Making the Most of the Chinese Yuan
The internationalisation of the Chinese yuan (CNY) began in earnest last year, with China sending a clear signal of its commitment to the long-term and sustainable internationalisation of CNY by expanding the scope of participation from 365 to 67,359 mainland designated enterprises. And 2010 saw the introduction of the offshore CNY deliverable market based in Hong Kong, which increased the attractiveness of CNY as a trade settlement currency.
The CNY trade settlement scheme and associated markets are fast moving. The regulatory framework is constantly being revised and updated to ensure use of the currency grows in a sustainable manner. Trading or investing in CNY is already providing value for international corporates. The opportunities available include improving efficiency, lowering foreign exchange (FX) costs and expanding operations – all ultimately improving bottom-line performance. However, some corporates remain hesitant to use CNY as a trade settlement currency because of a continuing perception of uncertainty over regulation.
For international corporates that are increasingly using CNY, the key is to be adaptable. This is the nascent stage of internationalisation and some uncertainty is inevitable, but entering the market now should confer significant competitive advantages in the long-term.
By pricing in CNY, corporates can drive higher sales and lower costs. By removing the FX risk from customers and through quicker payments, prices can be lowered – giving the seller a competitive advantage. Also, while corporates are taking on currency exposure, their liabilities can be reduced through effective liquidity management. Moreover, anticipated CNY appreciation will give international sellers increased earnings when converting back to their home currencies.
Corporate procurement will also change. Today, the majority of western retailers source a wide range of products from China – conducting their transactions in US dollars. Chinese suppliers build the cost of FX exposure into their pricing with little transparency. Once importers begin issuing purchase orders in CNY, however, they should be able to negotiate a lower price or longer payment terms by taking on the currency exposure themselves.
Nonetheless, there are restrictions that corporates should be aware of. For example, settlement in CNY involves a process of official documentation and declaration when trading with corporates in mainland China, although it is less than for trade conducted in foreign currencies. Cross-border CNY movement is generally limited to trade settlement and must be matched according to goods (or services) flow. A corporate cannot simply net their payments and receipts in their cross-border fund flows.
Another potential challenge is the quota on trade settlement conversion. The CNY8bn quota for 2010 was reached in October – earlier than expected – due to a surge in the volume of trade settlement and the practice of buying CNY required for settlements several months in advance. The good news is that the offshore CNY market in Hong Kong (CNH) was able to absorb the additional volume when the quota was reached and the Hong Kong Monetary Authority (HKMA) was able to tap its swap line with the People’s Bank of China (PBOC), demonstrating initial signs of the scheme’s scalability.
Greater flexibility has been introduced in 2011 with a CNY4bn quota for 1Q11, and the HKMA have promised to review this quota alongside the PBOC on a quarterly basis. The quota also requires conversions to be within a three-month period from the time cross-border trade settlements are made. The regulatory environment is clearly still in a stage of transition. Nonetheless, improvements are being made and corporates must remain aware and adaptable.
It is worth remembering that all regulation surrounding the CNY is written with sustainable long-term growth in mind, and some recent changes have created windows of opportunity for corporate treasurers. For instance, CNY can now be bought outside of mainland China and remitted or used offshore for settling trade transactions.
Potentially, CNY held off-shore (known as CNH) provides an opportunity to improve working capital management across the entire corporate structure. Effective liquidity management and hedging of currency exposure are the key issues, both of which can be partially solved by consolidating liquidity and FX management in one location via a re-invoicing centre in Hong Kong.
Hong Kong’s role is crucial to the internationalisation of the CNY with an existing infrastructure, continuous high level regulatory dialogue, deep open capital markets and a strong talent base with a high degree of familiarity with the mainland market.
For instance, pooling of CNH in Hong Kong has become easier due to a relaxation in regulations. It is now possible for CNH to be transferred between any two parties in Hong Kong. Corporate tax is also significantly lower there than in mainland China (16% versus 33%). This positive environment has led to a growing FX market centred in Hong Kong, with FX spot, forward and non-deliverable forwards. These factors – along with Hong Kong already being a major CNH trading base – make it the ideal location for corporates to establish their re-invoicing centres.
One viable example involves the setting up of a sourcing company. This is ideal for a corporate operating with domestic sales in China while also sourcing Chinese products for sale internationally. An offshore sourcing arm is set up in Hong Kong to purchase goods on behalf of both the mainland and international operations, with the mainland operation then purchasing inventory from the sourcing arm using CNY – thus allowing the sourcing arm to purchase goods with CNY in future and creating CNY and goods flow through a Hong Kong base. Funds raised from sales by mainland operations also go towards buying inventory for international operations, reducing the need for expensive currency conversion and CNY position hedging. It is also possible to set up a multi-currency cash pool, including CNY, using non-resident accounts to optimise interest.
However, there are issues corporates must examine before committing to this model. Import and export duties will need close consideration. Software infrastructure changes will also be required to gear systems towards operating with a new currency. In addition, the current need to match payment flow directly with goods flow for cross-border CNY payments might result in logistical issues – with each corporate needing to perform comprehensive individual assessments to form a full cost-benefit analysis.
The emergence of the CNH or ‘dim sum’ bond market in Hong Kong is a further boon to treasurers, allowing them to better manage their overall asset and liability exposure to CNY in general. For example, a company with no immediate trade-related need to hold CNY, but with a potential future CNY exposure, can immediately start to accumulate CNY by acquiring CNY-denominated assets. The same applies to the liability side with opportunities for companies to issue CNY-denominated debt. Indeed, several large corporates, including multinationals such as McDonald’s and Caterpillar, have issued CNH bonds in Hong Kong to a deep market of willing global investors. China Power’s recent issuance – a CNY800m (US$120m) five-year bond – was completed in December and oversubscribed by more than 10 times. Demand is high enough that Galaxy Entertainment Group was able to issue the first high-yield corporate bond sold in Hong Kong’s CNH market – a CNY1.38bn (US$207m) three-year bond with yields as at 4.625%. The issue was oversubscribed by 13 times. The potential for treasurers, asset managers and investors in this area is clear and serves as a strong indicator to the future health of the global CNY market.
Banks will no doubt play a key role in the expansion of the global market by advising corporates and providing them with the necessary financial instruments while liaising with regulators. Working alongside banks, the PBOC and HKMA laid the foundations of the CNH market in July 2010, when banks were allowed to bring forward contracts and other financial instruments key to hedging currency exposure to the Hong Kong market.
The products that have been developed in the CNH market are small-scale when compared to similar instruments denominated in other currencies, but they are varied. Each product designed by banks requires clearance from regulatory authorities, but clearance is usually forthcoming unless the product violates regulations already in place – most of which centre on cross-border trade.
The full potential of CNY will only be realised through banks and corporates working alongside regulators to produce creative and effective solutions that enable its use as a trade settlement currency. The CNY is clearly going to be an important global currency and indeed is already creating value for many corporates. It is just a question of each corporate solving the unique problems associated with it. Any corporate or bank that manages to be flexible and adaptive enough to do so will benefit from the competitive edge it will bring.