Novartis is a global leader in innovative pharmaceuticals, generics, vaccines and consumer health products with approximately 100,000 employees in 140 countries worldwide. Headquartered in Basel, Switzerland, Novartis’ annual revenue was $42 billion in 2008, and the company is ranked 61st in the Forbes 2000 list. In this issue of Treasury Today in China, Sherwin Zhang talks about meeting the company’s funding needs in the current climate.
Sherwin Zhang
Country Treasurer, Novartis Overseas Investments AG BJ Rep Office
Sherwin Zhang is the Country Treasurer of Novartis, responsible for the treasury management and risk control in China Mainland and Hong Kong SAR. He joined Novartis in 2002, and was rotated to Novartis HQ as Treasury Controller in 2005. Prior to joining Novartis, Sherwin spent five years in corporate banking/investment banking at CITIC Bank HQ. He possesses extensive experience in corporate treasury, banking, investment and risk control.
Sherwin graduated from the University of International Business and Economics, and has completed the BiMBA-Novartis Leadership programme and Harvard-Novartis Finance Excellence programme. He is a CFA charter holder.
Please could you give me a brief overview of Novartis and its activities in China?
The history of Novartis traces back to three companies: Geigy, whose origins go back to the middle of the 18th century; Ciba, founded around 1859; and Sandoz, established in 1886. In 1970, Ciba and Geigy merged, and in 1996 Sandoz and Ciba-Geigy joined to form Novartis. We entered China in 1987, and now there are 12 legal entities on the mainland and in Hong Kong SAR. Most of them are 100% owned by Novartis, and our total investment in China so far totals $400m. The annual revenue in China was RMB 3.7 billion in 2008.
What is your role?
As the corporate treasurer in charge of mainland China and Hong Kong SAR, I am responsible for all corporate treasury and risk management activities on a corporate level. I support treasury processes and internal controls in all business units and legal entities, ensure that all financial activities are in line with Novartis finance and treasury policies, provide regular consolidated financial reports and reviews and analyse investment activities.
In other words, cash management, working capital control, compliance and risk control, assisting headquarters with investment activities and financial reports and analysis are the main functions of my team. While our individual business units have their own treasury departments who carry out daily transactions, our corporate treasury team is in charge of the overall treasury management.
What are the main challenges facing the company today from a treasury perspective?
In China, we have high targets for cash management – we don’t want to see any idle cash stuck on our balance sheet. All cash should be injected into our daily operations or support direct investments to earn the maximum return. Our low balance strategy has contributed a lot to our cash management, but there are some side effects. The changes in regulations and policy or in financial markets usually impact us more than other companies in China, because our cash flow fits our working capital quite well and there’s a very low cash buffer.
Any delay in cash inflow, eg as a result of more paperwork required by the authorities, may cause a shortfall in cash flow and therefore immediately increase our financing costs. If funding costs in the market happen to be relatively high at that time, then our additional financial cost may be higher than other companies. So we have to be very sensitive to any changes and try to work proactively.
Another challenge is that the cash flows of our business units are well consolidated to obtain the best cash management and economies of scale, but there is very limited communication between the different business units. As their products all come from different industries, they don’t have much connection to each other in business – some finance managers even don’t know each others’ names. So treasury has to act as a very strong information hub to connect all the business units together, try to eliminate misunderstandings and enhance communications. And as you know, in China, turnover of finance professionals is very high, and new business setups or reorganisations are quite frequent. So building up trust between the new managers and us, and establishing good communication as soon as we can, is crucial to our cash management process.
Last but not least is the challenge most big companies are faced with: corporate targets may not be exactly the same as the business units’. Business units focus more on sales, while treasury cares more about issues such as cash flow, loans and investments. The business units have their own targets, which are usually very challenging – it’s a real management skill getting them to share their energy to help us to achieve our aims.
What are the company’s funding needs?
We have long-term funding needs, for example for fixed asset investments, and short-term needs for working capital, which can be further broken down into three to six months, fortnightly and daily.
How have these been met in the current conditions?
Most of the long-term funding needs are covered by capital injections and shareholders’ loans. The short-term funding needs are met by bank loans and overdrafts.
I understand you use a company cash pool – how effective is this?
We have implemented many projects in cash management and the cash pool is the most effective one so far. However, at the very beginning the cash pool was just the replacement of our intra-group entrusted loan, which became too inefficient to enable us to achieve our cash management target. Only three or four business units participated in the new structure when it was set up in 2006, and some of them were not active at all. But as we made improvements step-by-step, the cash pool became more convenient and user-friendly to our business units.
