Making the best use of surplus cash is a challenge for many companies in China. One possible solution is the use of third-party entrustment loans to lend cash to other corporations. We talk to Erick Haskell, CFO of adidas Greater China, about the challenges and benefits of this approach.

Erick Haskell is CFO of Greater China for the adidas Group. He has responsibility for the adidas, Reebok and TaylorMade brands in mainland China, Taiwan and Hong Kong. His responsibilities include finance, strategic planning and legal affairs.

Prior to joining adidas, Erick was Executive Vice President and Chief Financial Officer for the Home World Group, a major Chinese hypermarket retailer headquartered in Tianjin. In addition to his management of the finance, IT and legal functions, he also oversaw the company’s preparations for a listing on the Hong Kong stock exchange.

Previously, Erick has served as Senior Vice President at Wells Fargo Bank in San Francisco and CFO of Kmart Corporation’s International Division in San Juan, Puerto Rico. He began his career in management consulting at Deloitte, where he left as a senior manager in the Strategy and Financial Management Practice.

Erick holds an MBA from the University of Chicago, an MA in International Trade and Finance from George Mason University and a BA in International Affairs from the George Washington University.

Please could you give me an overview of adidas’s operations in China?

There are really two important aspects to the adidas business in China. Firstly, roughly half of all adidas’s production globally is done in China. On top of that, we have a significant local footwear and apparel business selling to the local Chinese market – that’s what I have responsibility for. It’s a big business; one of the biggest adidas subsidiaries in the world. As of the end of 2008 we had about 5,000 individual shops selling our products.

What is your role?

My official title is CFO of Greater China, which includes not only mainland China, but also Hong Kong and Taiwan. Within my CFO role, that includes not only the traditional finance roles, such as accounting, management reporting, statutory reporting, tax and treasury, but also the legal function, the strategic planning function and the risk management function. adidas is a multi-brand company – we own the Reebok brand and the TaylorMade Golf brand, so I have multi-brand responsibility.

What are third-party entrustment loans?

The concept of entrustment loans is quite unique to China. In China it is illegal to do inter-company loans. This doesn’t just mean me lending to another big multinational, but if I have multiple legal entities in China and if I want to lend the money between them, I’ve got to draw up formal loan agreements and charge interest and so forth. The main reason that entrustment loans exist is as a means for Chinese subsidiaries to lend excess cash to other entities that are in need of cash.

What I deal with are third-party entrustment loans. These are a way to marry up companies who have excess cash and companies who are starved of cash. There are companies in China, such as adidas, who have a lot of surplus cash, primarily because we can only remit dividends back to our headquarters once a year and we don’t have a lot of capital expenditure. So we tend to accumulate a lot of cash over the period of a year. The opportunities for me to invest this excess cash are quite limited. I can basically put it in a time deposit in a bank for a fixed period of, say, 30 or 90 days. There are increasingly some money market funds that I can use. But with all these, the yields are quite low. On the other hand, there are other companies that are extremely capital intensive, that are developing their presence in China and making huge investments. The capital constraints in China can make it difficult to get money in, and the borrowing costs for these entities can be quite high.

The benefit of third-party entrustment loans is that they allow companies with excess cash to lend cash to companies that are looking to borrow. By doing this, we can enhance the yield on our cash, while the cash-starved companies are able to decrease their borrowing costs. Basically, we meet in the middle and it works out as a benefit for everyone.

How do third-party entrustment loans work?

Although they are called third-party entrustment loans, really four parties are involved:

1. The lender.
2. The borrower.
3. An entrustment bank who serves as an agent. They are the ones who actually take cash from one company and provide it to the other.
4. A separate guarantor bank.

The role of the guarantor bank is important because it means that the lending company is not taking on the credit risk – other than the risk that the bank itself goes out of business. If the borrower was to default, the guarantor bank would be on the hook for that loan.

How easy is it to get a guarantee?

It’s relatively easy, although it depends on the credit quality of the borrowers. I’m lending primarily to big MNCs who have good credit ratings, so it’s generally not difficult to get. Usually the guarantor bank is the borrower’s biggest bank partner. So if I’m lending to a big MNC, they will go to their bank and say, “Can you provide me with a guarantee, I’m going to borrow money from adidas”. And then they’ll provide the guarantee.

When did you start using third-party entrustment loans?

We started the programme in mid-2007, and then at the end of 2007 there was a premature credit crunch in China. It is hard to imagine now, but there was a period in 2007 when it looked like the Chinese economy was seriously overheating. The Chinese government really pulled in the reins on credit and basically brought all bank lending to a halt. That’s when we really got into the third-party entrustment loans project, because demand for funds was enormous.

So the timing was good. We started with very small loans of RMB 30-50m, with tenors of three months. All our loans are RMB because our surplus here is in RMB. Then in late 2007, when there was a huge demand for money, we ramped it up. I now have one-year loans for RMB 200m outstanding.

