Trapped cash is money generated overseas that cannot be moved across borders due to regulatory, tax or business process constraints. As such it is not easily available to repay debt or to finance the business. This restraint can be very frustrating when the company has expanded, diversified and built up legitimate overseas rewards but cannot get hold of the cash to make optimum use of it. Not only is it unfair punishment for success but, more importantly, it can have a pressing impact on cash and liquidity management if not managed effectively.
The barriers to repatriating cash from an overseas denominated currency, usually in emerging markets with less liquid currencies such as China, include:
- Banning the use of local currency offshore accounts.
- Controls on currency convertibility and transferability.
- Central bank reporting admin constraints and overheads.
- Restrictions on intercompany lending.
- Tax implications to repatriation.
In addition, it is harder to combine restricted markets into a global system, with local bank relationships a necessity so that oversight and pooling of funds becomes a problem.
The thirst to acquire ‘trapped cash’ has certainly increased of late. Business liquidity management is becoming more important as commercial banks move away from traditional lending, credit becomes scarcer and banks are forced by the regulators to hold more reserves. In response to the global economic situation, businesses have adapted and are attempting to improve cash flow processes to manage working capital.
Businesses looked upon emerging economies as key growth markets to offset flat home revenues in developed nations following the 2008 financial crisis. At the same time however, cash held overseas is now viewed with more trepidation. Foreign exchange (FX) volatility is creating a time pressure; for example in the first 10 weeks of 2013 the pound has tumbled against its currency peers. This is naturally creating a desire to take advantage of the availability of cheaper sterling, especially in currencies that have little or no forward exchange potential.
Getting Access to Cash
The first step when repatriating cash is to understand the barriers and solutions available for a particular scenario. A blanket model cannot be counted upon, as some specific countries and currencies will require a unique strategy.
This process may also identify good reasons to leave cash in-country, such as forming part of a plan to spread risk with diversified banking providers, or maintaining capital onshore to adhere to rules governing debt-to-equity (D/E) ratios, or simply that the process and cost is too much to warrant bringing the cash back.
In terms of solutions, one possible quick-win is to look to align the business so that payments can be made from the local currency, which nets off the accruing revenue with ongoing payments for the local operation. This strategy will also help to reduce the funding of an overseas subsidiary from the head office as well as removing the currency cost and risk of doing so.
Another option is to establish a US dollar (USD) account in the host country as emerging economies may have less restrictions on the use of USD when compared to their domestic currencies. It may also be possible to set up a USD account offshore, offering further flexibility for making and receiving payments.
The use of dividend payments is also an option. Accrued funds can be transferred to meet dividend payments. Normally there are restrictions on this, with some countries only allowing a single dividend payment a year. A potential solution is to coordinate the business through multiple entities with different year ends, to split and stagger payments.
In many cases, companies can also look to pool cash, so positive cash balances in one place can offset debts in another and may also utilise transfer pricing and intercompany loans. Not all of the above methods will always be possible and more complex solutions may be required depending on the country or currency involved.
It is also important to monitor on-going developments with particular countries and currencies from a regulatory standpoint. This will help to highlight challenges and potential openings for opportunities. Where currencies are not freely convertible on a forward contract, non- deliverable forwards (NDFs) can be utilised to hedge the exchange rate risk for a particular currency, especially if there is a risk of depreciation.
Changing Dynamics: China
If we take China as a case in point, we can see a clear example of regulatory dynamics changing. China has come out very recently to confirm that it is shifting its timetable approach to liberalising capital controls and is instead looking at a series of reforms intended to relax capital controls and give more freedom to invest offshore currency deposits on the mainland. Most offshore yuan is currently held in Hong Kong, with sizeable deposits increasing in London and Singapore.
Stable capital markets and capital flows will be essential to China’s economic development and it is hoped that its currency will be fully convertible by 2015. China’s efforts to promote the yuan as a settlement currency for cross-border trade in goods is part of the solution designed to make the currency more desirable globally. At the start of this month, China and its regulators authorised a pilot programme for individual firms to use surplus foreign exchange (FX) for business needs, which is helping reduce trapped cash and raising working capital efficiency.
Another interesting picture is presented by the situation in Venezuela, where the late president Hugo Chavez last month devalued the bolivar (VEF) for the fifth time in nine years pushing an overall 32% devaluation against the USD. What will be the impact of Chavez’s death on future policy and controls, and does his succession present an opportunity or spell more of the same?
Recently we are seeing debate on so-called ‘currency wars’ which emanates from the aggressive monetary policy direction in Japan. Will this push to devalue the currency without coming out and actually saying so – a strategy embraced by the Bank of England (BoE) – spread to a race for the bottom? Not everyone can have the weakest currency, but protectionism could escalate and intensify the issue of trapped cash. Emerging market currencies will be the victim of unwanted appreciation from major currency devaluations, potentially sparking government or central bank intervention to control this.
As such, understanding the regulatory environment for emerging market currencies should be a key priority for corporate treasurers alongside the changing landscape and the underlying process of getting funds back, where required. Potential regulatory changes will be influential for respective currencies in the coming year and longer-term, with this regulatory shift maturing over many decades and continuing to do so as cross-border activities increase.
While some countries will continue to move further along the path of regulatory tightening, there are others that are relaxing their regulatory frameworks. Another key focus in the coming year will be how emerging market currency liquidity develops. Regulators will face the twin challenge of minimising exchange rate volatility while keeping exchange rates liquid. How different authorities approach these two tasks will need careful monitoring and will no doubt provide opportunities and risks in various currencies.
Emerging markets are expected to continue to help drive global growth in the coming years. These newer markets will become an even greater focus for investment and currency development flowing from the ‘BRIC’ nations of Brazil, Russia, India and China. Knowing the ins and outs of developments in these currencies, and how to deal in them, is becoming increasingly important for investors and businesses across the world.
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