All they need to do now is to send a monthly cash flow forecast to us, deposit their idle cash into the cash pool in a timely manner, then book the cash movement shown in the report we send them. They don’t need to worry any longer about either cash shortfall or any challenge from headquarters about inefficient idle cash. We fully take on the pressure and manage the cash at a countrywide level, which can help us save funding costs as well as reduce the amount of idle cash. Treasury leads the project, and the daily co-operation of our business units is the key to its success.
The cash pool not only reduces financial costs in our daily operations but also creates synergy between our business units. For example, towards the end of 2007, the liquidity of China’s financial market dried up all of a sudden due to macro-economic control. The banks didn’t have time to adjust to the new situation and had to stop lending to their customers. We were faced with a most serious problem as we always keep a minimum cash balance in line with our cash management guidelines.
Some of our business units, whose financial positions were not as strong as others’, couldn’t get enough money from the banks to fund their daily operations. We didn’t have much time to act once we realised how bad market conditions were. We had to ask the units who could get loans to borrow from their banks and provide the liquidity to our cash pool. So the problem was solved within a couple of days and gave us time to find other funding resources for the business units which were in trouble.
Another concrete example happened when one of our business units, which was in an early stage of development, temporarily could not use its injected capital due to new local authority practice. They might have had to pay a penalty and delay construction if they couldn’t make payments according to their contracts. They needed quite a huge amount of funding, and at that time our cash pool happened to be lacking liquidity due to working capital fluctuations. We asked other business units to temporarily speed up their overseas intercompany collections, in order to provide liquidity indirectly to the new unit via our cash pool and meet their urgent need, while we worked on solving the issue of capital.
Are there any activities which Novartis undertakes on a global basis that aren’t permissible in China?
Yes – netting is an example. Monthly netting is a very efficient tool. It’s linked to SAP and the treasury platform, we can save a lot of energy and bank charges and we can simplify our cash flows as well. But netting is not allowed in China. We have looked at some innovative products provided by banks which may provide a similar function to netting, but none of them can meet our needs in a simple way, and may cause us difficulty. Our internal netting rule is very strict – even one day’s delay would cause our global netting to become unbalanced and then our peers at headquarters might have to work overtime. But FX payments in China are often delayed due to the local authorities saying our documentation is incomplete, even though the omissions are sometimes tiny and negligible.
Another activity which is quite common in free markets but a little cumbersome in China is the intercompany FX payment for non-trade purposes. I would not say it’s not permissible at all in China, but actually the demanding requirements set by local authorities often make payables overdue.
Why did the company choose not to use third-party entrusted loan arrangements?
Usually a lender who is willing to provide a third-party entrusted loan would like to have a relatively stable investment period since setting up the loan is time-consuming. Our short-term funding needs, however, change with fluctuations in working capital. If the term is relatively long, we may have to make an early repayment if we have any unexpected idle cash, but it’s always subject to an early repayment interest penalty; if we ask for a short-term loan with more flexibility, say over two weeks, nobody wants to bother for such a short amount of time. And we try to keep our net balance just a little negative and avoid having too many loans, with the result that our need isn’t big enough to attract lenders.
However, we are thinking about it now, as our three-month bank loan has been growing over the last couple of months. We may convert it into a third-party entrusted loan in due course – it depends on our cash flow forecast.
What other funding options has the company considered?
As I mentioned, we try to keep our net balance just a little negative. Our short-term funding needs change quickly, so overdrafts and very short-term bank loans are still the most suitable products for us. But we have considered some products, such as bank draft discounting without recourse, which may provide lower cost funding options to us but less flexibility. We may go further if our three-to-six month funding needs keep growing and become stable – we may adjust our strategy accordingly.
Yes – one is to further improve the accuracy of our cash flow forecast. We have short-term or monthly forecasts (broken down by week), and long-term or 12-month rolling forecasts. The accuracy of our long-term rolling forecasts is not always satisfactory, as they are based on a budget which contains a lot of factors which change from time to time. We are looking at deconstructing the budget into its factors and tracking them closely – it’s a difficult project as all departments are involved.
Another one is the cash pool study in Hong Kong, though I am not confident that it will be as successful as it is in China. The main reason is that our net cash position in HK is negative, while the overdraft rate based on BLR (Best Lending Rate) is much higher than the bank loan rate based on the Hong Kong Interbank Offer Rate (HIBOR), which is around zero now. The overdraft, which is the backbone of our cash pool, may cost 10 times more now than a bank loan. A sophisticated control of cash may reduce the overdraft amount and the cost as well, but it needs a lot of communication and frequent bank transactions, which may increase costs at the end of the day. We may design another structure rather than cash pooling to adjust to the new market conditions.
