Cash & Liquidity Management

Question Answered: Dealing with trapped cash

Published: Jul 2024

“How should treasury approach the problem of trapped cash?”

Dollar notes stuck in a mouse trap

Sidhanth Hota

Group Treasurer
Airtel Africa

The most common reason for trapped cash is a lack of currency convertibility, and challenges finding hard currency which may be a factor of investor appetite, regulatory backdrop and other factors. The reasons for a lack of dollars varies country by country, and the solutions are also country specific. Witness how 12 months ago, there was a notable lack of hard currency in Nigeria that resulted in uncertainty for businesses trying to plan. It was difficult to calculate the rate of return on investment or plan capital expenditure.

A few months ago, along with other supportive macro-economic factors, Nigeria’s Central Bank came up with new regulations to promote better FX price discovery which included having to devalue the currency. Devaluing a currency is a painful process, and businesses may take some level of losses if they aren’t hedged. But having better certainty and price discovery gives investors the confidence to invest because they are more confident of being able to repatriate the returns of their investment. It also has a long-term benefit for the economy.

Kenya is another example of how the exchange rate and currency scarcity can be dynamic. Between 2021 and early 2024 Kenya’s currency was subject to meaningful devaluation and currency availability was sometimes reduced due to certain macroeconomic factors. In the last four months the Kenyan Shilling has seen meaningful appreciation against the US dollar and there is a marked improvement in foreign currency availability. Corporates in frontier markets, may have periods of trapped cash and uncertainty and navigating it involves a certain amount of hustle. This means calling on banking relationships for support until macroeconomic factors correct and foreign currency becomes more available.

Our treasury is entrenched with global, regional as well as local banks. Sometimes local banks have the largest network to find you solutions to navigate volatility in these markets, including trapped cash. Once a currency corrects and the economics turn more favourable, we look to find solutions for utilisation of the trapped cash. This is the art of managing esoteric currencies in Africa.

When it comes to hedging, we prefer deliverable hedges, although they may cost slightly more since they hedge exchange rate as well as convertibility risk – aka having deliverable FX at the end of the term. Sourcing the currency can be a meaningful portion of the risk in some emerging markets.

Businesses need a local bank presence and expertise, but to drive more sophisticated solutions they also need strong global relationship banks that can design bespoke products. It is therefore important for us to have the right balance, and a multi-bank approach. We notice in Africa some regional banks have very developed technology that is equal or better than global banks working off legacy systems.

Smartphone penetration is less than 50% in Africa and much behind the rest of the world. African countries have some of the youngest populations in world. We have to manage the volatility, but this is part of our business model because we recognise the exciting opportunity to continue our growth and the growth of digital and financial inclusion in the continent.

Robin Tabbers, Director, R&P China Lawyers

Robin Tabbers

R&P China Lawyers

For numerous foreign companies operating in China, efficiently repatriating profits earned in the country has been a persistent challenge. Leveraging NAV loans is one way businesses in China can strike a balance between accessing the necessary capital for growth and maintaining liquidity. NAV plays a crucial role in capitalising companies, particularly during their early stages in China. One significant aspect of this is the utilisation of NAV loans, wherein a loan of up to 200% of the capital can be obtained. This approach offers distinct advantages, as the loan can be repaid easily, resulting in less cash being trapped within the Chinese market.

Dividend distributions have been the conventional approach to bringing funds back home, but the process isn’t always straightforward and can be costly. Foreign-Invested Enterprises (FIEs) in China typically face a 25% corporate income tax (CIT) on their gross profit, and an additional 5 – 10% withholding tax when remitting dividends offshore, subject to any applicable double taxation agreement (DTA).

Moreover, dividend payments can only be made if the previous years’ losses have been offset, and FIEs are required to set aside 10% of their annual profits into a reserve fund until 50% of their registered capital is reserved. As a result, a considerable amount of cash gets trapped within China.

To mitigate the extremely delayed remittance of dividend and lack of interim dividend distribution options, foreign investors have been considering alternative approaches to dividend payments. One such method is charging their Chinese subsidiaries service, management or royalty fees, which allows for greater flexibility and avoids some of the limitations imposed by dividend payments. However, it is important to note that taxes, specifically CIT, may be once more generated in the shareholder’s home country as a result of this fee income.

