Cash Management: Mobilizing Your Money in China
Changes are on the horizon for managing liquidity in China, both internally and cross-border, and for the myriad of treasury managers of international companies who have to continually explain to their headquarters about why they have large pockets of cash sitting idle, these changes will be a welcome development.
The increasingly sophisticated use of entrustment loans (ELs) has resulted in a substantial improvement in the efficient use of local currency surplus funds in China.
ELs essentially allow inter-company financing activities, which otherwise would not be permitted under China’s legal framework. Banks are involved as agents only, facilitating the flow of funds between the participating entities and not taking any credit risk in the transaction.
While ELs in their original form can be seen as quite cumbersome (ie, each loan is a discrete transaction and must be renewed upon maturity), many banks have now come up with more flexible structures that allow groups to move funds between entities more conveniently than before. Such sweeping structures thus provide treasurers with a more efficient way in which to pool in-country surplus cash balances in order to offset any debit balances maintained at cash-deficit entities.
Where groups have large imbalances in cash positions between subsidiaries, the benefits are immediate and very significant, given China’s highly regulated interest rate environment. Borrowing costs are immediately reduced, while surplus cash entities can even enjoy a yield on their funds in excess of the regulated deposit rates offered by banks.
These physical sweeping solutions can be designed as daily zero balance, target balance, and threshold balance, which are commonly found in overseas sweeping structures. Cross-bank sweeping is also possible, permitting a true pan-China sweeping solution for corporates.
Despite the clear advantages to using ELs for managing liquidity in China, there are some notes of caution that should be considered:
Notional pooling is not yet possible, due to a number of reasons:
In the past, many multinational group companies have established a China Holding Company (CHC) that has received approval to engage in trading as a principle. The CHC can in turn be used to manage liquidity among the CHC’s subsidiaries.
In essence, the CHC acts as the sales agent for the operating subsidiaries to external buyers, with all subsidiaries selling their output to the CHC. In this manner, the CHC creates a de facto cash pool and can manage funds at the operating subsidiary level through leading and lagging inter-company trade payments.
Starting 1 September 2004, a new regulation governing Group Finance Companies has been promulgated by the China Banking Regulatory Commission (CBRC).
Briefly, CHCs are permitted to establish a group finance company to provide financial management to the CHC’s investees in China. Some of the key financial criteria that must be met in order to qualify for establishment of a group finance company include:
The permitted business scope for a group finance company is quite broad, and includes, but is not limited to:
Subject to CBRC approval, group finance companies can also issue bonds, underwrite corporate debt issuance for CHC investees, invest in marketable securities, and provide consumer/buyer financing for products manufactures by CHC investees.
This sounds exciting, especially considering that the registered capital requirements for the establishment of a group finance company has been reduced dramatically. However, the other financial criteria stipulated for the group as a whole are still onerous. It remains to be seen how popular the group finance company will become for multinationals operating in China.
Foreign currency entrustment loans are in principle permitted, although there is no clear pronouncement on how to practically arrange such loans from the regulators, namely the State Administration of Foreign Exchange (SAFE). Different banks may take a different approach to offering such foreign currency entrustment loans.
Furthermore, in July 2003 SAFE headquarters issued a draft discussion paper on foreign exchange regulatory changes that would permit in-country concentration of foreign currency for eligible international companies (i.e. both multinational corporates and large Chinese corporations). This paper contemplated both physical sweeping of a group’s foreign currency to a group concentration account held with the CHC (without using an entrustment loan), as well as notional pooling. Since the publication of this paper, there have been no substantive changes to the current regulatory environment to permit these activities, however.
Nonetheless, the banking community expects that SAFE will issue new regulations governing in-country physical sweeping of excess cash to a group concentration account, for subsequent movement cross border, before the end of 2004.
For many treasurers, there is a lot of pressure from group head office to move excess cash out of China. The options for achieving this are still quite limited, but some major regulatory changes affecting companies’ ability to move funds overseas are expected in the coming months.
Some of the permitted methods of moving funds overseas include:
Provided stipulated documentation is provided to a foreign exchange licensed bank, a corporate can freely pay dividends out of China. Furthermore, if a company is willing to undertake an interim audit of its accounts, dividends can be remitted out more than once a year.
During 2003, the regulations governing advance payments for imports were relaxed, allowing a China-based multinational who is importing from its group affiliates, to make advance payments for its imports without requiring the beneficiary’s bank to issue an advance payment guarantee. So long as there are legitimate trade transactions between the two parties, this is another channel to move out excess funds from China.
In certain circumstances, a capital reduction can be applied for. However, this is very rare and is usually associated with the restructuring or termination of a China-based operation.
In addition to these more common methods of moving funds offshore, the regulators are currently working on a scheme that would allow major multinational corporates that meet specific criteria to enter into cross-border entrustment loans with overseas group counterparties (see above), allowing the China-based operations to temporarily move excess funds outside China prior to formal declaration and payment of dividends. The regulations governing this cross-border activity should be published very soon, and there have been trial cases permitted by the regulators for certain high-profile multinational corporates already.
In conclusion, while moving money within and outside of China is still a challenge, the landscape is quickly changing. It is important not to assume anything in such an environment. What was previously considered not permitted, may in fact now be possible. In such a fluid environment, it is critically important to stay close to banking partners who have access to the latest developments from the regulators, in order to take immediate advantage of the rapidly relaxing controls on group liquidity management.