Companies that do business in China, or compete for a share of the Chinese market’s growth, should seriously consider making the renminbi (RMB) an integral part of their cash management strategy. Use of RMB to settle transactions can not only improve a company’s leverage on prices with customers and suppliers, but can also reduce financial risks the company faces, improve the effectiveness of corporate investments, and deepen business relationships.
If these sound like bold claims, consider how far China has opened itself to the world in a short time. The nation’s rapid trade growth has been pulled forward by the twin locomotives of extraordinary domestic growth in China and increasingly transnational industrial assembly lines. Although the nation’s GDP growth forecast this year is the lowest in 11 years, China continues to grow much faster than many other economies.
Meanwhile, the Chinese government has been loosening controls on the renminbi to establish it as a global trade currency, an investment currency, and a reserve currency. In 2014, about 22 percent of China’s trade was settled in renminbi. HSBC expects that share to rise to more than 30 percent this year, and to 50 percent by 2020, as companies become increasingly aware of the potential benefits of invoicing and settling in the Chinese currency.
So, why should you jump on the renminbi bandwagon?
RMB can help businesses achieve more competitive pricing. The first reason to consider is that the combination of RMB trade settlement and foreign exchange hedging can bring companies considerable savings.
In the past, Chinese suppliers typically added to their quotes a buffer of between 1 percent and 3 percent in order to hedge against the risk that exchange rates might move unfavorably before the transaction settled. As the yuan trading band has gotten wider, the RMB has become more volatile, which further increases the need for risk management tools and, consequently, increases the hedging premium a foreign company has to pay its Chinese suppliers for transactions denominated in other currencies.
Thus, businesses that settle in renminbi may be able to get better prices on materials they purchase from Chinese suppliers. In fact, in a recent global survey by HSBC that explored the attitudes and use of RMB by decision-makers at international companies, 61 percent of respondents from companies on mainland China said that foreign firms doing business with China gain financial advantages by using RMB.
Improved access to new suppliers, new customers. In addition to improving a company’s leverage in pricing discussions, adopting the renminbi enables an overseas business to build strong relationships with a wider network of Chinese partners. The renminbi is convenient for Chinese counterparties, so importers who use it may open themselves up to a group of Chinese suppliers that was previously unavailable: Those that want the ease of using their own currency, or are reluctant to take on exposure to the U.S. dollar because their cost base is denominated in RMB.
What’s more, agreeing to do business in renminbi may pay a relationship dividend for foreign companies looking to sell into China. Adopting RMB can help secure market share as competitors jostle for position in one of the world’s fastest-growing consumer markets. Doing so also demonstrates that a foreign company has a strong commitment to the Chinese market. HSBC research predicts that the average Chinese worker’s income will increase sevenfold between now and 2050, from around to US$2,500 per year to around $18,000 per year. This projection should give some sense of the potential for growth that this market holds.
Improved cash management and lower cost of funds. Though the renminbi just began life as an international currency in 2009, its rapid development has been helped by a reduction in restrictions. Those that remain are focused on investment flows into and out of the capital account, rather than on trade.
But regulations are being relaxed on the capital side as well. By the end of 2014, RMB-settled direct investment had more than tripled since the end of 2012, rising to ¥328 billion, as multinationals recognized the benefits of centralizing their treasury operations offshore and using China’s currency for local capital injections. New developments in cash management regulations mean that investments in China can increasingly be treated the same as investments in any other market around the world. Obviously, this means companies can deploy funds more efficiently and conveniently.
One HSBC customer recently began to use renminbi to streamline cross-border payments and collections. Previously, the company conducted no business in RMB, which meant it had to settle each cross-border transaction on an individual basis, dealing directly with the counterparty. This approach increased transaction costs and currency risk and fragmented the company’s payment processes.
The company’s Chinese subsidiary shifted to denominating some cross-border payments and collections in RMB and settling them on a gross-in/gross-out, netting basis with the parent company’s overseas treasury center. Once the funds reach the treasury center, the company can settle directly with the counterparty in Europe, North America, or elsewhere through a payments factory or shared service center.
For the company, this approach manages foreign exchange exposure and optimizes liquidity management. For the Chinese government, stories like this set the precedent for other multinationals, which will ultimately help boost circulation of the renminbi outside mainland China. The benefits to both Chinese and foreign corporations in China are clear: They can potentially improve both the speed and efficiency of payment processes, and make it easier to centralize transaction processing in a payments hub or shared services center. In addition, the option to denominate transactions in renminbi makes it easier to predict payment timing more precisely, which enhances working capital management and cash flow forecasting.
The acceleration in China’s financial liberalization is having a profound impact on cash management. Treasury management processes that move renminbi into and out of mainland China are evolving quickly, albeit on a pilot-program basis or with specific eligibility criteria. Catalysts for this transition include the need to add excess renminbi balances to global corporate cash pools in places such as Hong Kong, Singapore, London, and Germany, as well as the need to deploy excess global liquidity within China, or to fund Chinese operations using money raised cheaply overseas.
The past year has shown the will of China to further internationalize and promote the offshore usage of RMB by widening the network of clearing centers in new regions such as Europe, North America, and the Middle East. We anticipate that this trend will continue—that China will further relax restrictions in the near future, via new pilot projects for renminbi cross-border sweeping and/or less stringent eligibility criteria. And the more China relaxes barriers to use of the RMB, the better multinationals are able to connect their China-based treasury function with regional and global treasury management structures.
Hong Kong has played a leading role in the global expansion of the renminbi, and is still the largest and best-developed offshore market. But now, as the pool of renminbi liquidity grows in locations outside of China, the need increases for an offshore clearing mechanism that can facilitate renminbi transactions. For example, Singapore and London are emerging offshore renminbi clearing centers which settle both cross-border RMB payments and domestic RMB-denominated financial activities. When the new renminbi international payment system—Cross-border Inter-bank Payment System (CIPS)—is rolled out in China later this year, it could link the clearing infrastructures in Singapore and London as well. CIPS is expected to improve efficiency and straight-through processing by following formatting rules similar to other international cross-border clearing systems, and it’s expected to cover major time zones through an extended operating window.
How Corporate Treasurers Contribute to RMB Liberalization
Financial liberalization is set to continue as the Chinese government moves forward with its dual objectives of establishing renminbi as a leading global currency and establishing cities such as Shanghai as major international financial centers by 2020. Regulators are not pursuing this strategy in isolation, however. The collaborative nature of pilot projects, and the subsequent extension of successfully piloted regulatory changes throughout China—impacting regulators, banks, and businesses—means that corporate treasurers have an important role to play in shaping financial liberalization and prioritizing new developments.
Treasurers need to stay up to date, not only by pursuing appropriate new opportunities to enhance their cash and liquidity position in China, but also by understanding which pilot projects may be relevant to their organization. By becoming involved in pilot projects, companies can help shape regulatory changes and gain an early-mover advantage.
In short, the evolution of the renminbi represents an opportunity for foreign companies to cut costs and improve financial flows. Ultimately, it may also be a way to start new business relationships and to tap a vast pool of aspiring customers. That’s no small achievement for a currency still new to the international stage.
Drew Douglas is senior executive vice president and head of payments and cash management for HSBC in North America.