There is no doubt China offers an extremely attractive landscape for business. Its export market crossed the US$1.5 trillion mark in 2010. Even more encouragingly, its domestic market is flagged to expand to US$2 trillion later on in 2011.
Accordingly, there is a good chance that renminbi (RMB) trade settlements could make up almost 20% of China’s trade by 2015. This is all good news to multinational corporations (MNCs) or local corporations looking to take part in the China success story.
However, tightening monetary policy points towards a higher cost of funding, and trapped liquidity, meaning doing business in China is not always simple. Although access to liquidity is not generally an issue for large corporates, it is for China-based small and medium-sized enterprises (SMEs) in the procurement or distribution chain. Many do not have the experience, manpower or expertise to handle complex currency transactions, or handle RMB as an international currency.
Supply chain financing (SCF) offers a highly effective solution for these financing, documentation and foreign exchange (FX) challenges by integrating the corporation’s and bank’s expertise with a proven system that increases efficiency whilst simultaneously minimising risk and financing costs to all parties.
How SCF works
Once corporates, called ‘anchors’, have identified and named competent China suppliers or buyers, the bank can potentially offer them trade finance facilities. The key here is in evaluating the credit quality of the buyer and suppliers as strategic partners in the supply chain rather than on a standalone basis.
On the procurement side, the supplier can be financed by the bank either pre-shipment (against a purchase order (PO)) or post-shipment (against an invoice/bill of exchange) – but only on a deal agreed with the anchor.
On the distribution side, the bank establishes credit limits on the distributors or dealers (buyers), based on the anchor’s recommendation plus an internal credit evaluation. The bank then pays the anchor on invoice due dates and collects from the buyer on an extended due date – with a built-in ‘stop supply’ in case of a default.
A Real World Example
One good illustration of how this works is in the auto business. The Chinese motor vehicle market reached 18 million units in 2010 and estimates for 2011 indicate a 10-15% increase. This is good news for business but brings challenges in matching distribution to unfamiliar demand, as sales are increasingly in less well known, second-tier cities.
In this example, the corporate is an authorised importer/distributor of vehicles from overseas. It markets them to third party dealers (buyers) for sales nationwide in China. The SCF solution offers dealer financing based on prospective vehicle purchases from the anchor, with transactions conducted through an electronic channel.
This streamlines the overall process flow and the flow of funds, plus brings benefits to the corporate in the form of a de-risked balance sheet via accelerated cash flows from dealers, a significant saving in collection and cash management costs, and an overall reduction in financing costs.
Just as importantly, the arrangement strengthens the relationship between the corporate and buyer as more sales can be confirmed, through the incremental buyer facilities approved by the bank. For the buyer, it means a reduction in advance payments and provision of an assured source of financing.
SCF in International Trade
SCF also means both corporates and their trading partners can both rely on a rapidly closed transaction in the currency most suitable for them. With foreign currency movements out of China being highly regulated – US dollar payments outside China require State Administration of Foreign Exchange (SAFE) approval and documentation, adherence to foreign debt quota (FDQ) – there can be a heavy onus on supply chain SMEs to conform to these regulations, with a high degree of complexity handling unfamiliar documentation and regulations.
By using RMB to settle trade in the supply chain corporates can minimise costs for both imports and exports. This approach can be applied to purchasing from suppliers in China, as well as goods distributed to China dealers. It allows both payments and collections to be settled regularly on an RMB trade settlement basis, reducing the need for holding received funds in an export fund verification (EFV) account.
Specific regulations from China around RMB trade settlement pilot scheme only allow approved mainland designated enterprises (MDEs) in China to receive RMB from overseas. Even for Chinese importers paying RMB overseas, they should be located within the 20 pilot provinces under the scheme. So it is important that Chinese enterprises work with a bank that has the experience and understanding of the regulations to get the process conducted smoothly with the required documentations.
SCF and RMB Internationalisation Benefits
- Increased sales: access to liquidity for supply chain partners supports increased sales. Combined with the use of RMB, it can also widen overseas corporates’ client base in China since not all clients in China have access to foreign currency due to FDQ regulations.
- Increased control of FX and interest rate risk management: proactive risk management by corporate treasury teams to minimise costs and maximise hedges rather than by buyer/supplier trading partners.
- Improved cost control: SCF margins would normally be cheaper than standalone SME pricing. Further, invoicing in a supplier’s home currency enables more transparent pricing, wider supplier bases and improved supplier relationships and saves FX conversion costs.
- Simplified documentation: no requirement for exporters to use EFV account; no Hei Xiao documentation and simplified tax refund process.
Take the example of a client that outsources manufacturing and runs a regional sourcing centre in Hong Kong. This centre purchases from suppliers in China and re-distributes to dealers in China. The two key challenges it faced were foreign exchange (FX) costs and payment inefficiency. Previously, it settled cross-border payments and collections in US dollar even though manufacturing costs and some receivables from China distributors were in RMB. As fund movement out of China for foreign currencies is highly regulated, with significant documentation and foreign debt quota restrictions, this led to many inefficiencies.
The solution recommended was to minimise transaction costs by using RMB in its supply chain to settle trade for both imports to, and exports from, China. Using a two-weekly, two-way trade of both payments and collections, it reduced the number of FX transactions and removes the need for an ‘He Xiao’ reconciliation sheet, shortening the turnaround time by five to seven days.
Settling in RMB achieves an optimal working capital structure for the corporate and its trading partners, and concurrently maximises its natural FX hedge position.
Whilst the underlying trade is settled in RMB, the corporate has flexibility in financing in a different currency depending on the needs of buyers/suppliers, their hedging preference and their anticipation on interest rate and FX movement among a choice of currencies.
In short, SCF addresses many issues that a corporate and its supply chain partners face – assured liquidity in the supply chain, stimulating sales, partner loyalty, reduced transactional costs, improved control on FX and interest rate risks and simplified documentation.
But as with any innovative solution, the key is to choose a trusted and experienced partner.
The important areas any provider should offer are:
- Dedicated on-boarding team.
- Pan-China coverage and international footprint.
- Simplified credit assessment tools and appetite.
- Robust and proven portfolio risk monitoring.
- Online initiation, settlement and reporting.
- An understanding of evolving regulations.
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