The Chinese government is committed to transforming the renminbi (RMB) into a leading global currency. While the goal is clear, the rate of progress depends on a delicate balancing act between simultaneous reforms of the capital account, the mechanisms for allocating capital and the severity of market volatility.
Already, there has been a procession of measures to internationalize the currency and benefit multinational corporations.
“The moves China is committed to are all really positive. It’s just a question of which of them happens first,” says Evan Goldstein, Global Head of Renminbi Solutions at Deutsche Bank. “You have to be careful which reform to go after and what the pace of reform will be, when you are most concerned about domestic employment, growth in GDP and the need to shift from an investment-based to a consumption-based economy.”
With high hopes for this dynamic currency, what opportunities exist today and what factors will influence the shape of things to come?
In China, multinationals have only recently been able to access sweep accounts, starting in the Shanghai Free Trade Zone (SFTZ) in February 2014, and nationwide since November 2014.
This has allowed corporates to free-up trapped cash and consolidate overnight onshore renminbi positions into a single-entity, two-way, cross-border sweep account offshore for integration into a firm’s liquidity pool.
“There is a real uptake for the sweeping mechanism,” says Goldstein. “Corporations have the ability to assess their onshore [China] strategies against their operational requirements. In particular, this means subsidiaries can now let money flow through to the parent corporation. It is a big change.”
Sweep accounts are part of a multi-pronged policy that also includes changes to funding and lending and establishing the ability to use offshore parent company guarantees onshore. “It means corporates can optimize and get the best overall funding they need, whether internally or through the market,” Goldstein explains.
Significant steps — CIPS
An important development for the RMB is the creation of the China International Payment System (CIPS), a cross-border interbank payments system equivalent to the Clearing House Interbank Payments System in the US. Phase-one rollout is due to take place in the final weeks of 2015, and will create a bridge between SWIFT instructions from qualified institutions directly through to CNAPS2 (China’s second-generation payment system). It also expands the window of operations to 20.30 Central Standard Time to take European operating hours into consideration.
Basically, the launch of CIPS will remove some of the challenges of cross-border payments associated with time zone coverage, payment routing and interoperability with the infrastructure of other currencies.
“It should increase payment efficiency,” says Goldstein. “At the moment, there is a manual break, as there are fields in CNAPS2 that are not in SWIFT instructions. Also, SWIFT is in English and CNAPS2 in Chinese — CIPS bridges that gap.”
Gaps may be bridged in a technical sense, but the further away you get from an on-the-ground presence in China, the harder it is to understand the reforms and benefit from the opportunities that could be created from change.
Deutsche Bank is one of the few foreign financial institutions licensed to be both a broker in the interbank bond market and settle related transactions. “A lot of what we do concerns keeping our clients informed and educating them about the detail of the rules,” says Goldstein.
There is uncertainty, for example, about the different interest rates used in setting onshore and offshore foreign exchange rates. Corporate treasurers will be particularly concerned about interest rates and how they are set.
“When you hear that you can earn up to 1.5 times [interest] on your deposits, is that real or not? Should you expect to earn that, or is something else in play?” asks Goldstein. “When people hear about convergence, they want to know exactly what it means and what mechanisms are used to establish rates.”
Local knowledge is also of paramount importance for corporates when considering the benefits of the various government-led initiatives, such as the free trade zones.
“A lot of business people are still trying to find out the benefits of not just the SFTZ but also the other zones that have been announced,” Goldstein says. “Do they need to be there or not? What, if anything, would they miss out on? How do they maximize the benefits for their business?”
Benefits for trade settlement
For those firms engaged in trade finance activity, the RMB brings multiple benefits. A key driver in the ongoing internationalization of the RMB is the use of the currency in trade settlement. In 2014, cross-border trade volumes rose by 42%, maintaining the momentum of the previous year.
