Hugo Parry-Wingfield is the UK-based EMEA Head of Liquidity Product for HSBC Global Asset Management. He has responsibility for the development and implementation of the liquidity product strategy in EMEA.
Kee Joo Wong is Head of Global Payments and Cash Management of HSBC Bank (China) Company Limited, responsible for developing, implementing and driving cash management strategies in China.
New approaches to cash management and investments in China must be sought if corporate treasurers are to leverage the progressive liberalisation of the remninbi (RMB).
Not a day goes by without another statistic published that points to China’s fast ascent to global significance in international trade and, in turn, to global economics. But the opportunity only started to become a reality once China had embarked on its steady but relentless journey of financial liberalisation a few years ago.
Throughout 2012 and 2013 a number of key regulatory changes were unleashed as the People’s Bank of China (PBOC) or central bank drove further RMB internationalisation. A simplified cross-border settlement process, further exchange and interest rate liberalisation by widening the RMB FX trading range and removal of loan interest rate controls are a reality. The State Administration of Foreign Exchange (SAFE) too has been transforming administrative controls that will lead to greater consistency and transparency via a number of reforms to current account and capital account rules.
As China’s relevance and importance to international companies has increased, so the RMB has risen in importance for trade settlement. According to SWIFT, in October 2013 RMB was the world’s second most-used trade finance currency (some way behind the US dollar but significant nonetheless). It remains the 12th largest currency for payments globally (compared to 35th three years ago).
As the market has opened up, more companies have started to hold and utilise RMB cash balances – both onshore and offshore – for payments and receipts. The reasons for this are clear; doing so can improve FX risk management, potentially reduce costs, better align the company to its Chinese customers or suppliers payment preferences and, in turn, provide incentives for better trade terms.
Total RMB deposits onshore in mainland China stand at RMB 103 trillion and in Hong Kong (the largest offshore market) stand at RMB 826 billion (both as at November 2013), a little over 11% of total deposits across all currencies in Hong Kong1.
The development of China’s financial and commercial infrastructure adds tools and flexibility to enhance corporate working capital and cash management practices both in China and offshore operations. With the gradual relaxation on capital and currency controls, China is encouragong international companies to set up business operations and treasury centres onshore. Many of these enhancements have been managed through pilot schemes launched through a limited group of companies and banks.
Until recently, corporate cash and liquidity management in China has been largely domestic, in terms of the payments system and tools, liquidity management structures (such as domestic cash concentration) and how treasury functions operate. These practices and tools have evolved considerably over the past two years in terms of enhancements to domestic and to cross-border and offshore cash management.
The most significant developments include:
Schemes to streamline cross-border payments and receivables processing using netting and gross-in/gross-out settlement methods in pay-on-behalf/receive-on-behalf (POBO/ROBO) models; reduction of documentary requirements; and using technology to streamline manual processes. End-to-end electronic payment processing has been piloted, allowing electronic submission of supporting documentation. These schemes will allow payments into/out of China to be processed more efficiently, promptly and with greater control, visibility and centralisation.
Pilot initiatives are being rolled out to support cross-border sweeping and intra-group cross-border lending. These allow treasurers to manage surplus cash in China more efficiently, with internal funding optimisation achieved through linking onshore positions with their international treasury structures.
With the expansion of cash and liquidity management tools, and the increase in RMB currency balances held, treasurers naturally focus on how short-term balances are managed and invested within their usual risk management framework and investment policies. A number of options exist in various offshore markets such as London and Hong Kong, but what about RMB balances that remain in mainland China?
RMB deposits sitting in bank accounts in China currently provide a return largely determined by existing central bank regulations which provide a baseline rate commonly known as the PBOC deposit rate. See boxed example.
A further option (typically for longer-term cash) is structured deposits. These are arranged with additional terms, usually incorporating a derivative transaction allowing investors to hedge against movements in interest rates or FX. Tenors vary.
There has been commentary on liquidity levels in the China banking sector recently, with volatility in interbank rates in China towards the end of 2013; for example the seven-day repo rate increasing from 4.5% to 8.5% during December. The central bank has however provided liquidity since then as part of its normal operations and rates fell in January.
The regulatory framework in China currently does not permit inter-company lending. The only way companies can lend to one another is under the ‘entrusted loan’ framework used by banks in China to help companies structure their cash pooling solutions. Apart from using bank deposits to generate a return, companies with excess RMB liquidity in China continue to explore onshore RMB liquidity management structures (such as RMB cash concentration/pooling) to optimise their onshore RMB working capital amongst group entities and as a means of reducing external bank borrowing needs onshore.
Companies are now permitted to lend their excess RMB liquidity in China to related companies offshore. A transfer-pricing mechanism ensures transactions are maintained at arms-length. This option offers the opportunity to mobilise RMB excess liquidity internationally to be utilised as an internal source of funding, reduce external indebtedness or participate in centralised investment programmes. Some companies might not find this model optimal in the absence of ways to redeploy liquidity more efficiently, and considering RMB deposit rates and returns in China remain attractive.
An onshore legal entity in China can also invest in an onshore RMB money market fund (MMF). The industry in China is just over ten years old, with assets under management of RMB 883 billion (c. $146 billion) at the end of December 20132. There are over 100 MMFs in the country, falling into two categories; funds provided by international asset managers (and managed similarly to those offered in Europe and the US), and funds offered by local Chinese asset managers who follow the risk profile set out in local domestic regulation.
MMFs in China can offer investors a valuable complement to existing bank structured deposits or reverse repo transactions. They invest in a basket of short-term money market instruments targeting a liquid or low-duration portfolio, offering next-day liquidity. The range of issuers and asset types in China is lower than money markets in the US and Europe. However, a typical fund offered by an international manager includes investments in Chinese government bonds, Central Bank notes, PBOC bills, repurchase agreements backed by Chinese sovereign debt, deposits and other investments from the three agency banks that are 100% owned by the Chinese government, as well as deposits and other investments issued by the “big four” banks.
|RMB deposit type||PBOC deposit % return per annum*|
|Normal RMB deposit||0.35|
|One day call deposit||0.80|
|Seven day call deposit||1.35|
|Three month time deposit||2.60|
|Six month time deposit||2.80|
|12 month time deposit||3.00|
*New regulatory changes in China introduced in 2013 allow for the above rates to be adjusted upwards to a max of 110% of the PBOC rate, at the discretion of the respective bank.
Source: PBOC, as at end December 2013.
MMFs in China can provide a higher net-return compared to short-term bank deposits – by way of illustration, and for comparison to the deposit table above, the average net returns for the month of December 2013 of all AAA-rated RMB MMFs was 4.339% per annum3 (there are currently five RMB MMFs that hold the local AAA rating in China). There are two reasons why this can be the case; firstly, dividend income from a MMF is free from corporate income tax in China (compared to a 25% income tax on bank deposits); secondly, the interest paid on bank deposits in China is regulated, whereas the majority of investments placed by a MMF are not, and are therefore driven by the market and so returns can potentially be higher or lower.
As financial liberalisation continues and accelerates, it will become easier to do business in China. As more schemes are rolled out, and existing pilots are broadened, corporate treasurers should look to create greater efficiency and control over their RMB and foreign currency transactions and balances. Confidence remains that the RMB will become fully convertible in the next five years and, as markets deepen, greater choice for investment options are expected, including for offshore RMB investment options in the future.
Given the pace and complexity of change, it is important to stay informed and to work with the right banks and asset managers. These should not only understand the local market and be actively involved in new schemes as they are piloted and rolled out, but also have international reach to provide a consistent service globally, enabling companies to connect their cash management across the markets and currencies in which they deal.