval of each facility.
SAFE also introduced FX Concentration Header Accounts through which onshore entities can manage FX with bank accounts in Shanghai. Their purpose is to facilitate bringing corporate treasury onshore in line with China’s goal to make Shanghai an international financial centre by 2020. Amongst other things, FX Concentration Header Accounts are used to sweep funds cross-border thereby connecting onshore pools with global cash pools offshore.
The most popular cross-border inter-company lending scheme is the PBOC’s. PBOC has liberalised cross-border lending rules to support the internationalisation of CNY. Onshore entities can, reasonably freely, make cross-border loans to related parties offshore. In most regions, PBOC has delegated approval to commercial banks. In some regions it seems the local PBOC is approving facilities itself, but firstly the approval is not onerous and secondly, it is easy enough to do the loans through bank accounts in Shanghai (where approval is delegated to banks) so this is not a big impediment.
These cross-border inter-company loans can be implemented as simple bullets, or as term loans under a facility, or as a bank-automated sweep. The latter provides a route to integrate China liquidity to global liquidity pools in a fully automated and efficient manner.
Sweeping is allowed in both directions – out from China and into China – but the net balance (for the time being) must be a net loan from China to offshore. Treasurers are keen to see full two way sweeping, and PBOC is trialling this in the new Shanghai Free Trade Zone. This trial is widely expected to go nationwide soon.
The maximum amount of these inter-company loans is capped at the total capital of the onshore entity. There is some disagreement amongst commercial banks about the group limits when connecting onshore pools to global pools. In any case, the cap is high enough to allow considerable flexibility for MNCs operating in China.
I imagine many readers are thinking this is too good to be true. China is a large and complex country, and will provide years’ more excitement for treasurers, but what I describe above really is available, and really is not that hard. Treasurers who have implemented these solutions – even when they needed to get pre-approval – generally report that the internal issues (like getting board resolutions to open new bank accounts and change management) were more challenging than the external ones (like regulators and banks).
Yields on CNH are lower than CNY, so, once you have got your CNY offshore, you need to do something with it. The most common choices are to:
Keep CNH in a notional pool offshore (and drawdown other currencies).
Use CNH to pay internal or external suppliers.
Swap CNH to another needed currency.
A combination of the above.
Farewell to trapped cash?
To sum up, as of now: any entity can pay and receive CNH cross-border without pre-approval; FX can be swept on and off shore with SAFE approval; CNY can be swept offshore without pre-approval.
Surely, that should pretty much take care of trapped cash? Well, at the very least, it certainly gives rise to a more nuanced view of trapped cash. We can say that regulations and particularly the exchange controls are no longer such a big problem in China. The tax constraints (both onshore and offshore) are likely to remain unchanged, but that is another can of worms entirely. So, yes, I think we can say this is the end of (regulatory) trapped cash in China.
As a postscript it is remarkable how quickly these changes have been rolled out. It shows that China is very serious about internationalising CNY and also very serious about bringing more market discipline to onshore markets. Watch this space very closely.
The views and opinions expressed in this article are those of the authors.