It’s more efficient to do larger loans in terms of having to roll them over more frequently. Also, once we got through the period where the Chinese government was raising rates, things dramatically changed globally and I could see that we were going to go into a rate cutting environment. So I had the team actively seek long tenors and around six months ago we locked in a lot of year-long loans at higher rates. We’ve seen half a dozen rate cuts since then by the PBoC.

Are there many companies operating a similar programme?

Not as many as you would think. Despite the benefits we have seen, I’m by far the biggest person in the market doing this now. I don’t know why this is – it could be that local teams struggle to convince their headquarters that there’s really limited risk in this. If you think about it, third-party entrustment loans are guaranteed by big global financial institutions, so there’s really no difference between keeping it in a bank with them versus having them guarantee it. For me it’s been a great solution – a great yield enhancer, and it hasn’t increased my risk.

How are the requirements of borrowers and lenders matched up?

This is done by the banks. Initially they did this hesitatingly. The banks knew that I had a lot of cash and they wanted access to some of that cash, and as a favour they would say, “I have a client who wants to borrow some money, they can lower their borrowing costs and adidas can get a little better yield”. But if you think about it, it’s not the best thing for the bank to do, because theoretically they are losing a lending client and a deposit client at the same time. They do take a small fee but they hesitated to do this because we essentially become a competitor to them to a certain degree. That was before the crunch.

Then in October 2007, lending in China literally stopped overnight. As a result, the banks were quite happy to do third-party entrustment loans. They had desperate customers who needed funds and so they would tell them, “We have contact with adidas and adidas has spare cash, we can hook you up”. The banks all had quotas as to how much they could lend. But for some reason, when these banks make guarantees on third-party entrustment loans, only 10% of the value of the guarantee counts against the bank’s lending quota, so it was basically an extra source of funding that did not have a material impact on their ability to lend.

The benefit to the companies was that they could get cash they desperately needed. And in our case we were able to increase the rate we were charging because funds were very scarce. Before the crunch, we used to split the difference between the deposit rate and the borrowing rate. Let’s say the other company’s cost of borrowing was 6%, and my deposit rate was 2%; generally we would meet in the middle, somewhere around 4%. After the freeze, we went right up to the lending rate, so I was lending at the same rate, if not higher, than the banks were. So I was getting a very good yield; the companies were getting access to funds that they couldn’t otherwise get – and the banks were happy to do favours for both clients in the middle.

Once the credit situation eases do you expect the market will look different again?

It already has to a certain extent. When we talk about the credit crunch in China we’re on a slightly different timeline than the global credit crunch. We know well what the causes and the impact of the global credit crunch were, but in China it was a slightly different phenomenon. This is where the Chinese government wanted to really put the brakes on inflation and cool down the economy. It’s strange to think that little more than a year ago, our concerns were totally different – we were worried about runaway inflation, runaway growth and the Chinese economy overheating. That’s when they put a complete freeze on credit.

Now, of course, we have a different situation. The government has really relaxed credit and the question is whether the banks are willing to lend or not – it’s more the impact of the global credit crunch. I can’t get the same high rates I got before as bank lending has begun again, so now we’re closer to the old model where we split the difference on the rates. I would say that lenders are still slightly more in control, we have a little more bargaining power, but as credit continues to loosen, not only globally but here in China in particular, we’ll go back to the way it was when we split the difference.

What challenges have you encountered during the project?

The biggest difficulty was that once we got into the credit crunch globally, I had counterparty risk limitations imposed on me. Our headquarters stipulated that I could only have €40m exposure to any one financial institution. As we did bigger and bigger loans, the guarantees counted towards this exposure because, theoretically, if the borrower defaulted and also if the bank was to disappear overnight, like Lehman Brothers, that’s an exposure for me.

So it became difficult finding enough banks. I would hit the counterparty risk threshold with one bank, I would go to the next bank, hit the counterparty risk threshold and go on to another bank. So I’m now working with a number of banks, including Standard Chartered, who we began the project with. The legal agreements were also an obstacle to start with as they were quite cumbersome. But now we’re quite good at drawing them up and I think because we’ve done it so many times, it gives the legal team on the borrower side comfort that we know what we’re doing.

Another interesting challenge, particularly when the credit markets froze, was determining a fair interest rate on the third-party entrustment loans. There is no clearing house – no common central place where everyone gets together to figure out prices – so we were literally phoning around the banks, finding out what rate people were willing to borrow at and what I was willing to lend at, which was relatively inefficient. So that was a bit of a challenge, it was quite time-consuming, but eventually we got through it.

Are you planning to grow this project in the future?

To be honest, I hope not. I say this because I hope that over time we will start to see a relaxing of the capital controls here in China. If we could remit dividends more easily, I wouldn’t be sitting on these big cash surpluses and I wouldn’t need to do this anymore. However, as long as we have these cash surpluses, as long as the regulatory regime exists, I will continue to do this. From a risk-return standpoint, I’ve found it’s the best vehicle I have for deploying excess cash.