Renminbi realism Relatively low offshore rates have led many to assume that only those with pressing funding needs elsewhere will currently find the process of moving surplus renminbi offshore worthwhile. But as Mario Tombazzi, Regional Head of Liquidity and Investments for Asia Pacific, and Vina Cheung, Global Head of RMB Internationalisation, Payments and Cash Management, at HSBC explain, a combination of other factors and opportunities needs to be considered. The renminbi (RMB) is clearly a currency that is going places in international markets. According to SWIFT, the RMB is now the seventh most popular currency for payments in terms of value 1. Furthermore, 16% of China s total trade is today settled in RMB, a figure that HSBC Research believes could rise to 30% by 2015. The regulatory changes announced by the Chinese authorities over the past few years also suggest that this momentum is likely to persist. But while recent regulatory changes permitting RMB lending by onshore entities to those offshore have captured headlines, the question still remains as to who benefits from this environment and how? The answers depend upon who you are. For Chinese multinationals, the funding of their international expansion using their functional currency has become far more straightforward. Onshore RMB surpluses can be immediately invested in new overseas business and the continued funding of existing and new offshore activities is also allowed. For other multinationals the situation is more nuanced. Those with significant deficits in other countries obviously have a strong incentive to cover those deficits with surplus RMB liquidity they have accrued in China. For them, the effort required to integrate China into their existing global or regional liquidity structures is worthwhile, because of the reduced overall funding costs they can achieve, plus increased control over the redeployment of internal financial resources. For non-chinese multinationals without structural or seasonal funding needs elsewhere, the advantages of incorporating RMB into their global liquidity structures to facilitate mobility of Group funds offshore are on the surface less clear cut, but are in fact far more compelling than they seem. At first glance, the fact that the liquidity and rates available in instruments relevant to most treasuries are lower and more volatile in offshore centres than their onshore counterparts would seem to beg the question for these multinationals of: why bother? In fact there are a number of reasons. As mentioned earlier, the RMB is clearly a currency that is going places, so the question actually covers two very distinct topics: The convergence of processes and governance practices into standards which are already adopted in the management of the business in other markets. This includes procurement and invoicing, 1 http://www.swift.com/assets/swift_com/documents/products_services/rmb_tracker_february2014_final_sdc.pdf 1
and extends to cash management, liquidity management and risk management relevant to all multinationals Realising maximum value from internal sources of liquidity, from both a financial and a liquidity/funding risk standpoint A logical progression The business case for managing RMB in the same fashion as any other global currency is linked tochanges in how it is being used and treated. In the first stage of RMB liberalisation, the focus was on trade settlement. Corporate clients were primarily concerned about: The commercial benefits they could realise by converting to settlement in RMB How they could make trade payments to China out of their home countries without difficulties 2 How they could manage their purchase of RMB efficiently The operational and invoicing changes group entities would have to make in preparation However, this also represented the first stage in assimilating RMB into existing global/regional payment processes and re-engineering in the interests of efficiency and control. In view of the relaxation of controls on outbound (and to an increasing extent also on inbound) cross border flows of renminbi, that thinking on efficiency and control also applies to liquidity management processes. Management of RMB can now be centralised and standardised to much the same extent as any other global currency in a multinational s portfolio of currency exposures.
Why act now? In the short term, for corporations without pressing deficit needs elsewhere, centralisation and standardisation of RMB into global liquidity management processes may not appear to yield a substantive monetary return. But this misses the fundamental point that opportunities exist for payment and invoicing processes, together with associated FX and process risk elements, to be further standardised and centralised. These are important building blocks which augment the efficiency of, for example, just-in-time funding, which in turn increases the degree of mobility and the intrinsic value of internally generated liquidity. Additional important factors and opportunities to consider here include: Growth: the current signs of growth returning to developed markets are likely to increase corporations global liquidity mobility needs in support of rising working capital requirements Processes: the efficiencies and global visibility achieved by incorporating RMB into existing global processes deliver both risk and monetary benefits Relative rates: driven by shifts in supply and demand, the relative position of offshore/onshore rates may change over time. If so, the current return differential of holding RMB offshore will no longer apply Investment options: the range and liquidity of offshore RMB financial instruments suitable for treasury use will continue to expand Growth There are signs that developed economies are starting to recover: In the US, the Commerce Department2 recently reported that the country s economy grew at a 3.2% annual rate in the final quarter of 2013 In late 2013, the ECB raised its forecast for 2014 Eurozone GDP to 1.1%, with one ECB board member mentioning the possibility that certain economies such as Austria and Germany might hit 2%3 More recently, the January Markit Eurozone Manufacturing Purchasing Managers Index revealed that manufacturing activity grew at its strongest rate since May 2011, with a rise to 54 4 The global situation