Lifting the Lid on Trapped Cash

While much has been made of new and upcoming challenges – particularly on the regulatory side – there is growing concern around a more historical challenge that is now staging a comeback; that of trapped cash. Referring to cash unintentionally ’trapped’ within a country, due to sudden or unexpected currency or capital movement restrictions, trapped cash is a risk most commonly faced by those dealing with unfamiliar counterparties and economies. As a result, the recent growth of trade with and between emerging markets makes it a renewed concern.

That said, it is not just new or developing markets where this risk exists. China, the world’s third largest economy by gross domestic product (GDP), is particularly notable for its restrictions on foreign currency capital, currency conversion and foreign-held current accounts. As China’s trade connections continue to grow, both internationally and regionally, such restrictions are likely to affect an increased number of corporate treasurers. Cyprus has also been a recent concern.

While trapped cash can be a short-term problem – such cash would not have become trapped in the first place if the restriction in question hadn’t been sudden or unexpected, and likely a temporary measure – it can naturally have a serious impact on working capital. For this reason corporate treasurers must ensure they are fully equipped to both monitor and mitigate such situations.

Freeing Trapped Funds

Once cash has become trapped, impacted by factors such as currency controls and capital movement restrictions, there are two main courses of action.

The first and most obvious is to explore different avenues of releasing the cash. This depends on the ability to accurately monitor the trapped cash; one option being to open a foreign currency account in the counterparty country in order to receive SWIFT messages and thereby gain greater visibility over the cash position.

Depending on the nature of the legal restrictions in place, it may then be possible to either open a foreign currency account elsewhere and transfer the money, or request that the receivable be paid in another currency altogether. This latter option remains a common feature in markets such as China and Brazil, where payments made in US dollars help both foreign and domestic trade counterparties to circumvent the currency restrictions in place. That said, it is also a solution that relies to an extent on corporates having a strong relationship with the transaction counterparty (on the buyer side), as the latter will be exposed to exchange rate risk and the transparency of the transaction may be impacted.

Making Cash Work

If releasing the trapped cash is not possible, then efforts must be made to put the cash to work locally. This second course of action is a must in today’s climate of constricted liquidity, where the optimisation of working capital is vital to success and cash cannot sit idle no matter where it is held.

For corporates with activities or ambitions – for example to open a branch or expand operations – in the country in question, then the obvious solution is to use the trapped cash as domestic working capital and invest it as capital expenditure. 

Where this is not a viable option other techniques are needed, with the most straightforward method of continuing to gain value out of trapped cash being to invest in money market funds (MMFs). In this way, revenue can be earned to offset the cost of keeping cash in one place; particularly pertinent at a time when negative interest rates are a growing possibility for many key markets.

A second solution is to leverage the financial capital in the framework of another transaction. In bilateral trade relationships – where the corporate both sells into and buys from the counterparty economy – trapped cash, currently owed as a receivable, can instead be used to settle accounts payables in that country.

The third option, again on the account payables side, is to leverage the cash as collateral. This involves an entity in the counterparty country issuing a guarantee on the corporate’s behalf, with the trapped funds used as the deposit in this financial guarantee. This guarantee can then be used as a negotiation tool for another transaction, for example as ‘X’ amount of basis points to be deducted off the final payment.

The Bigger Picture

It is not only corporate treasurers who are looking to avoid the issue of trapped cash. Take China, driven by cross-border trade yet wishing to retain tight controls over the domestic currency and balance sheet, which realises that restrictions on currencies and capital movement can hinder trade and thereby economic development. China’s solution has been to open an ‘offshore’ currency in the form of the Hong Kong (CNH) renminbi (RMB). By decoupling this offshore RMB (CNH) from its onshore yuan (CNY) counterpart, the economy has become more open to cross-border trade without having to relax its domestic exchange controls.

Ultimately, whatever specific measures are taken to circumvent or mitigate the problem of trapped cash, such solutions must be set against a backdrop of enhanced visibility, specialist market knowledge and broad currency capabilities. Certainly, visibility is crucial to being able to monitor cash positions and the first step to gaining greater control over its movement and use.

This need for enhanced visibility is equally applicable to the counterparty markets themselves, in that corporates must have a thorough understanding of their trade counterparty’s economic and regulatory environment if they are to (potentially) anticipate any developments and be better placed to mitigate their effects. To achieve this specialist local knowledge is needed; a tall demand in an era where trade is being conducted with a growing number of relatively unfamiliar markets.

Conclusion

Not only do corporates face myriad cross-border differences with regard to economic infrastructure, regulatory environments and preferred business practices, but any changes in these frameworks can be both complex and fast-moving; the RMB’s evolving status being a case in point. This places pressure on corporates’ local banking partners to provide such insight; something best achieved through partnership with a global bank with an international footprint.

Finally, in order to more ably resolve situations of trapped cash, corporates must ensure their bank can provide them with a full range of currency capabilities. These should include advanced electronic platforms able to enhance visibility over cash positions and more efficiently process payments, and the flexibility of working in a comprehensive spread of currencies including the RMB. Such capabilities help address the threat of trapped cash and enable corporates not only to adapt to today’s shifting international trade flows, but also to make the most of them.

43 views

Related reading