A more flexible and tax-efficient alternative is leveraging outbound intercompany loans. This method allows companies to repatriate remaining cash while providing the flexibility to reinvest back into China when necessary for business expansion.

There are two primary schemes for extending loans to offshore affiliates: loans in foreign currency regulated by the State Administration for Foreign Exchange (SAFE) and RMB loans regulated by the People’s Bank of China (PBOC).

Companies such as Coca-Cola have successfully utilised the PBOC scheme, enabling them to send a RMB250m loan to an offshore affiliate within a mere tenworking days. Reports also indicate that medium-sized companies have successfully repatriated cash using this method. In comparison to dividend distribution, outbound loans offer two significant benefits: greater flexibility and a deferral of the 10% dividend withholding tax. As with any business practice in China, variations exist between cities and even districts, and individual banks maintain their own approval policies. It is crucial to consult with legal professionals and your bank at an early stage to determine the specific local requirements when utilising intercompany loans to release trapped cash.

In addition to intercompany loans, two other recent developments deserve a mention. Multinational corporations established in the Shanghai Free Trade Zone can now establish a two-way RMB cash pooling system, integrating their onshore RMB cash flow generated throughout China with their global cash pool, subject to certain restrictions. Some major MNCs have already implemented such cash-pooling systems with reputable banks.

Another method for utilising trapped cash involves providing it as collateral for loans obtained by offshore affiliates. While this was previously achievable by providing a guarantee to a PRC bank, the process has become much more streamlined.

Marion Reuter, Regional Head of Transaction Banking Sales UK/Europe, Standard Chartered

Marion Reuter

Regional Head of Transaction Banking Sales UK/Europe
Standard Chartered
Desiree Pires, Head of Corporate Sales, Markets, Europe, Standard Chartered

Desiree Pires

Head of Corporate Sales, Markets, Europe
Standard Chartered

One of the biggest risks of trapped cash comes from significant depreciation in the local currency. Any devaluation will erode the value of the cash that might be trapped in country, but it may be possible for corporates to hedge this risk.

Traditional FX hedging solutions are not available in all countries because many lack a liquid forward market. However, non-deliverable forwards are being offered by banks in an increasing number of currencies and could be used to hedge an exposure. We are also seeing a growing FX options market in some emerging market countries, including Africa. In certain cases, these may be an attractive solution from a cost perspective when compared against the cost of rolling forwards, especially given the potential for significant currency moves in these markets.

Corporates also have other options away from traditional hedging. Longer-term, companies could consider agreements with suppliers or customers requesting payment in chosen currencies that reduce the risk of trapped cash, or can be used to offset and reduce net exposures. MNCs can also navigate the problem by keeping funds in a stable currency. But this is complicated by restrictions on opening non-resident accounts.

Working with local banks can also help. A mix of local and international banks can support MNCs sourcing additional pools of liquidity in certain markets, although it does depend on the underlying requirement. For example, whilst more than one bank may help with FX liquidity, multiple local banks from a cash management could result in process inefficiencies and increased operational risks.

Partnering with different banks involves bringing different account statements into one system and there will be local banks that are not on Swift. They can’t send structured MT940 messages which makes it difficult for treasury systems to pick up the information in an automated way. This means that even though technology like ERPs support corporates doing business in the region, sometimes it doesn’t.

Still there are digital solutions. For example, it’s possible to automate cross-border currency payments that reduce the administrative burden for treasury and avoids having multiple currency accounts, especially for minor currencies.

Another trend we see is that companies are setting up regional treasury centres to manage Africa more regionally where also the Middle East and especially Dubai are upcoming locations. This works well in combination with a team on the ground.

The local team play an important role meeting documentation and central bank requirements that require people on the ground with an oversight of the local market. The centralised team based in the Middle East can then take decisions on the materiality of the different risks in the context of the group as a whole, leveraging group wide relationships.

Next question:

“Companies talk about the importance of sustainable and inclusive growth. What does it mean, and how is treasury involved?”

Please send your comments and responses to by 12th July 2024.

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