When the Chinese authorities first promoted the renminbi (RMB) as a cross-border settlement currency in early 2009, many agreed it was the right direction to go in, but few at that time expected that its internationalisation would happen so quickly.
Now, four years later, the People’s Bank of China (PBOC) estimates that the RMB accounts for around 16% of China’s total import and export settlements. Moreover, the opening up of RMB capital inflows and outflows is happening earlier than expected, albeit still gradually and under the control of the government. Below is an explanation of how this internationalisation process started and has evolved, and how it is affecting the corporate world both inside and outside of China, with huge ramifications for treasurers and trade finance specialists.
Regulatory Evolution and Major RMB Milestones
So far, there has been solid progress every year in the evolution of RMB cross-border settlement since 2009. An overview of this history is provided below:
2009 – Controlled Liberalisation: In April 2009, the State Council in China launched a pilot RMB cross-border trade settlement scheme. Initially, only Shanghai and four cities in Guangdong province were included in the pilot, and Hong Kong was the only permitted overseas counterparty country. Soon after, the scheme was expanded to cover Macau, and all Association of Southeast Asian Nations (ASEAN) markets as counterparties. At that stage, RMB cross-border settlement was restricted to a small number of selected enterprises in a small number of selected cities for goods trade only. There was no real indication yet that the RMB was to be used as a mainstream settlement currency. Meanwhile in July that year, the Hong Kong Monetary Authority (HKMA) issued guidelines and a circular on conducting RMB business in Hong Kong. The nascent offshore RMB market started to form.
Figure 1: History of the Growth of RMB Deposits in Hong Kong.
Source: CEIC Data and ANZ.
2010 – A Year of Acceleration: In 2010, the PBOC announced the expansion of the RMB trade settlement programme to the rest of the world and locally to 18 other provinces and cities, in addition to the initial participants. The scope of the settlement programme was expanded to cover service trade and other current account transactions. Before the end of the year, the PBOC further expanded the number of Mainland Designated Enterprises (MDE) from 365 to 67,359. As only those exporters approved as MDEs could continue to enjoy tax rebates when converting US dollars (USD) to RMB, the MDE list expansion boosted the use of the RMB as a trading currency among many more exporters.
2011 – Removal of Remaining Restrictions on Current Accounts and Allowing RMB Foreign Direct Investment: In 2011, the liberalisation programme finally opened up to all Chinese cities and provinces following the visit of Vice Premier, Li Ke Qiang, to Hong Kong, where he pledged to support the further internationalisation of the RMB. This final step effectively removed the geographical restrictions for both trading counterparties in and outside mainland China. It effectively removed the hurdles for companies that wish to trade in RMB freely. Corporations now only need to take note of the administrative requirements of providing supporting documents to banks in China. In the same year, the PBOC announced its intention to allow Chinese entities to invest directly in overseas markets in RMB. A directive was also issued to provide guidance for foreign investors to apply for inward direct investment in RMB. Many more onshore banks were approved to provide RMB settlement and/or agent bank services.
2012 – More Experiments with Capital Accounts: In this year, regulation around RMB Non-Resident Accounts (NRA) was standardised. Companies which trade with China can follow a clear procedure to open their RMB NRA, and RMB funds in NRA can be converted to other currencies and moved out of China freely. More exciting still was the progress made on capital account. Firstly a special economic zone in Shenzhen called Qianhai was established to test more innovative liberalisation ideas. For example, banks in Hong Kong can lend RMB directly to corporate borrowers in Qianhai, and likely banks in Qianhai can provide RMB finance to Hong Kong. Secondly, PBOC in Shanghai approved several multinational corporations (MNCs) to repatriate their onshore RMB surplus by way of inter-company loans within a preset quota. It was a milestone ‘open-up’, albeit on a pilot basis, as it effectively addressed the ‘trapped cash’ problem which bedevilled many treasurers and has concerned many cash rich foreign companies operating in China for many years.
I predict there will be more relaxation on cross-border RMB capital flows in the next three years, as China aspires to achieve basic RMB convertibility.
RMB Internationalisation: Key Principles to Note
Opening of RMB Cross-border Settlement for Current Accounts: Current account activities for trade include goods or services, royalties and dividends, among others. Treasurers want insight into these activities and quick cash position assessments. Inward and outward current account payments can now be made in RMB without any restrictions, aiding treasury integration. However, to prove the payment is associated with a current account item, companies in China are still required by the PBOC to provide supporting documents (such as trade contracts, invoices and customs declaration forms) when remitting to an overseas beneficiary or receiving RMB from an overseas remitter. The internationalisation process is not, therefore, complete and treasurers and their finance partners still have to operate with certain restrictions.
