Q&A on Cash Management and Settlements in China
Cash management is one of the greatest challenges for corporate treasurers in China and they often find themselves restricted by regulations from the foreign exchange authority (SAFE) and the central bank (People’s Bank of China). gtnews puts questions on cash concentration, entrusted loans and the clearing system to Stephan Levieux, an expert based at HSBC’s Hong Kong office.
Q: What are companies able to do in terms of netting and pooling?
Levieux: There are two major obstacles to the implementation of a domestic netting structure, namely value added tax (VAT) and business tax. Companies are required to pay the exact amount for invoices subject to VAT. Where VAT does not apply, business tax needs to be paid on the underlying gross turnover. Both conditions make the implementation of a domestic netting structure impractical. There is to date no expectation of a possible relaxation of rules in this area.
The foreign currency control requirements, which include the need to provide supporting documents for each individual transaction, effectively prevent the implementation of a cross-border netting structure including Chinese entities. For foreign currency (current account) transactions, setting off inward and outward transactions contradicts China’s import and export reconciliation regulations, which require foreign invested enterprises to match each receipt or shipment of goods with funds paid or received on a standalone basis.
There have, however, been two notable exceptions to this rule. Two large foreign multinationals with large investments in China have secured approval from the State Administration for Foreign Exchange (SAFE) to operate a gross-in / gross-out mechanism.
This solution allows their Chinese subsidiaries to participate in their global netting structures while still meeting SAFE’s reporting requirements. The key benefit is the reduction of the remittance charges (ie companies only require one outward and one inward payment) as well as the consolidation of the corresponding foreign exchange requirements.
The management of a cash pool in China faces a number of regulatory obstacles and standard bank services such as notional pooling or cash concentration are not available. The use of notional pooling could be perceived as a breach of the prevailing interest rate regulations. Furthermore, cross-entity guarantees are not recognised in China, which effectively prevents the net presentment of the underlying balances on the banks’ balance sheets and makes notional pooling an uneconomical proposition for banks in China. The cash reserves, which banks need to maintain with the People’s Bank of China (PBOC), are another consideration preventing the use of notional pooling.
The use of cash concentration remains constrained by the restrictions on inter-company lending as stated in the regulations issued by the PBOC. However, the framework provided by entrusted loans and the ability to offer RMB overdraft facilities that banks have secured from the PBOC have enabled banks to offer services very close to a standard cash concentration service.
For multinationals preferring to make use of a foreign bank for this purpose, the challenge is to find a banking partner with a sufficient number of branches and renminbi licences to be able to offer a meaningful nationwide solution.
Having said that, there are other means to create a cash pool in China, particularly if one is in a position to leverage one’s corporate structure for that purpose. Multinationals with established holding companies in China now have the opportunity to centralise the sales and invoicing of group products and present a single face to customers. Doing so also enables companies with the right structure to manage and centralise their cash at the holding company level through leading and lagging techniques.
Q: What role do foreign banks play in netting and pooling for MNCs in China?
Levieux: If one defines liquidity management narrowly, the role of foreign banks will essentially be limited to the provision of automated solutions for the management of renminbi entrusted loans. While their system capabilities are likely to be superior to those of the Chinese banks, the quality of the proposition will also be dependent upon the foreign bank’s market reach, ie how many branches does the bank have in China and are these branches able to offer renminbi services?
If one considers the broader working capital cycle, particularly the order-to-cash cycle, the choice of the appropriate banking partner is critical. The fragmented nature of the payment infrastructure in China generates significant challenges with regard to the collection of funds and of the related payment details. Choosing the right banking partner is therefore paramount if one wants to minimise the impact that such challenges may create on the company’s collection processes, whether to accelerate the collection of proceeds or to facilitate the company’s accounts receivable reconciliation.
Generally, the sharing of information about best practice and market development is also important.
Q: What is the most common method of liquidity management in China?
Levieux: Within the short to medium term, entrusted loans are likely to remain the most popular solution for liquidity management in China, particularly as some banks have the capability to provide a fully automated solution.
There are also market indications that SAFE is considering issuing shortly a new regulation on foreign currency entrusted loans. When this is confirmed, the new regulation will represent a very significant development for liquidity management in China, as it appears that it will cover not only domestic structures, but also cross-border ones (from China to overseas), thereby providing the first opportunity to integrate surplus liquidity held in China into a regional or a global liquidity solution.
The new regulation will not however eliminate foreign exchange controls. Hence, corporations holding large surplus of renminbi liquidity will not have the opportunity to swap them into foreign currency for liquidity management purpose.
Q: Is there any sign of lifting the ban on inter-company loans?
Levieux: Some multinationals have tried to push for further relaxation of regulations with regards to inter-company lending. However, we do not expect any changes in that regard in the short term. Corporations will need to continue operating inter-company lending within the framework provided by entrusted loans, which requires a bank to act as intermediary between the underlying entities.
This has financial implications, particularly as entrusted loans are subject to business tax. However, this does not necessarily impact the efficiency of the structure, as some banks are now able to provide fully automated solutions operating essentially in the same way as a standard cash concentration service.
Q: What method of clearing is most commonly used in China and what plans are there for an automated system?
Levieux: China has a relatively complex payment infrastructure and various systems are commonly used. Each city has a paper based clearing house to handle company cheques or paper Giros (in-city priority payments). The PBOC is developing a nationwide RTGS system (CNAPS – China National Advanced Payment System), which has now been rolled out to 32 cities across China. However, the big four local banks (Agricultural Bank of China, Bank of China, China Construction Bank, and the Industrial and Commercial Bank of China) are also able to leverage their huge branch network and their own internal payment capabilities to offer nationwide services. These internal clearing mechanisms operate to clear renminbi fund transfers, cashier’s orders, demand drafts, etc.
Foreign banks such as HSBC, that are active in the provision of cash management services, are members of CNAPS and have a direct link to the system. However, they have also established alliances with the big four local banks, supported by nostro accounts and direct links, to be able to offer payment services through the local banks’ internal clearing systems.
The PBOC is also developing a low-value e-clearing system under CNAPS, but has not communicated a timeline for its launch yet.
Clearing mechanisms are also available to support domestic US dollar payments, while the Shenzhen Special Economic Zone also operates a Hong Kong dollar clearing system. The US dollar and Hong Kong dollar clearing systems operated in Shenzhen are also linked to the corresponding RTGS systems in Hong Kong.
The availability of funds varies significantly across the various clearing mechanisms and the corporate treasurer will need to understand the corresponding dynamic to assess the impact on the company’s working capital cycle. While payments through CNAPS are normally done on a real-time basis, fund transfers through the local banks’ internal systems require between 24 to 48 hours. The clearing of cheques will take 24 hours within the same city, but will take anywhere from five to 35 days for a cross-city item.