also appears to be improving, with the IMF predicting global growth will reach 3.7% in 2014, versus 3% in 20135 While these numbers are hardly spectacular, they signal positive growth, which will in turn increase working capital requirements in supply chains as sales activity picks up. The liquidity to fund that working capital increase will have to come from somewhere, and multinationals Chinese operations are more likely to have been generating excess liquidity since 2008 than their operations in the US or Europe. Therefore any integration of RMB into global liquidity programmes now is likely to pay dividends later in the efficient and timely self-funding of rising working capital requirements. Processes A further motivation for immediate action on RMB liquidity integration is efficiency. As with the currency s participation in global payments/receivables centralisation programmes during the earliest stages http://www.bea.gov/newsreleases/national/gdp/2014/gdp4q13_adv.htm http://www.reuters.com/article/2014/01/14/us-ecb-nowotny-idusbrea0d0el20140114 4 http://www.markiteconomics.com/survey/pressrelease.mvc/fa8005f424084e018d665383c341ef75 5 http://www. imf.org/external/np/tr/2014/tr012114.htm 2 3 3
of its internationalisation, liquidity integration brings improved efficiency. Global treasury has direct visibility and control of balances, thereby simplifying liquidity forecasting and management. Operational risks are reduced and the management of currency and balance sheet risks is also simplified. Corporations in the technology, heavy industrial and pharmaceutical sectors have been leading the way in centralising RMB processes. Many of these companies have a standard global process blueprint and continually monitor situations where exchange controls or regulation prevents a currency from conforming with this blueprint. As conditions change (as they have in China) these corporations move the currency onto their process blueprint. In many cases, the situation is aided by the fact that these organisations have significant internal invoicing and intra-group trading flows, which further adds to the efficiency justification. It is also worth bearing in mind that a liquidity structure is overlaid across payment and collection processes and is expected to evolve and adjust as more sophisticated processes are adopted. As part of its natural lifecycle, a basic liquidity management approach is established where regulations or domestic market practices prevent the adoption of more sophisticated alternatives. Whenever payment or collection processes are not ready to be centralised and need to retain a more fragmented and localised dimension (either due to local market conditions or the corporation s organisational/ technical structure), the appropriate liquidity management technique still ensures optimal cash flow redistribution and consolidation. When circumstances change so that the re-engineering of payment and collection flows becomes possible, this also enables the design of the liquidity structure to be enhanced. This applies to China, where schemes have been announced over the last 18 months that allow: The centralisation of foreign currency and RMB cross-border payments/collections into a pay-on-behalf/receive-on-behalf (POBO/ROBO) model The adoption of intra-group trade settlement using netting and a gross-in/gross-out mechanism HSBC has been the front runner in responding to this sort of change. It was the first bank to: Obtain approval from the State Administration of Foreign Exchange (SAFE) to implement a foreign currency netting solution for a Korean multinational Establish a tailor-made gross-in/gross-out RMB cross-border trade settlement solution designed to eliminate foreign exchange exposure and optimise liquidity management for a Fortune 500 company The changes implicit in the introduction of the Shanghai free trade zone (SFTZ) only serve to reinforce this argument. Entities based in the SFTZ are permitted to have bilateral RMB cross border liquidity flows, which by allowing the integration of onshore and offshore markets obviously enhances the degree of control and flexibility of any liquidity programme. Until recently, these bilateral flows were subject to explicit quotas. However, a recent circular (see sidebar Regulatory update ) from the People s Bank of China (PBOC) makes no reference to these 4
quotas. This seems to imply a move instead towards a controlling limit role performed by banks, where service parameters offered to customers would be determined on the basis of the SFTZ guidelines that a bank is permitted to operate within. It is clear that the SFTZ is intended as a test bed for financial innovation, so RMB investment, deposit, and interest rate products similar to those offered in offshore financial centres are expected to emerge there first. The SFTZ clearly has the potential to become an international financial hub and a domicile for treasury centres for Asia, thereby enabling further process and risk management centralisation. HSBC has been at the forefront in developing solutions that leverage the market driven and innovative environment of the SFTZ. One such solution is a recently launched RMB netting programme for a French company s cross-border intra-group transactions via its subsidiary in the pilot zone, which uses the POBO/ROBO model. Consequently, even for those with no immediate need to redeploy RMB liquidity elsewhere, there is strong motivation to make it part of globally consistent standards and liquidity processes in the interests of efficiency and strategic flexibility. Relative rates While offshore RMB deposit rates are currently less attractive than their onshore equivalent, this situation is by no means guaranteed to persist. For example, the SFTZ high level guidelines cover the liberalisation of capital account items and pave the way for the liberalisation of interest rates on deposits, which will be an important driver for convergence between offshore and onshore rates: Capital markets: financial institutions and corporates within the SFTZ are allowed to conduct investments and to trade on the securities and futures exchanges in Shanghai. Offshore parents of SFTZ corporates can issue RMB bonds in onshore capital markets. Trading in international financial assets will also be considered, depending upon market demand Offshore financing: Chinese and foreign corporates, non-bank financial institutions and other organisations registered in the SFTZ are allowed to borrow both RMB and FCY funds from offshore markets In addition, FX reform such as the potential widening of RMB trading bands6 is another driver for onshore/offshore interest rate convergence, as is the rapid deepening of offshore RMB money markets. This applies especially to Hong Kong, but also to other large international financial centres, such as London. 6 https://www.research.hsbc.com/r/20/rjsk01b 5
