China: the bloom is hardly off the rose

The rising adoption of RMB signals China’s continued strength as a growth market. SWIFT’s monthly RMB tracker showed that in May 2015, more than 1,000 financial institutions worldwide used the currency for payments with China and Hong Kong, which represents 35% of all institutions exchanging payments with the latter across all currencies.

This is up from 29% two years ago and translates into a 22% hike in the number of institutions using the RMB and a 6% increase in adoption. With wider adoption of the RMB globally and China’s easing of cross-border fund flows, MNCs face emerging opportunities to leverage the redback as a trade, treasury and investment currency on a global basis.

Free Trade Zones boost offshore access

To propel RMB internationalisation, China set up the Shanghai Free Trade Zone (SFTZ) in 2013 and launched a series of pilot programmes to improve offshore access. Once corporates set up special bank accounts in the Free Trade Zones (FTZ), they can deploy their SFTZ-based hubs to access offshore funding and foreign exchange (FX) markets. On the back of the success of the SFTZ, further FTZs were later established in Guangdong, Tianjin and Fujian.

Meanwhile, in the offshore market, while RMB spot and derivatives trading volumes have significantly increased and spreads have tightened, the redback’s longer-term outlook remains promising. The International Monetary Fund (IMF) regards it as a question of when, not if, the RMB will join its special drawing rights basket as the fifth constituent alongside US dollar, yen, pound and euro.

RMB as trade settlement currency

By leveraging the RMB, MNCs can reap various benefits, such as reducing FX risk and administrative costs, expanding their client base and strengthening supplier relationships. There is growing evidence that companies can improve their negotiating position with Chinese customers and suppliers when using the RMB for trade invoicing purposes.

For companies buying from China and selling overseas – especially MNCs executing intercompany transactions with their Chinese entities – settling deals in RMB reduces exposure to FX risks. In making the assessment, a company needs to ensure sufficient implementation resources are assigned to execute the change and the perceived benefits warrant the costs incurred. Switching to RMB trade invoicing should be a long-term strategy, given regulatory restrictions in China and the potentially high switch-back costs. The key is for treasurers to start preparing their companies to make the timely switch when the opportunity arises.

Centralising risk management

Mitigating FX risks requires concentrating FX at a level where appropriate skills and tools are available. Today, companies are able to reduce currency and funding mismatches by switching to RMB invoicing and settlement – provided their affiliates or third-party suppliers and customers are willing to do so – to reduce FX exposures and enhance risk management. At the intracompany level, companies are able to instruct their China entities to pass their FX exposures to affiliates abroad and then further centralise risk management to regional or global treasury centres to improve efficiency, visibility and control.

Likewise, for MNCs with significant intercompany flows with China, there are benefits in centralising the FX risks at an overseas function such as a treasury centre or in-house-bank (IHB) instead of at the local Chinese entity, which may not have the know-how or primary responsibility to effectively manage FX positions.

CNH Market: Using derivatives to rein in risks

The offshore renminbi (CNH) market provides a series of risk management instruments to corporates, including FX forwards, FX options, interest-rate swaps, and cross-currency swaps. FX forwards have been the most active and liquid by far, while interest rate swaps are being developed at a much slower pace.

In the offshore markets, corporates have the option to hedge with deliverable forward (DF) or non-deliverable onshore CNY forward (NDF). The use of a DF is gaining popularity concomitant to the growth of offshore markets, as it avoids basis risk and has better liquidity than NDFs. As the market will naturally pivot towards where liquidity sits, the NDF market is expected to eventually exit.

Hedging strategy

According to Citi Treasury Diagnostics, there is an early indication of a shift towards bifurcated hedging practices between the Group of Ten (G10) and emerging market (EM) currency exposures. For G10 currencies, most of the corporates in the survey chose to hedge their currency exposure on a regular basis and use forwards as hedging instruments. The rationale behind the bifurcated EM hedging strategy include high hedging cost, poor liquidity, and weight of the EM currency denominating transaction flows, basis risks between the underlying onshore and offshore NDF.

CNY-CNH: Convergence or divergence?

The movements of the onshore-offshore (CNY-CNH) interest rate and FX rate is another indicator closely monitored by treasurers. In particular, market shocks often trigger speculation flows between the onshore and offshore markets. The current divergence of the CNY-CNH spot rate resulted from the People’s Bank of China’s (PBOC) new RMB-USD exchange rate fixing regime, which will probably be reduced in a few months’ time. In the long run, the rates are expected to converge given further liberalisation of two-way cross-border flows of RMB.

Globalising cash and liquidity management

Restrictions over cross-border movement of cash traditionally hampered companies’ ability to incorporate China into global liquidity management, which led to trapped cash or no access to group liquidity. This was particularly true when corporates tried to mobilise cyclical surplus cash across borders. Today, MNCs can link their domestic operating cash into cross-border liquidity management structures in both RMB and foreign currency, although different regulatory requirements must be adhered to. The two-way cross-border sweeping programs, SFTZ and nationwide, provide MNCs with the options to integrate China into global treasury management.

Advanced treasury structures

MNCs can now consider deploying advanced treasury structures globally, such as netting, IHBs and payments-on-behalf-of (POBO) to increase the efficiency of their cross-border treasury management. As with FX and liquidity management, these advanced structures were previously either not possible in China or limited.

Evolution of treasury centralisation

Due to China’s regulatory restrictions, many MNCs with sizeable operations in China have often maintained a dedicated China treasury team to manage country-related treasury issues. Operating in a critical, but restricted market, these China treasurers tend to have more autonomy on local pooling structures, bank selection, or entering into external financial deals, which often involve local or external funding, investment and on-shore hedging.

Recent regulatory relaxations have made it possible to centralise much of the in-country treasury responsibilities at the regional or global level. Treasurers can thus consider moving the remaining operational functions to a shared services centre (SSC) to enhance efficiency and transparency.

The RMB Journey Continues

With a top-down mandate, China’s determination to drive RMB internationalisation will continue.

The recent regulatory changes have enabled MNCs to integrate existing China practices into global treasury management, with many corporates realising enormous benefits in increased overall control, efficiency, and effectiveness.

To take full advantage of China’s evolving treasury landscape, maintaining a dialogue with a trusted banking partner is crucial to stay abreast of the latest regulatory developments. As RMB globalisation efforts accelerate and improvements in cross-border controls continue, tipping points for RMB invoicing will eventually emerge.

By Ann Lin Khoo and Li Yan

Ann Lin Khoo has been with Citi since 2013 and is currently the Head, Global RMB Solutions in Treasury and Trade Services, Hong Kong. Prior to joining Citi, Ann Lin has held roles as Senior Product Manager, Global RMB and Head of Liquidity Management Solutions, North Asia for JPMorgan’s Treasury Services division as well as Hong Kong Payments & Liquidity Product Manager in Payments & Cash Management, HSBC. Ann Lin has completed certifications from CertICM, CPA, Australia and a Bachelor of Business from Monash University, Australia.

Li Yan is currently the Greater China Head of Treasury Advisory Group at Citi and leads the effort for clients based in Greater China, with a focus on providing advisory on treasury practices and structures to support growth of client franchise in these markets. Prior to Citi, she spent 16 years at Ericsson, most recently in Sweden with Group Treasury and as Regional Treasurer in North East Asia and Greater China.  She has also worked as Pepsi’s Treasury Manager for Greater China and Japan for a number of years. She has a wide range of experiences in treasury, including liquidity management, supplier and customer financing, FX management, and treasury operation in both developed and emerging markets. She has a Masters in Finance from London Business School, and obtained qualifications as a China Public Accountant.

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