The Shanghai Free Trade Zone (SFTZ) has been a hot topic this year. But is the SFTZ really critical for treasury in China? In this two-part Insight, we talk to Acarate’s David Blair about the zone’s impact, as well as nationwide schemes that are changing the face of liquidity management in the country.
The story so far
Although Prime Minister Li KeQiang recently expressed dissatisfaction at the progress of the SFTZ, for treasurers, there have already been some significant developments. While the zone has a broad scope well beyond corporate treasury, the SFTZ nevertheless shot to prominence in treasury circles as the test bed for liquidity management solutions that effectively open China up for corporate cash management.
But first of all, let’s recap on the development in China so far. A decade ago, CNY was a controlled currency, and moving money in and out of China required approval and registration with the State Administration of Foreign Exchange (SAFE). Incoming capital had to be registered and handled in special equity bank accounts. Outgoing trade payments required taking a stack of paper to the local SAFE office to get their chop (red official stamp), which then had to be taken to a bank to initiate payment.
SAFE was the only regulator involved in cross-border transactions because CNY was not convertible. Treasurers knew that the People’s Bank of China (PBOC) set the interest rates that banks charged and paid to their subsidiaries, but had few direct dealings with the central bank.
In 2004, PBOC allowed Hong Kong banks to offer retail CNY services. This facilitated Hong Kong citizens bringing back CNY from their weekend shopping trips in Shenzhen to benefit from the carry trade. They had nowhere to deposit their CNY, however, so in 2007 PBOC allowed CNY bond issues in HK – so called dim sum bonds. A few Western MNCs have availed themselves of this opportunity.
In 2009, things became even more exciting as the PBOC launched a pilot scheme allowing selected corporates to settle commercial flows cross border in CNY. This is especially interesting because, until 2008, only SAFE regulated cross-border transactions. There were now two regulators, cross-border, in and out of China:
Since then, progress has been rapid – but not always clear. “Most notably, PBOC completely opened up cross-border commercial flows in 2011, but there remains a lot of confusion in the market about this,” says David Blair, Managing Director at Acarate. As of January 2011, any company in China can settle commercial invoices cross-border in CNY. Also, CNY cross-border flows are regulated by PBOC; and PBOC has delegated the checking of documentation to banks, so corporates can pay CNY cross-border electronically and straight-through processing (STP) (whereas when corporates pay FCY, a stack of documents still need to be chopped by SAFE before payment).
“This obviously gives a big boost to China’s ambition of internationalising their currency – a goal which is strongly supported with an impressive web of swap lines and new regional and global multilateral banks,” adds Blair.
Cross-border liquidity management
The PBOC then began to allow pilot corporates to sweep excess CNY to offshore locations. Then, very quickly, they opened up the scheme nationwide, and delegated approval to the banks – which makes implementation much easier. Many thought that this was the end of trapped cash in China.
Yet treasurers are demanding people. “The PBOC might have expected some gratitude for ending the trapped cash problem,” says Blair. “Instead treasurers complained about the lack of two-way flows – they wanted to be able to lend in to China as well as get cash out of China.” In response to these calls, the PBOC implemented some pilot two-way sweeps and in June 2014 announced nationwide two-way sweeping with approval delegated to the banks.
Foreign currency flows
Not to be outdone, SAFE has also been working on FCY flows. It has implemented the FX Master Account (FMA) to encourage corporates to do their global cash management in Shanghai. It has also implemented cross-border two-way sweeping, first in Shanghai, and nationwide since June 2014.
“The big difference is that SAFE wants to approve all quotas before implementation,” says Blair. “Whereas the PBOC, partly because they did not have the infrastructure to approve corporate quotas, has consistently delegated authority to the banks after the initial pilots. Of course, PBOC can audit the banks any time, so there is no risk of non-compliance.”
Shanghai Free Trade Zone
The SFTZ has been an important test bed for both SAFE and PBOC pilots. The question now is: does the zone still matter, given that both SAFE and PBOC opened up their two way sweeping schemes nationwide in June 2014?
At recent conferences, this has been a topic of debate. “Many treasurers are playing the waiting game and sitting back to assess whether they should establish a base in SFTZ (or another FTZ),” says Blair. Others are just getting on with it, and apparently succeeding.
The recent EuroFinance conference in Shanghai came just after PBOC notice 324 issued in early November 2014. “Notice 324 details the implementation rules for nationwide cross-border two-way sweeping,” Blair explains. “Companies must be large and established, net inflows may not exceed 10% of China group companies’ total equity including retained earnings, net outflows have no limit but the group onshore cannot borrow to sweep offshore, and the sweep must be done from a dedicated account with a bank experienced with cross-border CNY.”
Against this backdrop, SFTZ may still have a small edge over nationwide schemes because SFTZ sweeps do not have a pre-set limit. That said, they are subject to monitoring and users expect that PBOC will object if amounts get too large. “This regulatory largesse probably stems from the tight conditions for setting up in SFTZ in the first place,” Blair notes.
As a reminder, the above applies only if you want to lend CNY into China from offshore. If you want to get CNY out of China, that has been open nationwide for a while and is working well. According to Blair, “If you want to settle commercial invoices cross-border in CNY, that has been open nationwide since 2011 and is working smoothly. This possible benefit of SFTZ applies only to corporates needing to lend CNY into China cross border. Of course, you can still do it the old fashioned way with a FCY intercompany loan registered with SAFE.”
In short, if you do not already have a presence in SFTZ, Blair believes that it does not make much sense to set one up for liquidity management purposes. “Everything you can do in SFTZ, you can also do nationwide. PBOC notice 324 has confirmed nationwide cross border two-way CNY sweeping on reasonable terms. There is a small advantage of larger inbound quotas in SFTZ; no one has yet complained to me about quota sizes.”
It has also been suggested that the quotas inside the SFTZ might be more generous than the quotas applied nationwide. This can only be validated next year when the detailed guidelines are out. The quotas are generally based on the capital of the corporate, or the group when the sweep is from a domestic cash pool.
It’s a wrap…
The conclusions to be draw from this so far are:
SFTZ does not seem to offer material benefits to treasurers.
Anyone can settle commercial invoices in CNY.
Anyone can sweep CNY out of China.
Anyone will be able to sweep CNY into China next year.
PBOC has made CNY very attractive by delegating approval to banks.
This in itself is amazing progress in a very short time.
In the second part of this Insight (next week), we look to dispel some of the myths around the new liquidity management landscape in China.