The internationalisation of China’s currency, the renminbi (RMB), is one of the most significant financial events this decade. It offers enormous opportunities for companies active in China to improve risk management and the efficiency of their treasury operations. However, as an evolving situation – and one driven by government rather than market forces – it is essential for corporate treasurers to keep a close eye on the latest developments, and to choose partners that combine local knowledge with global capabilities.
Historically, treasury management in China has been challenging for international companies. Currency controls have meant that RMB could not be used outside the country, so making payments to a parent company, for example, was a complex, time-consuming and costly business for treasuries. In addition, the inability to use RMB outside of China made foreign exchange (FX) exposure hard to manage for treasurers: while revenues were typically in US dollars (USD), local procurement, payroll, and tax payments, for instance, would be in RMB.
Since 2009, China has embarked on a gradual process of liberalisation that is welcome, but can be hard to understand. For example, the currency is generically known as the renminbi (RMB). However, as China has not fully liberalised its capital flows, RMB exists as two distinct trading currencies. While the onshore yuan (CNY – the only currency code recognised by SWIFT for payments) is determined by government policy, the offshore CNH, which is tradable in a handful of locations, including London, Hong Kong and Singapore, is determined by market demand and supply.
Figure 1: RMB as a World Payments and Trade Finance Currency.
Despite the remaining complexity in the international trading and financing arrangements for RMB, the currency’s increasing liberalisation has already solved some of the biggest challenges facing multinational corporations (MNCs) active in China. For example, it is now possible to achieve a common goal of corporate treasurers everywhere and incorporate China into a regional or global liquidity structure. As China grows ever more important to the global economy – remembering that it is set to become the world’s largest economy by 2020 according to Citi’s ‘Global Growth Generators’ report published in February 2011 – then it should be obvious that corporates cannot afford to ignore the opportunities presented by RMB internationalisation.
To better understand the potential benefits of invoicing and being paid in RMB, rather than USD, it is helpful to consider three scenarios and the advantages of using the currency in each instance.
Benefits for Multinationals with Operations in China
For MNCs with operations in China, using RMB offers an opportunity to enhance treasury efficiency. In the past, currency controls have prevented China from being part of regional or global structures for FX. Now it is possible to centralise FX into a treasury centre: this creates scale – lowering costs and making better use of expertise and sophisticated tools that may only be available at the central treasury – while delivering greater visibility and control of risk. It also allows the consolidation of positions to facilitate natural hedges, which reduce transaction volumes and lower costs further.
At the same time, by operating in RMB rather than an international currency, China MNC subsidiaries can be freed up to better manage their cash positions using domestic physical or notional pooling, which compares favourably to more complicated onshore foreign currency liquidity management structures.
From a liquidity management perspective, liberalisation allows RMB to be included in regional treasury or global liquidity structures to maximise returns. It also enables the currency to be integrated into a company’s inter-company netting structure – currently on a gross basis and subject to regulatory approvals – which can reduce FX requirements and improve inter-company settlement efficiency.
Companies seeking to fund their China operations have historically had to use USD, which creates FX exposure. Liberalisation makes it possible to access offshore RMB funding in the ‘dim sum’ bond market or the Hong Kong RMB loan and trade finance market. This eliminates FX exposure and also offers an opportunity to achieve a more attractive cost of funds.
Opportunities for MNCs with third-party trade flows in China
For MNCs with third-party trade flows with China, paying Chinese suppliers in RMB rather than an international currency may make it possible to negotiate improved trade terms because FX risk is eliminated for the Chinese exporter. Historically, many Chinese suppliers have included a buffer to accommodate FX fluctuations or have sought to renegotiate terms as the FX rate changed. Paying in RMB can therefore offer the multinational greater pricing transparency and enhance cash flow forecasting.
While FX risk is transferred to the MNC when they pay in RMB, they may be better placed to manage it than their Chinese suppliers, especially with expert treasury assistance. In addition, by paying in RMB MNCs gain potential access to a much wider range of suppliers and business opportunities in China, especially small and medium-sized enterprises (SMEs) which may naturally prefer to settle in their home currency.
Encouraging Trade Flows Between Emerging Markets
China is now the world’s most important economy from a trading perspective. According to a 3 December 2012 report by the ‘Associated Press’, it is already the largest trading partner for 124 countries compared to 76 for the US, and its significance is disproportionately greater within emerging markets. For the many emerging market companies that transact with China, making payments has historically been expensive and cumbersome.
For example, a Nigerian firm importing from China has to convert from naira (NGN) to USD to pay its Chinese exporter. The Chinese exporter then converts the USD into RMB for local payments and expenses. Renminbi liberalisation allows the transaction to be denominated in a currency of one of the parties, eliminating the use of USD as an intermediary currency and achieving a cost saving, which can be shared between the trade partners in the form of better terms.
Such companies can also now potentially access RMB financing, which offers lower costs than local currency funding in some emerging markets. Equally, by paying in RMB, emerging market companies – including MNC subsidiaries – gain an opportunity to access more clients and business opportunities in China, especially among smaller companies.
Figure 2: Comparisons of RMB Cross-border Options.
RMB trade settlement conducted in Hong Kong, which accounts for 80% of all renminbi-settled trade, reached RMB1.93 trillion in the first nine months of 2012, already exceeding the annual total of 20111. In London, spot RMB FX grew to an average daily volume of US$1.7 billion, a 150% increase compared to 2011, according to a ‘City of London RMB’ business report last year. However, trade settlement represents a smaller part of the total value of RMB payments compared to institutional flows.
The reasons for limited corporate use of RMB payments are varied. The evolution of RMB as an international currency has been incremental, often trailed by pilot projects and frequently applicable only to certain types of companies or those with operations in specific provinces. As such, it is often difficult to understand the potential benefits available to treasuries, or even whether they are achievable.
MNCs need time and resources to change their internal treasury processes, such as transfer pricing, logistics and IT systems, before they can re-invoice trade flows in RMB. For trade flows with third parties, time is also necessary to negotiate commercial terms. Furthermore, adoption of RMB in a company’s supply chain globally requires a corporate to rethink its risk management practices; something that must be carefully planned before being rolled out.
While none of these challenges should be underestimated, there are clear advantages to embracing the rise of RMB, and services now exist to support the currency’s integration into wider treasury management objectives.
Conclusion: Gain a Clear View
By working with a trusted advisor, whether it is a global bank with local capabilities or an established consultancy, it is possible for a corporate to get a clear view of the very real opportunities presented to treasuries by RMB liberalisation, and to benefit from this internationalisation.
The advisor, whoever it is, must have a local presence in and knowledge of China and be in constant dialogue with regulators if it is to offer MNCs the insight and tools they need to exploit RMB liberalisation. Remember that the rules are changing all the time, so being able to keep on top of them and to offer treasury solutions and advice that can take advantage of the liberalisation programme is the key benefit that a partner should be able to offer.
1 Source: Briefing to the Legislative Council Panel on Financial Affairs, Hong Kong Monetary Authority, 19 November 2012.
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