While this convergence may not be immediate, it provides a strong motivation for corporations that do not need surplus RMB liquidity to cover deficits elsewhere to incorporate their RMB liquidity into a flexible global liquidity strategy. They will then be in a position to respond immediately as RMB onshore/ offshore conditions change. Investment options The investment options suitable for excess corporate RMB liquidity have continued to grow steadily. While the dim sum bond market has tended to attract a lot of the headlines, there have also been interesting developments at the short end of the yield curve. For instance, early 2013 saw IFC (a World Bank Group member) issue the first CNH-denominated discounted note with a three-month tenor under its Global Discount Note Programme. Innovation in the offshore market has also been supported by the launch of the CNH HIBOR fixing in June 2013. By providing the benchmark for RMB loan facilities and financial instruments, CNH HIBOR is supporting the market for RMB lending and interest rate/hedging/investment products. For example, Bank of China (Hong Kong) has already issued a one year RMB certificate of deposit on behalf of its parent that uses CNH HIBOR as the benchmark rate. More generally, the evolution and growing liquidity of CNH derivative products, including more exotic options and forwards, means that the basic building blocks for efficiently manufacturing new CNH traditional and structured deposit products are now available. The expansion of the Renminbi Qualified Foreign Institutional Investor (RQFII) programme into Singapore, Taiwan and London in July 2013 should provide another important step in the evolution of the offshore market, as should the increased RQFII quota for Hong Kong. RQFII products give offshore investors opportunities to invest indirectly into China s equity and fixed income markets in advance of the full liberalisation of China s capital account, which will ultimately allow direct and free investment into onshore assets. All of this supports the development of a larger and more liquid inter-bank money market, leading to offshore interest rate conditions becoming more aligned with the onshore market. Conclusion For Chinese multinationals expanding their overseas operations, and for other multinationals with significant deficits outside China, the rationale for integrating RMB with existing global liquidity programmes is immediately self-evident. The first group will need global access to their excess RMB to fund their overseas activities, while the second group will need access in order to minimise their global funding costs. A combination of no immediate need and less advantageous offshore RMB deposit rates has meant that multinationals outside these two categories have tended to defer action. However, this stance misses numerous opportunities including strategic flexibility, process improvement, cost effective funding of growing supply chain activity and enhanced risk management. Considering these opportunities in conjunction with the rapid evolution of the RMB as a global currency suggests that now might be a good time to adopt a more active RMB liquidity strategy. 6
Regulatory Update The PBOC issued a circular in late February 2014 that specifies important additional measures supporting the expansion of RMB cross-border usage in the SFTZ. The most significant from a corporate liquidity management perspective, can be summarised as follows: RMB offshore borrowing in the SFTZ This measure opens up an alternative channel by which entities in the SFTZ can access offshore funding sources. It builds upon former legislation allowing corporates to borrow offshore subject to a borrowing cap rule, foreign debt quotas and regulatory approval. While the previous measures applied to corporations both within and outside the SFTZ, the new measure is specific to SFTZ entities. It introduces different criteria, specifically on borrowing capacity, minimum tenor, and the use of a special purpose borrowing account. However, the most significant differentiator is the absence of restrictions on the lending party, thereby implicitly extending the borrowing source to offshore financial institutions, when previously only intra-group lending was permitted. Mutual exclusivity The existing and new measures appear to be mutually exclusive and therefore will appeal to two distinct categories of corporation: those with internal funding capacity and those who rely on external financing. While the PBOC will still control the amount of inbound financing flows and be able to limit it in the initial phase of liberalisation, the expectation is that this channel will be opened further in the near future. RMB two-way cross-border sweeping The circular covers operational aspects such as the requirement to use a special purpose account and to document the service appropriately between participants. However, the most significant point is the absence of references to loan quotas, which suggests a shift away from this approach to a controlling limit role performed by banks when determining the operating parameters to establish as part of the service offered. These parameters would not require endorsement by the PBOC, but be determined on the basis of the SFTZ guidelines that the bank is permitted to operate within. RMB current account, centralised RMB payments and collections in the SFTZ This measure reflects the pace of adoption of best practice in the management of accounts payable/receivable in the SFTZ. The most important change here is that third parties and external entities are allowed to participate in the centralisation of settlements, netting programmes and POBO/ROBO practices. 8 7
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