The Rise of the Renminbi: Taking Advantage of Growth in the Chinese Trade Finance Market

In recent years China has taken several significant steps towards the internationalisation of the renminbi (RMB). In April 2009 the Chinese government launched a pilot scheme with Hong Kong, Macau and ASEAN countries, allowing selected enterprises to make cross-border trade settlements in RMB. Following its successful launch, the project was expanded considerably in July 2010 to include 20 Chinese provinces, allowing Chinese enterprises based in these pilot provinces to handle import and export business with trading partners worldwide. About 95% of the Chinese foreign trade is covered by enterprises located here. To claim a tax rebate for export business, enterprises need to be registered as ‘mainland designated enterprise’ (MDE). The scheme’s growing momentum is apparent in the dramatic increase in the number of these MDEs. From 350 registrations in 2009 more than 70,000 export enterprises have now registered themselves as MDE.

The demand for trade transactions to take place in RMB is expected to continue, driven by a progressively confident Chinese import market. As a consequence of the growth in imports, and therefore the increased importance of the Chinese market to exporters, Chinese companies are likely to find themselves in a much stronger position when it comes to dictating terms of trade – including the settlement currency. In this respect, there are two primary economic drivers behind Chinese companies favouring RMB.

The first of these is simply a question of currency availability. Despite the sustained rise of the economy, many local Chinese enterprises and consumers do not have access to either US dollars or euros. As a result smaller businesses unable or unwilling to conduct payments in RMB face the risk of being marginalised from progressively-broader swathes of China’s rapidly expanding economy.

Second, settling trade transactions in RMB means that the currency risk is transferred abroad from the Chinese importer to the foreign exporter. Instead of the Chinese buyer needing to source foreign currency to buy luxury cars, for example, it is the German auto-manufacturer taking payment in RMB that is subject to the volatile risks of the foreign exchange (FX) market when transferring its earnings back into its core accounts.

Benefits for Business

Yet, it is important that corporates see the rise of RMB as an incentive to pursuing trade interests. In fact, the potential for trading in China is broadened enormously by the adoption of the RMB as the settlement currency. It is necessary, however, to have the assistance of a trade bank with the required knowledge to provide help to corporates trading in RMB. This can be achieved, for instance, by ensuring that currency and non-payment risks are transferred from the trading entities to their banks, and that payment processes are made more reliable.

Many global banks are experienced practitioners at handling risk, and are happy to manage this process on behalf of their exporting and importing customers. The managing of FX risk is a typical example. Mechanisms such as non-deliverable forwards (NDFs), alongside other FX instruments, can be used to ensure that exporting and importing businesses are shielded from the worst effects of currency volatility by transferring the risk to the bank.

In the case of a NDF, this works by allowing banks to hedge against FX risks involving difficult-to-convert currencies. This is achieved by arranging a short-term contract with the counterparty (in this case a Chinese enterprise), in which both parties agree an exchange rate and a settlement date for the FX transaction. On the settlement date the difference between the previously agreed rate and the spot market rate is then paid to the appropriate party.

To revive the example of a hypothetical German car maker, the NDF provides a means for the company to repatriate its earnings by converting payment received in RMB into its home currency. Having received a payment of, for instance, RMB10m the auto-manufacturer can arrange an NDF with its bank to hedge against volatility in the FX market. An agreement might involve an exchange rate of RMB9.5 to the euro, maturing in six months time. This would equate to approximately €1.05m. If, in the circumstances, the strength of the euro increases over the six months, and the car-maker is only able to purchase €1m at the point of maturity, the NDF ensures its bank will provide the €50,000 difference.

Unfortunately, in relation to China, the reality of implementing the RMB as international currency is rather more complicated. Offshore and onshore liquidity are effectively separated into different currencies, focused on mainland (CNY) or Hong Kong (CNH) settled trades. Furthermore, the utilisation of CNY and possibilities of cross-border payments in CNY remain restricted and regulated, which demonstrates that the intricacies involved in trading with China require good advice from your bank

Dealing with Financial Risk

The primary concern when exporting to China, however, remains financial risk. This underlies the continued popularity of the letter of credit (LC). Unfortunately, while the country has made great strides in liberalising and improving its business practises, China retains its reputation as an environment in which conducting LC business needs profound knowledge and experience.

It is well known that documents under LCs are checked very strictly by Chinese banks. Minor discrepancies can cause rejection of documents, and consequently late payment, or even non-payment, of shipments under LCs. This makes the handling of LCs by the opening and confirming banks a vital issue – and one requiring detailed local knowledge and strong relationships with local banks.

Today, the checking of documents is often outsourced to processing centres in Asia or India, which reduces costs at the expense of the customer. However, the importance and complexity involved in ensuring that documents presented under LCs fully complying with the LC terms and conditions, mean that it is a distinct advantage for documents to be handled by competence centres close to the customer. This allows for advice to be given immediately and, if necessary, for the exchange or amendment of incorrect documents.

Strong correspondent banking relationships support handling and generating LC business. Certainly this is our route at Commerzbank where, in China, we have a network of partnerships with over 130 local banks. These partnerships are complemented by 21 documentary competence centres located close to Commerzbank’s ‘Mittelstand’ customer base in Germany. Furthermore, each of Commerzbank’s foreign branches and subsidiaries, in 19 countries, has their own documentary department for the handling of LCs of our customers abroad. As a result, Commerzbank is able to open, advise and confirm LCs in close conjunction with both its own clients, and locally via the branches or correspondent banks used by Chinese mid-tier customers themselves.1

Prospects for Growth

Indeed, the bank has recently expanded its services by opening RMB accounts for corporate customers in Germany, and by enabling them to undertake cross-border payments for trade related purposes and handle documentary business in RMB. This allows German clients to make or receive cross border payments in RMB directly from customers in China, also under letters of credit. Already an experienced partner for corporate customers in trade services with China, Commerzbank helps its clients to capitalise on new business opportunities in the Chinese market through this wide range of services.

And, for those companies able to penetrate the Chinese mainland, the potential consumer market is enormous. Research by McKinsey suggests that by 2025 China’s lower middle class will amount to 520 million people, with a total disposable income of RMB13.3 trillion.2 Signs of the growing appetite for luxury products in China are evident. Germany’s marquee car manufacturers, Audi, BMW, and Mercedes-Benz, for instance, saw individual car sales grow as high as 132% in 20103, with comparable gains evident in sales of other luxury products such as handbags and jewellery. In a report released in February, the independent equity broker CLSA predicted that China will account for 19% of global demand for luxuries by 2020.

Exporters that wish to pursue these opportunities, therefore, need to take the simple but necessary precautions of ensuring the smooth functioning of their trade finance processes. As a consequence, engaging international business and cash management expertise will become more important than ever.

1http://www.chinadaily.com.cn/bizchina/2011-03/01/content_12095196.htm

2https://www.mckinseyquarterly.com/The_value_of_Chinas_emerging_middle_class_1798

3http://online.wsj.com/article/SB10001424052748704557704575437563691162460.html

 

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