Capital controls are a function of both political and economic policy over which corporates have little or no say. The growth agendas of certain countries within Asia have loosened these controls to an extent, but recent slowdowns have seen the rules revisited. So, is your cash still trapped?
In a world where cash visibility, liquidity and sovereign risk remain major themes for international corporates, capital controls are a concern.
Corporates operate across a landscape of complex local and home market regulations where they generate and hold cash overseas. “In countries where inter-company lending, stringent capital frameworks, foreign exchange and taxation are regulated, they become key considerations for the repatriation of cash,” notes Kee Joo Wong, Asia Pacific Regional Head of Global Liquidity & Cash Management at HSBC. “This is often misinterpreted as a barrier to repatriation and is commonly referred to as ‘restricted cash’ or, more commonly, ‘trapped cash’.”
Whilst moving cash on capital account tends to be troublesome, moving commercial account cash is generally permitted by regulations. ‘Trapped’ or economic restriction impacts corporates on an intra-day, daily, quarterly or annual basis and there is a need to have good forecasting processes to counter the inefficiencies. All capital controls exist for good reason. But these reasons are subject to change as domestic, regional and global macro-economic conditions evolve and hence it is extremely important to understand the driving forces for an efficient plan, says Sandip Patil, Managing Director and Region Head, Global Liquidity and Investments, Treasury and Trade Solutions, Citi Asia Pacific.
Their primary purpose in China, for example, has been to encourage inflows but put the brakes on any likelihood of a runaway drawdown of the country’s foreign currency reserves, whilst at the same time maintaining a relatively stable RMB/USD exchange rate.
In November 2016, the Financial Times reported that Chinese authorities (PBoC and SAFE) had introduced “stricter vetting procedures” for China-based companies seeking to remit foreign currency for overseas acquisitions. Dividend payments and shareholder loan repayments by foreign investors were also subjected to tighter scrutiny, it said.
In January 2017, Chinese regulators started preventing banks from shifting RMB out of the country as part of their clampdown on loopholes under the country’s strict new capital controls regime. Not written down but verbally ‘agreed’ with banks, this so-called ‘window guidance’ was not codified in law and so theoretically makes it easier to turn the transfer tap on again as needed.
But RMB, in China’s push for liberalisation and internationalisation, is up against the vagaries of the global market. Since around 2015, the Chinese currency has been facing pressure to depreciate against the US dollar. In 2016, the value of RMB depreciated over 6% against the US currency. This is why the PBoC took steps to slow down and manage that decline by buying RMB. In doing so, it depleted its foreign currency reserve – from US$4trn to US$3trn.
Now, as the SEC pushes tentatively forwards with its rate rise cycle in the US, and the PBoC shows unwillingness to tighten monetary policy in the shadow of a Chinese economic slowdown, once more RMB is subject to downward market pressure.
According to Dr Ming Huang, Professor of Finance at the Samuel Curtis Johnson Graduate School of Management, Cornell University, quoted in a report by Trans-Pacific View journalist, Mercy Kuo, the Chinese central bank is “neither willing to let the RMB suffer a drastic decline due to considerations of financial stability and international trade frictions, nor willing to let its foreign currency reserve drop down to dangerous low levels”.
For the long term?
Such a scenario leaves the macro-economic risks including capital outflow, says Patil. Hence, it is not unexpected to see “precautionary measures”. However, with stronger fundamentals on commercial flows, the restrictions tend to change and hence, need dynamic calibration. With China’s 19th National Party Congress anticipated for November this year, Dr Huang expects capital controls to remain in place at least until then, “and possibly for much longer”.
Ong Shiwei, Global Head for Cash Liquidity Management, Standard Chartered, acknowledges that trapped cash has been a long-standing issue in parts of Asia. And whilst there may be regulatory changes that deepen the challenge in individual countries in the short term, she agrees that in the longer term, “this issue is not going away”.
“Countries that have been liberal in the past, such as Australia and Singapore are likely to remain as such, while cash will continue to be trapped in countries such as Vietnam, Sri Lanka and India,” Shiwei opines. Similarly, she does not expect to see any fundamental change in semi-regulated countries, such as Malaysia and Indonesia, where foreign currency can be moved cross-border but local currency is retained in-country.
“Recent trends show that we may be entering an era of protectionism,” comments Shiwei. She recognises that the countries that have been opening up, China being a leading example, are indeed taking a step back and looking into a long-term path towards liberalisation of their regulations and currencies.
Working within the rules
In light of volatile market conditions and pressure on emerging markets, protectionist regulations are typically expected to defend the market forces. Although Patil does not necessarily see this sustain for long, there is always a negative impact on trade and commercial flows till the protectionist mindset prevails.
Wong argues that regulations have been influenced by trade and monetary policy, foreign exchange reserves and interest rate differentials. “Understanding these regulations actually provides a window of opportunity for corporates to move funds with conditionality,” he notes.
Of course, the issues of liquidity and restricted cash have always been pertinent considerations for corporates, Wong adds. Treasurers have particularly had to address the issue of restricted cash in circumstances where their cash balances are sizeable, the means of alternate funding for the group are limited, the costs of borrowing are expensive, and of course where repatriation costs are prohibitive.
Indeed, for corporates in Asia, the key markets of China and India are notably high on the agenda for cash repatriation. The size of these markets coupled with prolonged periods of growth have led corporates to build up significant surplus cash balances, says Wong. As a result, he says treasurers are focused on understanding and adapting to evolving local and national regulations such as restrictions on capital accounts, repatriation caps related to ownership equity, and evidencing trade-backed documentation.
However, anecdotal evidence, in the form of a frank conversation with Treasury Today Asia, suggest that some banks are less than helpful with their corporate clients when it comes to managing their trapped cash, the reason being that those banks would rather keep that cash on their local balance sheets than shift it into massive pools in regional hubs.