The PBOC does not impose documentary requirements on any overseas beneficiaries or remitters, thus only the China counterparty is responsible for providing supporting proofs. However, regulators or commercial banks in overseas markets may still request companies to provide trade-related proofs for RMB payments into China as a precaution.
Trapped Cash and The Relaxation of RMB Cross-border Flow for Capital Accounts: There have been a few directives regulating RMB capital account flows over the years. However, in general, any RMB cross-border flow from a capital account is still subject to case-by-case approval involving a number of authorities. Typical capital account flows include, among other things, direct capital investment, mergers and acquisitions (M&A), and loans, either from or to China. The PBOC is presently formulating more policies and rules to open up the RMB capital account at a controlled pace.
In late 2012, PBOC started to allow a small number of multinational companies to repatriate RMB surplus by way of inter-company loan. This effectively allows global MNCs to include China in their global treasury pooling scheme and is considered as a major breakthrough in addressing the issues of ‘trapped cash’. The PBOC is likely to expand their approval to more companies going forward.
Figure 2: The History of Onshore and Offshore RMB Deposit Rates.
Source: CEIC Data and ANZ.
Sources of RMB for Companies Outside Mainland China: If a company wishes to pay its China supplier in RMB, the first step is to understand how to access RMB. Corporations that sell into China can receive RMB from their Chinese buyers. If firms cannot obtain RMB from trade settlement with Chinese counterparties, they can purchase RMB from banks in their local markets or banks in RMB offshore centres, such as Hong Kong, London, Singapore and so on. Banks outside mainland China or offshore RMB centres can also provide RMB to customers by receiving RMB services from banks in mainland China or banks in offshore RMB centres.
What Does it Mean to the Corporate World?
FX and Hedging Benefits to Companies in China: For China exporters whose costs and expenditures are in RMB, foreign exchange (FX) risk will be eliminated if they can receive RMB from overseas buyers. Likewise, China importers can also achieve a natural hedge if they can buy goods from overseas suppliers in RMB. Trading directly in RMB also relieves China exporters and importers from the tedious and daunting tasks of FX documentation and reconciliation – this can give companies that settle in RMB an advantage over their competitors because they are helping Chinese companies take advantage of these benefits. It also allows corporates to diversify their currency portfolios, which can be especially important since the RMB is performing quite strongly against other currencies at the moment.
FX Risk Implications for Companies Outside China: It appears that companies trading with China now have to take on board the FX risk from their Chinese counterparties by accepting RMB settlement, creating additional risk for companies that use USD as their trading currency. However, there is a strong consensus that the RMB will eventually become a fully convertible major international currency, easing this treasury concern. Thus, the earlier companies prepare for trading in RMB the better they can position themselves against their competitors. Treasuries that are willing to accept RMB risk earlier than their competitors are more likely to negotiate better trade terms.
There are other factors driving the increasing number of companies receiving and holding RMB, such as anticipation of appreciation and preparation for RMB expenditure and investment in the future. It makes sense for corporate treasurers to look at how and whether the RMB will form a key part of their company’s future business model. For example, the restructuring of entities in overseas markets to optimise currency management could yield significant benefits. For MNCs engaging in cross-border trade as intra-group transactions, the benefits could be even greater.
If an MNC buying goods or generating revenue in RMB converts to RMB trade with its China factory or China sales company, it will relieve its China subsidiaries from the burden of managing exchange rate risk onshore. Instead, this risk can be migrated to regional or global treasury centres with greater expertise and market tools for currency management. It also makes sense for an MNC to receive dividends in RMB if it has reinvestment plans for China. Even if it does not an offshore RMB market, such as Hong Kong, may offer better conversion rates. Global companies can also apply to PBOC for approval to sweep surplus RMB funds sitting in China into a regional or global cash pool, under the RMB cross-border inter-company loan pilot scheme.
In order to understand and take full advantage of the on-going RMB internationalisation programme, corporate treasurers should consider partnering with banks that have a strong understanding of the local Chinese market and a network and infrastructure to support international trade. RMB solutions need to be integrated with existing services – using the same accounts with no new forms and transparency on all accounts in online banking systems.
The increased momentum around the RMB currency is creating both opportunities and challenges for treasurers. Early preparation is vital for long-term success, as it is increasingly likely that RMB settlement will be a necessity, not a choice, in the near future as China continues to grow and grow.
There is an opportunity for corporate treasurers to take a strategic approach and outline a plan of action now, in order to realise long-term cost benefits. As currency risk increases and market volatility continues, understanding the potential operational challenges will be a crucial concern. Conversely, understanding the potential opportunities is also crucial, as there are first mover advantages available.
If the RMB becomes fully convertible then it will become one of the largest currencies in the world in terms of average daily turnover. RMB settlement could potentially impact those that do not trade with China, not just those that do, so treasurers need to be prepared.
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