With a spell of tremendous market volatility in the wake of the devaluation of the renminbi (RMB) now behind us, it is perhaps an ideal time to review the new options that have emerged in recent years allowing corporates to transfer exposures offshore. Is this the right time for corporates to look again at bringing RMB into their global cash pools? Citi’s Managing Director, Asia Pacific Sales Head, Treasury and Trade Solutions Munir Nanji believes it is.
The People’s Bank of China’s (PBoC) decision in August 2015 to allow for a depreciation in the RMB against the dollar serves as a timely reminder of the importance of RMB internationalisation, both for foreign multinationals doing business in the country and domestic Chinese companies alike.
Already, the event is shaping conversations that leading banks are having with their corporate clients around liquidity management strategies. Although, several years ago, when informed of the first new pilot schemes permitting cross-border pooling in RMB or foreign currencies, initial interest from treasurers was somewhat muted (given the very good rates on deposits in China at the time and the fact the currency was appreciating); circumstances are now quite different. Now the PBoC is, albeit very gradually, allowing market forces to assume a greater role in determining the RMB’s value and treasurers should understand that this means the currency may not be as stable in the future as it has been historically.
“The volatility has been significant,” remarks Munir Nanji, Asia Pacific Sales Head, Treasury and Trade Solutions, at Citi. “As China liberalises and the currency becomes part of a larger financial system, more volatility is inevitable.” The interest rate environment is in a similar state of flux, as evidenced by an apparent distinction between the onshore and offshore markets. While the Shanghai Interbank Offered Rate (SHIBOR) has fallen (in the past year) from the 3% to 1% range, its offshore counterpart, the CNH Hong Kong Interbank Offered Rate (HIBOR), has been moving in an opposite and more volatile direction, climbing from the 5% range to 10% immediately following the devaluation.
As such, there are now strong risk management and investment imperatives adding to the funding efficiency case for incorporating RMB into global cash pools. “If you are a treasurer then just a few weeks ago you were probably thinking that you may as well hold on to RMB since it was a strengthening currency,” says Nanji. “But then there is a sudden devaluation taking place and heightened volatility in both the FX and interest rate markets. Now treasurers at head offices outside of China are probably thinking that the time has come to get RMB connected to those global pools, because by doing that they can hedge the excess RMB positions and ensure Chinese entities are supporting the liquidity needs across the group, and vice versa. They know now that they need to act.”
The story so far
Given the reforms of recent years, there is really no excuse not to act. Over the past five years, China has consistently demonstrated its commitment to liberalising trade, by promoting the currency and taking numerous other steps to open up the economy.
With the ambition of offering Chinese corporates procuring raw materials abroad to begin using RMB as a settlement currency, the Chinese authorities began easing regulations around convertibility in 2009 with the launch of a milestone pilot scheme for cross-border trade settlement in RMB. Since then, the pace of reform has astonished many seasoned China-watchers. Trade settlement was in due course expanded nationwide; offshore clearing centres were established in Hong Kong, Singapore, Taiwan, and London; and beginning in 2014, RMB and foreign currency cross-border pooling was introduced through the Nationwide and Shanghai Free Trade Zone (SFTZ) testbeds.
A more conducive regulatory environment has been matched by infrastructural improvements. “This means that companies that wish to include RMB in their global cash pool that is managed from, say, Europe or the US, are able to pay beneficiaries in China on time,” says Nanji. “If the cash pool is resided in London, for example, the payment would normally route to Hong Kong via the SWIFT network. Hong Kong would utilise its domestic clearing system (CHATS) to route the payment further through the China National Advanced Payment System (CNAPS) to the final beneficiary in China.”
Of course, the various ‘hops’ in this process mean this is not quite as straightforward and streamlined a process as one would like with the current infrastructure not being sufficient to provide cross-border RMB clearing on a real-time basis. “It’s not as simple as one would like, but there is infrastructure there,” says Nanji. “There will be reject rates, obviously, because of the many different systems money must pass through and the information required for a straight through transaction. But, as your pools become centralised, you can use the infrastructure now in place, with the long awaited Cross-Border Interbank Payment System (CIPS) aiming to provide a seamless clearing infrastructure for cross border RMB payments.”
SFTZ or nationwide?