Although selection of the RMB for a trade deal may carry an exchange rate risk, there is the potential for better pricing when transacting with a Chinese counterparty. Market observers suggest that Chinese exporters often add a buffer of as much as 5% to guard against unfavorable exchange rate movements.
If the parties involved in a cross-border transaction are willing to trade in RMB, then the Chinese party may offer a discount as the offshore counterparty will cover the exchange rate risk.
There are other advantages as the cost of hedging offshore can be lower than hedging onshore. Companies can also widen their supplier and customer bases to include Chinese companies which may previously have been inaccessible due to an unwillingness or inability to transact in a foreign currency.
“Both exporters and importers can derive significant benefits from RMB trade. For example, goods invoiced in RMB can help grow client bases in China given the preference for Chinese importers to pay in the currency. FX exposures and costs can be minimized and, importantly, supply chain costs can also be reduced through recycling RMB received from sales to fund onshore operations,” says Goldstein.
Likewise, paying for goods in RMB can broaden the supplier base, reduce supply chain costs and facilitate more favorable and transparent pricing of goods.
This growing market has given birth to a new range of trade solutions for the RMB, including import/export letters of credit, documentary collection and open account payments.
Furthermore, the roll-out of the Simplified RMB Cross-Border Payment Scheme in 2013 has resulted in a vastly more efficient RMB trade settlement regime. RMB payments can be processed prior to documentary verification to enhance straight-through-processing and further automate cross-border payments. This has also enabled companies to better integrate RMB into their Electronic Data Interchange for expedited payments processing and treasury management.
As the RMB has emerged as a treasury management currency, it has also enabled cost-savings, efficiency gains, better risk management and has also been the catalyst for enhanced access to China.
The onshore RMB is regulated, but recent relaxations have opened up greater possible financing structures and solutions for multinationals with operations in China. As a result, RMB adoption may allow an MNC’s FX management to be centralized in a regional or global center, along with more efficient payment and collection processes.
As well as streamlining operations, capital account liberalization can also deliver better risk management in FX hedging, opportunities around trade financing and financing opportunities through onshore and/or offshore related entities.
Already a number of solutions are in operation that can assist working capital management. RMB intra-group cross-border lending, which no longer requires People’s Bank of China approval, can be executed by banks with the capability to provide automated sweeping that enables straight-through-processing of cross-border RMB payments.
RMB cross-border payments/collection on behalf of, POBO/COBO offerings, enables corporates to use netting to centralize RMB payments and collections. The regulations around these services make it possible to nominate one entity within a group to transact payments and collections on behalf of all entities.
Although RMB adoption can bring a host of benefits, as always, the crucial issue is implementation. Initial implementation will necessitate changes to existing treasury management processes, operating procedures, accounting valuation and contractual arrangements for cross-border trade receivables and payables.
There is much to consider. Treasurers should determine if they need to re-negotiate sales terms or pricing with trade counterparties. They should also highlight which of their counterparties are likely to accept RMB and also the benefits of re-denominating in RMB.
Obviously, internal awareness and education is essential, ensuring that the rules and regulations pertaining to RMB are taken on board.
FX risks need to be identified, particularly around the differential between onshore and offshore rates. Also, in the absence of netting, how will intercompany receivables and payables be managed?
Accounting and reporting brings its own challenges — balance sheet implications, China Corporate Accounting Standards and determining booking rates. There are also tax issues, notably export tax rebates and value-added tax.
Treasurers will also have to decide where to set-up a regional treasury center for RMB payments and how it will affect the way their global treasury is structured.
Goldstein concludes that the RMB has moved center stage with many treasury operations and the importance of the currency will continue to grow: “As the internationalization of the RMB gathers pace, more and more instruments and solutions are likely to emerge and their usage more commonplace. This undoubtedly brings opportunities as well as challenges. It is therefore imperative that corporates with ambitions in China should partner with banks that have the credentials to ensure they are able to realize the potential of this still vibrant market.”
Global Head of Renminbi Solutions