From the February 2012 issue of Treasury & Risk magazine

Paying Suppliers in RMB

Paying Chinese businesses in renminbi instead of dollars has advantages.

Companies in the U.S. and Europe have historically paid their Chinese suppliers in U.S. dollars. This arrangement has the advantage of convenience, as Yuri Polyakov, head of financial risk advisory for Lloyds Banking Group, outlines: “A lot of companies source things from China and they welcome the fact that they can pay in dollars instead of in renminbi—it makes their lives easier. Companies in the U.K. and Europe know how to deal with dollar flows and all they have to do is measure euro/dollar or sterling/dollar risk. For companies in the U.S. it’s even easier, as they don’t have to manage FX risk at all under this arrangement.”

However, since the launch of the renminbi cross-border trade settlement scheme in 2009, some companies have begun to realize that despite the convenience factor, paying Chinese suppliers in U.S. dollars comes with some fairly sizable disadvantages. First and foremost is the fact that suppliers are charging their overseas customers a premium for paying in U.S. dollars. “Depending on the customer, some are paying 2%, some 3%,” Polyakov says. “In contrast, when you look at the historical volatility of renminbi over the U.S. dollar, it’s below 0.5%—so paying a margin of 2% to 3% seems very excessive.” Other estimates suggest the premium could be as high as 5% to 8%.

In addition, when two parties transact in a currency that is not a base currency for either of them, it introduces a certain level of risk into the transaction. “If you’ve got a company in the U.K. buying from China in U.S. dollars, that means that both of them carry an exchange-rate risk,” says Edward Till, head of trade product for Europe at HSBC. “If you use one of the base currencies of the two entities, at least one party doesn’t have to do any hedging, so you’re taking some of the risk out of the system.”

Furthermore, if the Chinese currency were to move to a free-floating model, companies may find that they have no choice but to pay in renminbi. “Local suppliers will suddenly take on a huge risk, and the exchange rate will start to move,” says Polyakov. “There is nothing to suggest that they will continue to keep their agreement to bill in dollars at this point.” In other words, companies currently paying a premium to use U.S. dollars may not be gaining any protection if there’s a sudden change in the situation down the line.

To avoid having to make a significant transition in the future, there is an argument that companies could begin the process on their own terms by starting to move a limited number of their contracts over to renminbi billing. This would enable them to begin establishing the infrastructure and understanding the money flows and additional currency risks involved. Switching to renminbi payments also has advantages for Chinese suppliers, as they no longer need to hedge their currency risk.

Despite growing interest in this area, Till says relatively few companies in the U.K. have made the move since HSBC introduced renminbi payments via letters of credit a couple of months ago. “Having said that, a lot of contracts are negotiated on an annual basis, so there is a lag between the banks making it available and companies wanting to adopt it,” he adds. “Open account is harder to assess, but we’ve got a lot of companies with renminbi accounts open, and one assumes that part of the reason for this is that they are settling trade, whether export or import, on these terms.”

In some countries, more companies are taking the plunge. “In Asia, it’s a lot more common now,” Till says. “Last year we saw a big increase in intra-regional trade being denominated in renminbi. There is also a much higher uptake in Russia—it’s interesting that some of that emerging-market-to-emerging-market business is more likely to be changed than some of the more established trading corridors.”

In the U.S., where companies are already transacting in their home currency, switching to renminbi billing may not be quite as attractive, although the prospect of being able to reduce the cost of goods may still make it worth considering such a move.

For treasurers contemplating such a move, annual negotiations with suppliers would be a suitable opportunity to begin discussions about a possible move to renminbi billing. In the meantime, companies could pave the way by talking to their banking partners in order to gain an understanding of the new risks the company would incur under a renminbi billing arrangement and the infrastructure changes that would need to be put in place.

 

To read more about doing business in China, see Navigating the Turbulence Ahead.

 

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