Over the past year, China has been gradually expanding some of the policies tested in the SFTZ nationwide. For treasurers in China this raises the question of whether to leverage the initiatives in the SFTZ or look to the programme being permitted by the regulators at a national level.
Based on an internal survey done by Citi across 250 respondents, over half were still looking for further infrastructure changes before using the SFTZ as a key treasury location. Key reasons for leveraging the SFTZ have been driven by already being located within the zone, especially with the geographic expansion and the significance of China to the overall business growth and strategy.
Nanji expects that it will not be long before we see these minor discrepancies ironed out, as we have seen from the recent regulatory announcements relaxing the borrowing quotas and qualification criteria for the nationwide programme. This is largely driven by the success of the SFTZ which gives the regulatory authorities the confidence they need to take the entire experiment nationwide. “If you are already sitting in the SFTZ then clearly it is very easy to join,” he explains. “It becomes more complicated when you are in another location and you have to decide, do I join the nationwide zone or do I join the SFTZ? For that reason, I think, we are going to gradually see more harmony.”
Chart 1: Treasurers views on the SFTZ
Interest in both the SFTZ and nationwide amongst Citi’s client base has already been very robust, and the bank expects this to accelerate even further in the coming years. This is a natural consequence of the RMB’s growing acceptance as an international currency for treasury and gradually with trade (in August 2015, for instance, SWIFT revealed RMB had become the fourth most-used currency for international payments, passing the Japanese yen, Canadian and Australian dollars in the last year).
But it is also a reflection of the fact that corporates transacting in RMB are becoming ever more cognisant of the benefits of connecting RMB and foreign currency in China to the group’s global pools when using the currency for trade. First and foremost, there is the matter of reducing complexity around counterparty FX and processing for Chinese entities. “If you are a Chinese subsidiary, you need to think about the simplicity,” Nanji explains. “That is the biggest benefit for them.” The benefits do not end there though. Chinese subsidiaries can use pooling structures to bring money into the country to finance both their own operations and those of their critical suppliers (something which may assume greater importance should economic conditions in China deteriorate and delinquencies begin to increase).
The benefits of unlocking all of that trapped cash that has been building up in China are also felt offshore too. China is now the second largest economy in the world and, as such, any company with business there will have a very large portion of their revenue there. Would it not be much better for corporates to have those revenues sitting inside their global cash pool? Nanji certainly thinks so. “If treasurers have all the other currencies in their cash pool but the second biggest economy in the world is not connected I think that is just sad,” he says. “It’s a pity that some companies are using the Japanese yen and the euro, but not RMB.”
The benefits of integration are every bit as applicable for Chinese corporates offshore too. Big Chinese names – take Huawei and Alibaba as an example – are now increasingly global in their outlook and, as such, are exploring how cash pooling solutions might benefit them. “Knowing that they have got to report back their foreign currency sales in RMB, some of them are considering establishing pools offshore, which would offer them the ability to also set-up treasury centres offshore,” says Nanji.
Leading the way
As more and more corporates become sold on the idea of incorporating China into their global cash pools, the only difficult decision left for the treasurer to make is in choosing which bank is best placed to help them achieve this. What bank has all the right resources and experience to help them navigate the various bureaucratic requirements?
In attempting to answer this question, treasurers might wish to consider which bank has over the past five years been leading the way with every new regulatory development in China’s FX market over the past five years. “We have a long track record in working with companies getting the necessary approvals from SAFE and PBoC,” says Nanji. “Whether it was the first cross-border lending that took place; the companies that established netting programmes; the companies that want to set-up offshore centres – each time we are proud to say that we have been the first in the market,” says Nanji.
In working so closely with the Chinese regulators, Citi is also now in a unique position amongst the banks to influence how such reforms are implemented on behalf of their clients. “In many ways we have been able to shape the regulatory thinking,” he says. “We assure the regulators. We show them how we actually link platforms together globally, and they come to our offices and through these induction processes gain some level of confidence on how the systems work and, as a result, we can get them to think about setting up infrastructure for these companies.”
Add to the above Citi’s long standing relationship with financial infrastructure providers such as SWIFT, corporate treasurers should be left in no doubt as to who can bring the best support for the enablement of the RMB as an international currency.