This is just anecdotal evidence but some may say there’s no smoke without fire and if some banks are not making best effort to move corporate cash to where it best serves its owners, then trapped cash really is what it says it is – and corporate treasurers must remain vigilant for optimal solutions.
For the time being, foreign MNCs in particular will be compelled to use traditional methods for capital repatriation to the corporate HQ or elsewhere. These methods, such as creating dividends, royalties and management fees may, in certain circumstances, be augmented by procedures such as intercompany lending. “Interest rate optimisation also remains important to leverage the value of trapped cash,” notes Shiwei, “even if the capital is inaccessible outside of the country in which it was generated.”
It is a slightly different story for Asian MNCs. Here, trapped cash is a lower priority as companies are typically looking to develop a deep regional presence, and therefore are happier to maintain balances in-country for ongoing investment. It is worth noting that this scenario is less likely with cash trapped in other regions, such as Africa or Latin America, says Shiwei.
The fundamental risks of trapped cash, referred to at the start of this article, are forcing a corporate response as each jurisdiction takes steps to protect its own interest. “We are seeing increasing demand amongst customers for techniques to reduce trapped cash, not only for liquidity management purposes, but also to reduce sovereign risk,” comments Shiwei. “In addition, treasurers are seeking to simplify their cash management structures and rationalise bank relationships and accounts to optimise visibility and control as far as possible.”
Although remedies for trapped cash are somewhat limited, the creativity of the treasurer has nonetheless driven the implementation of investment policies capable of reaching across the countries of operation, says Wong. Establishing visibility and control of cash through information and data platforms offers clear advantages, whilst adopting formal liquidity and foreign exchange management strategies has enabled treasurers to automate physical sweeping in less regulated markets with yield interest enhancement for residual balances.
Alternate means, through collateralised cross-border funding such as deposit pledged loans, are also now being explored by the market, he adds. It is true to that some businesses are funding their China business from offshore capital, adds Patil. As long as China continues to be a manufacturing engine of the world, he feels such alternate models will always be experimented within the scope of defined regulations.
Tackling the problem
“The phrase trapped cash has a negative connotation but sometimes, it can be a less material issue financially,” argues Patil. Malaysia is seeking to reposition its economy in the face of current economic climate. With regulatory changes, the movement of cash is not as free as it was, he notes. Exporters are required now to repatriate dollars, partially convert to local currency and hold special accounts to take these actions. “Some of the changes increased trapped cash problems in Asia,” he notes. “It is not that the problem cannot be solved at all. There are flexibilities that the government has allowed ie deserving exceptions.” For corporates, as is the case in China, working with the banks and the Malaysian regulators can facilitate an easing of the flow, “so long as the intentions are clear and trust can be built”.
India is unlikely to see significant change in its status as a trapped cash market, says Patil. Domestically, the market is stable, the country’s financials are improving and it’s a growth market, he notes. From a cross-border perspective cash continues to be trapped: “It was trapped, it is trapped and is likely to be trapped for quite some time.” However, there are always options to use liquidity optimally locally and reduce costs/improve yields.
But thinking laterally, the net profits generated by corporates here can be deployed for the benefit of the local business allowing companies to grow more rapidly. The same growth story is happening in Indonesia, notes Patil. He does not feel companies need to worry too much about trapped cash under such positive circumstances.
Is it really a problem?
Indeed, if there is no material use for the cash and if it can be used to grow the domestic business faster, then clearly companies are not suffering from “the trapped cash problem as much”, Patil comments. And in certain circumstances, as is the case in Malaysia and China, working with the regulators and convincing them of company’s core objectives with that cash can secure approval for exceptions. Here, even with the likely conditions applied to such easements, more freedom can be enjoyed than would otherwise be available.
Better yet, the experience of trapped cash pushes companies to be more efficient, he argues. This sometimes leads to beneficial structural changes in the organisation. Where, for example, centralisation of treasury at a regional level is not possible because of capital controls, companies presiding over multiple legal entities in-country can bring these together. Clearly this requires flexibility with a consolidated treasury policy but this enables the creation of a single pool of liquidity across participants, and presents a case for consolidating banks in the process.
For Shiwei, techniques such as payments of behalf of (POBO) and receivables on behalf of (ROBO) offer the potential for a new approach to managing cross-border liquidity and even tackling trapped cash.
There are broadly two types of POBO and ROBO, she explains. The more popular approach is the funded scenario, with intercompany positions often implemented in conjunction with virtual accounts. “Realistically, this is only achievable in liberal economies,” she says.
A second approach in this mould is an agency or pre-funded concept which, if applied appropriately, could be a way of alleviating cash being trapped at all. “For example, rather than collecting receipts locally, a company may choose to invoice and instruct the payer to pay into an offshore account,” Shiwei explains. Clearly there may be some tax, documentation and service or management fee implications here, but in her view, such an approach represents a workable strategy for minimising trapped cash, alongside other techniques.
A wider conversation
The overarching need is for improved visibility, control, yield and, in turn, working capital and forecasting efficiency. The treasurer is in the front and centre of the response to this. However, it is a big ask of one function to drive such sweeping changes.
“The scope for strategic footprint expansion has a wider reach and should also include reference to aspects such as the geopolitical environment, foreign exchange controls, trade policies, inter-company and legal structures,” warns Wong. In such a case, he feels treasury is only one component of the corporate’s consideration when tackling the issue trapped cash.
However, with Patil’s view that the general status of capital controls is “not about to change significantly in Asia in the near future”, treasury’s input is vital. “Just because there is trapped cash, it does not mean a company should give up. There are lots of positive changes they can make and treasury’s role should be front and centre.”